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?
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.”