Commodity stocks riding high, but for how long?

-- | 17/07/2020

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Glenn Freeman: I'm Glenn Freeman for Morningstar. And today, we're talking about mining stocks. And I'm joined today by one of our directors of our equity research team, Mat Hodge.

Mat, thank you very much for your time today.

Mathew Hodge: Pleasure.

Freeman: Mat, just recently, you've published a special report looking at each of the dozen or so mining companies that we cover. So, I want to ask you what are your general expectations just coming up to the reporting season and especially from the three big miners, the BHP, Rio Tinto and Fortescue?

Hodge: Yeah. So, obviously, anyone that's mining iron ore is going to do very well in this current reporting period like the price has been very positive this half. So, we'd expect Fortescue in particular to do very well but also Rio Tinto and to a lesser degree BHP. BHP has a bit of a headwind that the others don't in that it has exposure to metallurgical coal and also a bit of oil and gas as well and prices for those have been pretty depressed in the half. But yeah, I mean, the near-term outlook is very strong for those ones. Other commodities more of a mixed bag just depending on what they are – base metal price has been down a bit to an extent, (oil sands) has been a little bit soft and coal has been soft, so those coal-facing miners, the outlook is not so good there. But if we want to look a bit further into the future, then I think those kinds of conclusions look a bit different.

Freeman: Out of those three which – they are regarded as pretty expensive at current level. But which of those three is our preferred pick?

Hodge: Yeah, it'd still be BHP. It is around – we see more upside from current levels around oil and gas as those prices recover. Our energy team has not changed its long-term outlook. And the thing with oil and gas is those fields deplete naturally. So, it requires new investment to meet the same level of demand even if you don't have growth in demand. So, that requires new investment and you need a price at which that makes sense to do it. So, we still see upside from there and we obviously see upside in met coal from where it is now around $110 a ton.

Freeman: What is Morningstar's intrinsic view on, say, iron ore prices and coal prices?

Hodge: Yeah. So, near term, thermal coal and met coal is pretty weak. And the thing that's interesting with kind of thermal is the price in China is still pretty good. It's still kind of where we expected it to be maybe if you wind back 6 or 12 months ago. But because of the trade war China has decided to not take imports of certain commodities and try to be more self-sufficient and coal is one area where they can do that. I don't think that dislocation is going to last because there really is quite a bit difference between the China domestic price and the thermal coal price on the export market. So, we see upside there. But I mean, those stocks that are exposed to that have been pretty well hit. So, I think there's value there.

Iron ore – I mean, really, you had the tailings dam failure in early 2019 from Vale. Vale has still not recovered from that. They are still having issues with their tailings dam. Brazil has done a horrible job around coronavirus. And on top of that you had China which despite a pretty well-established infrastructure and plenty of housing has decided to stimulate its economy again and is likely to spend more money on fixed asset investment and its steel production has bounced back very quickly. So, you've had strong demand and weak supply, which is where we are at. Longer-term though, I think the kinds of returns that these miners are making out, just the iron ore miners, are phenomenal. I wouldn't expect those to last. I mean, to do so it would imply a (moat) that the price is way above the cost of production. And we note that a Chinese-led consortium recently won a bid to develop the Simandou deposit in Africa. While it's going to take a while for that to happen, that would mean that some Chinese-influenced companies will be producing meaningful iron ore on the global markets. So, I don't think extrapolating the status quo is sensible or likely.

Freeman: And to that point about the iron price, do you have a view on when the price may start to pull back to sort of more normalised levels?

Hodge: Yeah. Well, I guess, I'd expect that Vale to do better than they had and they've really just had more problems, particularly with coronavirus layering on. So, it looks like it's going to be another year of high prices. But I mean, it is very difficult to tell. It depends on what China does as well, right? They've continued to play the same game. But once that kind of stimulus rolls through, you get some production coming back from Vale, I think we might see some moderation in prices from here.

This report appeared on www.morningstar.com.au 2020 Morningstar Australasia Pty Limited

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