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The dragon’s tail
David McKay
Posted: Tue, 05 Jul 2005
[miningmx.com] -- “PROFITS have doubled for the second year in a row. Return on equity has increased nearly three-fold over the past two years, to 19% in 2004. Net operating cash flows almost doubled to US$41bn in 2004.” So reads the opening of a report by auditing firm PricewaterhouseCoopers in which it also tipped the world’s commodity boom to continue into 2006.
The question is how long can it last? Stephen Priestley, MD of JP Morgan Chase, expects the commodities boom will stick around longer than most expect. Managements that called the cycle correctly will continue to generate cash, with merger and acquisition activity likely to become an increasing feature in about 18 months time, Priestley says.
Companies such as BHP Billiton will continue to be aggressive, he says. That company in particular is likely to seek more exposure to counter-cyclical commodities, such as diamonds
and oil. The problem is that there aren’t many so-called mid-tier companies around – raising the expectation that mergers between big brothers, competition rules accepted, are possible.
Xstrata spokesman Marc Gonsalves says that the company is generating handsome cash and constantly examines all its corporate activity. Having stepped back from overpaying for WMC – it was out-bid by BHP Billiton – Xstrata is looking for new targets, he says. Speculation du jour is that Xstrata is lining up either Impala Platinum or Lonmin, if only it can be sure what the rand/US dollar exchange rate’s going to do.
Hugh Cameron, author of PricewaterhouseCooper’s report, says that an increase in the concentration of ownership will also help end the boom-bust cycle in which the resources industry often finds itself. “Improved management of the supply-demand cycle should overcome the severity of the ‘boom-and-bust’ phenomenon, which has historically led to capital destruction in the
industry.”
China is the driving force in minerals consumption. However, it’s worth noting that it’s seeking to own lines of supply. Its companies have spent $1,9bn since 2003 investing in offshore mining firms. There are also fears of a slowdown, with the seeds being planted next year.
Take the iron ore industry, which has shown massive price appreciation. Chinese iron ore imports increased 25% in first-quarter 2005. That’s 252m t on an annualised basis, or 40% of seaborne trade.
But Chris Lancaster, an analyst at RBC Capital Markets in Sydney, calculates that the massive market surplus for iron ore – the material that helps make steel – is expected to move into oversupply during 2006/2007. “As a result of a forecasted market oversupply from 2005 and beyond, we forecast iron ore prices to drop by 27% for lump and 24% for fines in the Japanese 2006 financial year.”
Mining equities normally run ahead of metals prices. Currently, the crisis in
Europe regarding the EU’s constitution is one factor keeping spirits high in the minerals industry. But even now, analysts observe some equities have run hard.
However, there are still pockets of value. The rand weakening has given Anglo American, Lonmin and some of SA’s gold counters momentum. Anglo’s decision to invest $150m in the privatisation of Chinese coal producer China Shenhua Energy has been warmly greeted, a decision that contrasts with its aggressive selling down of non-core assets.
Merrill Lynch says that a depreciation of the rand to US$1/R7 by year-end (it’s already weaker than the stockbroker’s current estimates) would be positive for Anglo. “That could result in an $372m (11%) increase in our headline earnings estimate in 2005,” says the broker’s mining analyst, Dave Hall.
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