IT’S perhaps a sign of the confused state of the mining market that two prominent brokerages don’t agree on the meaning of the recovery in mining equities during the first quarter which saw Anglo American and Glencore gain 25% and 66% respectively.
In a note wittily titled, ‘We interrupt this rally to bring you … fundamentals’, Deutsche Bank said the re-rating in mining shares this year reflected a rotation by investors into sectors that benefited from economic turns such as the weaker dollar.
“The rally to date reflects a rotation into sector benefiting from a weaker US dollar, Chinese stimulus and the oil price rebound more than it reflects the slowly improving fundamentals – and we think each of these positives is now price in,” it said. The note was dated March 22.
Paul Gait, an analyst for Bernstein, however, is more positive. Pointing to improvements in the Chinese property market, and holding the view that 2015 was China’s hard landing – not a ‘new normal’ – he believes the industry is now in the early stages of a recovery.
“As such, the decline in metal demand seen in 2015 was not part of the “new normal” but was rather the consequence of deliberate policy tightening designed to eliminate some of the excesses of previous policy choices,” said Gait.
Supporting his contention that China’s property market is recovering, Gait says that growth in land purchased for construction has rebounded to its highest level since the start of 2015. “Area under construction growth has increased to the highest level since April 2015, and floor space of new starts growth has turned (strongly) positive for the first time since 2013,” he said.
There is agreement, however, that the mining sector is generally in a much better space than a year ago, largely through its own ‘self-help’ measures involving cost cutting and balance sheet adjustments.
The price recovery in the first quarter of most metals, as well as producer currency weakness – such as the 25% decline in the value of the rand against the dollar in the past year – has significantly boosted free cash flow across the sector. (The rand has strengthened against the dollar this year but only because the currency could an extraordinary knock in December whilst President Jacob Zuma reshuffled his finance ministers).
“17 of the 19 companies under our coverage are now producing free cash flow after dividends in 2017,” said Deutsche Bank. “Free cash flow yields average 10% for the big four diversified miners, and 8.4% for the whole sector next year,” it said. “Gearing is also reducing: we forecast a drop from 26% in 2015 to 22% in 2016 and 16% in 2017,” it added.
