January 16, 2019 / 4:08 AM / 6 months ago

Breakingviews - Miners can close the confidence gap in 2019

A worker checks a truck loaded with iron ore at the Fortescue Metals Group (FMG) Christmas Creek iron ore mine located south of Port Hedland in the Pilbara region of Western Australia, November 17, 2015. REUTERS/Jim Regan/File Photo

SINGAPORE (Reuters Breakingviews) - Miners are in position to close the confidence gap in 2019. One important indicator suggests equity investors are fretting about a Chinese slowdown and don’t trust cashed-up bosses at BHP, Rio Tinto and elsewhere to stay restrained. The pessimism is overdone.

    After a turbulent 2018, when high prices and record profit margins gave way to tumbling markets, apprehension is understandable. Chinese macroeconomic data has not been encouraging. Factory activity contracted in December for the first time in 19 months and car sales shrank last year for the first time since the 1990s.

    Even so, investors – who have kept miners at a discounted valuation for much of the past decade – may be pricing in too much pain.

    Take the value put on every dollar of future cash, a proxy for shareholder belief in the sustainability of money coming in and sensible outlays. While the overall market, as measured by the MSCI all-country world index, has cooled to nine times forward cash flow per share, the mining sector trades on average at just over five times.

    Miners spend to dig, of course. The valuation gap widened dramatically after a string of writedowns from around 2013. Those revealed metal men to be especially poor stewards of corporate cash. It has barely narrowed since, however, despite cost cuts, management changes, asset sales and billions returned to shareholders. Bernstein’s analysis of that disparity – the relative multiple – puts it at about one standard deviation below the average since mid-2015.

    There are two reasons change is warranted. One is that metal price estimates have been too negative. While growth has slowed, China’s policymakers have moved swiftly, and supply remains tight. Copper will hit $7,000 at the end of 2019, Goldman Sachs analysts reckon, from a current London Metal Exchange three-month delivery price of just under $6,000.

    The second is trust. Miners have mostly kept repeated promises over recent years to be more judicious. They will be tested this year with cash piles high and prices low, and can prove their prudence with sage deal-making.

    To return to historic discount levels relative to the broader market, mining share prices on aggregate would have to rise by some 36 percent, according to Bernstein’s analysis. That leaves ample room for improvement.


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