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Stock Watch: Mining sector

Tom Stevenson

Tom Stevenson - Investment Director

Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

One story has dominated the markets this week - the outbreak of coronavirus, or Covid-19 as it’s now better known.

Attention has shifted from health to economics as investors have moved on from worrying about the spread of the disease - it does seem to have been reasonably well contained in one province of China - to the broader impact on growth in the world’s second biggest economy.

Comments from companies like Apple in technology and Hyundai, Nissan and Jaguar Land Rover in car manufacture have shone the spotlight on industries with complex supply chains. 

If the initial hit was felt in sectors like tourism, hospitality and aviation, the longer-term damage looks like being in those businesses most severely disrupted by an extended New Year shut down. That has prevented factories getting back to work as quickly as expected.

Investors are scrutinising a whole new set of data - things like coal consumption and road traffic congestion - to try and get a real-time fix on what is actually happening on the ground in China. The worry is that, unlike in past outbreaks, we might not get a V-shaped rapid recovery from the expected first quarter slump in activity.

If the impact is more protracted than hoped for, then one sector that will be in the eye of the storm is mining. And, as it happens, this week and next is seeing a string of results announcements from commodities producers. It’s a good time to focus on BHP, Anglo American and Rio Tinto.

As the chart here shows, the last ten years have been an interesting time to be an investor in these three mining giants. Depending on your timing, you could have made excellent profits, lost a packet or, if you’d bought and held on a decade ago, moved broadly sideways.

Miners in focus

None

Five year performance

(%)
As at 19 Feb

2015-2016

2016-2017

2017-2018

2018-2019

2019-2020

BHP

-50.2

95.2

17.6

28.0

0.0

Anglo American

-62.4

208.0

32.2

18.5

12.1

Rio Tinto

-38.0

100.8

18.7

15.1

7.2

Past performance is not a reliable indicator of future returns.

Source: FE, as at 19.2.20, total returns in local currency

In this volatile sector, it really is all about timing, whatever we normally say to the contrary.

The reason for mining’s volatility is the long investment timescales. Miners have to spend heavily years ahead of when they will actually bring their copper, iron ore or nickel to the market. They have to place big bets, therefore, on what demand might be quite a long way into the future. Unsurprisingly they often get it wrong.

The big dip in share prices in 2015 reflected just such a mismatch between slowing demand in the world’s biggest consumer of commodities, China, and the investment that had already been made to meet higher demand than actually arrived.

For some of the companies involved, that period was described as a ‘near death experience.’

Things have looked up in the past five years and the companies are in much better shape, with stronger balance sheets and profits. Investors have been rewarded with rising dividends.

But this week, all the talk has been about Covid-19. On Tuesday, BHP’s newish boss Mike Henry warned that the full-year outlook was dependent on the virus’s impact being contained within the first quarter of 2020. If it drags on, he said we should expect forecasts to be revisited.

That may be nothing more than a statement of the obvious, but it highlights the risks involved for investors in the sector. And that’s even before you consider other factors like exposure to potentially toxic products like thermal coal (which BHP would like to exit at some point). 

In an investment world that is increasingly focused on environmental, social and governance issues the miners are right up there with oil and gas explorers as companies with plenty of questions to answer.

The flip side of these concerns is the hope that the Chinese authorities will move swiftly to stimulate their economy if it looks like Covid is undermining its long-term growth targets. With GDP forecasts for the first quarter falling daily, a stimulus package looks ever more likely.

And investors are being paid for the uncertainty too. With a dividend for the full year to June of a little over £1 a share, investors are looking at a yield of around 6% at today’s price. That will go some way to compensating for the demand concerns.

Anglo American’s results were unveiled on Thursday morning, so the market is still assessing them. 

Overall, investors were pleased with what they saw. Earnings before interest, tax, depreciation and amortisation - so-called EBITDA, and the figure most analysts watch - rose 9% to $10bn. That was about $100m more than expected.

As well as a 35% rise in average iron ore prices during 2019, Anglo also benefited from record high palladium prices. This is a metal used to scrub toxic gases in catalytic converters. Anglo is one of the world’s biggest producers and has benefited from a surge in the price after years of under-supply.

Now the spotlight is on the company’s proposed purchase of North York Moors fertiliser mine owner Sirius. Some investors in the target company are up in arms that Anglo seems to be buying the distressed assets on the cheap.

Anglo is not for the faint-hearted. Before the financial crisis, its shares traded as high as £35 each and they bottomed out at around £2.30 during the 2015 commodities slump. That’s the context in which the latest surge should be seen.

It’s worth noting, though, that even after rising nearly 10-fold in a few years the shares still trade on only 11 times earnings and offer a yield of more than 3%.

Looking ahead, next week’s commodity offering is Rio Tinto. Attention here will be very much focused on the company’s strength in iron ore which accounts for the lion’s share of profits. These have benefited strongly from the rising price of this metal, especially in the first half of last year.

High prices lead to strong cash flow which feeds through to a miner’s ability to pay a decent dividend to shareholders and this has been the case in recent years. As with BHP, the dividend yield for Rio is around 6%.

Investors in the mining sector should not expect a smooth ride. Share prices are volatile and the sector is controversial. The reward for that is a high income in an otherwise yield-hungry environment.

More on BHP
More on Anglo American
More on Rio Tinto

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.

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