The truth about the com­mod­ity sec­tor hurts

Was the com­mod­ity su­per-cy­cle from 2000 to 2010 ac­tu­ally just a ‘price up­swing’ as In­vestec Se­cu­ri­ties sug­gests?

Finweek English Edition - - THE WEEK | IN THE NEWS -

lookas one may, but it’s hard to find many glim­mers of hope in the com­mod­ity mar­ket and there­fore few point­ers for in­vestors. The best ad­vice is to steer clear of a sec­tor still in trauma, es­pe­cially as the tone of many the sell-side an­a­lyst notes is of the post-mortem va­ri­ety.

For in­stance, pick­ing through the flot­sam and jet­sam of what is a ma­jor com­mod­ity crash, In­vestec Se­cu­ri­ties pon­ders the view that the so-called su­per­cy­cle from 2000 to 2010 was in fact “... a price up­swing” driven by China’s in­dus­tri­al­i­sa­tion.

It may prove to be in hind­sight “... part of a nor­mal cy­cle al­beit one that hap­pened to be of un­usual mag­ni­tude and du­ra­tion”, the bank says. “The threat now fac­ing the in­dus­try is a pro­longed down-cy­cle caused by fall­ing in­dus­try costs and a pro­longed pe­riod of over­sup­ply, re­sult­ing in sus­tained weak­ness in com­mod­ity prices.”

The weak­ness has al­ready been fairly sus­tained.

Ac­cord­ing to Bar­clays Cap­i­tal, the past five years have been the cru­ellest on min­ing stocks since a slump in metal prices in 1966, nearly half a cen­tury ago. “Look­ing for­ward, it is hard to see what might pull the sec­tor out of its tail­spin,” it muses. “A de­mand shock seems un­likely given the state of China’s econ­omy.”

With things look­ing so grim, Bar­clays has down­graded its share earn­ings out­look for the world’s top four min­ing com­pa­nies by 28% on aver­age with An­glo Amer­i­can the hard­est hit at -46% fol­lowed by Rio Tinto (-32%), BHP Bil­li­ton (-31%) and Glen­core up slightly by 2%.

The up­pish­ness on Glen­core is partly re­lated to its re­sponse to investor fears that with $30bn in net debt, the com­pany was over-lever­aged at a time when it was best to be less ex­posed. It has since an­nounced plans to lower net debt by $10bn – a devel­op­ment that has seen pos­i­tive re­sponses from Deutsche Bank, which says that the com­pany’s debt re­duc­tion plans were “locked in” and op­er­a­tions “were hum­ming”.

One of the fac­tors An­glo is likely to be hard­est hit by is the poor out­look for iron ore, al­though it’s suf­fer­ing on this score is a shared one: ac­cord­ing to Bar­clays, the iron ore sec­tor is re­spon­si­ble for 63% of the en­tire min­ing sec­tor’s pre-tax earn­ings. Gold­man Sachs said in a re­cent re­port that Kumba Iron Ore, in which An­glo Amer­i­can has a 70% stake, could face a fur­ther bat­ter­ing even though the stock is some 76% weaker year-to-date (at the time of writ­ing). This is ow­ing to con­tin­ued op­er­a­tional is­sues at Kumba’s Sishen iron ore mine, which will only de­liver 31m tons in 2015 due to a lack of avail­able high-qual­ity ore. Kumba is also ex­pected to re­port higher costs as waste ton­nage in­creases to 230m tons from 200m tons.

Added to that, the world’s iron ore pro­duc­ers are con­tin­u­ally im­prov­ing their cost con­trols, which puts pres­sure on the higher cost pro­duc­ers, es­pe­cially as de­mand de­clines in China. The out­come is an­other year of cash burn for Kumba.

“Cash burn will lead to pres­sure on the bal­ance sheet,” says Gold­man Sachs. “We be­lieve that Kumba has lim­ited lev­ers left to com­bat fall­ing iron ore prices, and any re­struc­tur­ing would likely in­clude lay-offs, which are his­tor­i­cally chal­leng­ing in SA.”

Ra­zor blades, any­one?

“The threat now fac­ing the in­dus­try is a pro­longed down-cy­cle caused by fall­ing in­dus­try costs and a pro­longed pe­riod of over­sup­ply.”

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