The Rudd government’s plans to impose a 40 percent resource rent tax (RRT) on ‘super’ mining profits – similar to that incurred by energy stocks – won’t of itself impact commodity prices. But according to RBS Morgans analyst Roger Leaning, it could have a major impact on where commodities, notably iron ore are sourced globally.
He says the punishment felt by share prices across the sector, especially from BHP and Rio Tinto – which fell by over 5 percent and 7 percent respectively following the RRT announcement – reflects heightened sovereign risk now associated with investing in Australia’s mining assets.
Based on Leaning’s estimates, an RRT could impact on the NPV of mine stocks by between 7 percent and 15 percent. However, until there is greater clarity on myriad deductions and the all-important ‘taxing-point’ – he says the impact of any RRT remains speculative at best.
“The RRT appears to penalise higher quality and more efficient mine producers which may acquire mines with marginal operations to offset their more profitable ones,” says Leaning. “The RRT could also open the door for China to be an alternative source of funding as investors look for opportunities beyond Australia.”
Despite the market’s flat-lined near-term price outlook for gold, oil and most base metals, accelerated global construction activity and supply constraints make iron ore, copper, zircon and coal standout commodities. Much of this upside is wired to China which now depends on imports for over 60 percent of its zircon, and iron ore alone. It also imports between 35-60 percent of nickel and refined copper consumption.
Growing demand for steel production – up 24.2 percent on February 2009 as construction activity accelerates worldwide – is also supporting higher mid to long-term prices.
There is lingering uncertainty over iron ore and metallurgical coal prices once annually negotiated fixed contracts revert to quarterly based system later this year. But Goldman Sachs JBWere expects second quarter 2010 to mark the peak of iron ore’s price cycle (at US$170/t), with US$150/t forecast for calendar year 2011.
With the seaborne market for hard coking coal expected to remain structurally tight for at least the next two years, Goldman’s expects hard coking coal prices to average US$250/t through 2H10 and US$225/t for 2011 – 34 percent above its previous forecasts.
But if initial ‘reference prices’ – indicated by settlements with Japanese and Korean steel mills – are any proxy, Wilson HTM expects the next round of negotiations to deliver a tidy 87-90 percent upside to iron ore prices – with coking coal prices expected to jump by a corresponding 50 percent.
Decoupling copper from the market’s ‘ho hum’ sentiment towards other base metals is greater depletion of inventories and return to deficit, with stock-piles starting to come off. According to Andrew Muir mining analyst with Hartleys, what makes the medium to long-term outlook for copper even more favourable – despite its 70 percent price jump in a year – is the limited potential of new mines coming on-line any time soon.
Admittedly, there’s nothing to suggest a major downside for any commodity prices. But Muir says some commodities look decidedly more exposed to correction having run hard over 2008-2009 – further accentuated by increased production costs. According to Wilson’s, nickel is most in danger of a correction later this year. By comparison, zircon prices have increased by US$20/t for 2010, and then US$50/t for following years, as extra capacity is needed to meet growing demand.
Recovering demand, still well below pre-GFC levels is expected to belie the biggest fall in copper prices since rally early February. Goldman’s expects the price for the ‘ductile metal’ to climb from a projected average of US$3.52 in 2010 to an average US$3.75 in 2011.
So which stocks are expected to benefit most from projected price gains? Muir expects iron ore stocks with the right ‘all-important’ infrastructure solution to be stand-out beneficiaries, and cites Atlas Iron (AGO) as a prime example. Based on its robust growth profile, he currently has Atlas trading on a 67 percent discount to its 12-month price target of $4.50.
With direct exposures to increasing steel demand through iron ore sales growth to Chinese steel mills, Atlas has sufficient port capacity to meet its export needs up to 12 Mtpa by 2012 – three times the levels the Pardoo DSO project is currently ramping-up to produce. It’s understood Atlas will use proceeds from a planned $143 million capital-raising to advance numerous pipeline projects, including mining commencement at its Wodgina iron ore project in the second quarter of calendar 2010.
Meantime, Goldman’s long-term price increases for all coal types had a significant impact on its coal stock and diversified miner valuations. Based on projected price increases, the broker has revised earnings per share (EPS) 2010 forecasts for BHP Billiton (BHP) and Rio Tinto (RIO) up 5.8 percent, and 25.5 percent; and 24.5 percent and 40.4 percent respectively in 2011.
The strength of the near-term price increases in the iron ore stocks also resulted in far greater increases to the broker’s EPS forecasts, especially pure-play stocks. Goldman’s is forecasting 2011 EPS increases for Atlas, Mount Gibson Iron (MGX), Murchison Metals (MMX), Macarthur (MCC) and Centennial Coal (CEY) of 84.6 percent, 80.8 percent, 311.8 percent, 49.8 percent, and 33.0 percent respectively.
According to Wilson’s, Macarthur Coal provides the best leverage to a recovering steel market through low volatile pulverized coal injection coal (LVPCI) coal demand. Assuming the merger with GCL proceeds, Wilson’s have a target price of $17.51, and on a stand-alone basis – including CITIC but neither Noble-related Middlemount nor GCL acquisitions – of $16.83. “On either basis, the offer by Peabody ($14/share) markedly undervalues Macarthur – with upside to our target price of $17.51 of 22 percent,” says Wilson HTM.
With a 26 percent upside to its target price of $5.60, Wilson’s also has a buy recommendation on major supplier of thermal coal to Australian domestic and overseas power stations, Centennial Coal (CEY). Based on robust demand for electrical power, Wilson’s says Centennial is far less sensitive to economic conditions than metallurgical coal. “Centennial is continuing its program of stgeloping export load-out facilities at its western and central coast mines to facilitate an increased proportion of export sales and increased margins over the next 3-4 years,” says Wilson HTM.
On the copper front, based on share price discounts to its 12-month targets of 42 percent, 27 percent, and 43 percent Goldman’s has buys on PanAust (PNA), Equinox Minerals (EQN), and OZ Minerals (OZL) respectively.
With an upside to the target of 48 percent, one of Wilson’s favoured base metal stocks offering good exposure to copper’s upside is Kagara (KZL). The broker likes Kagara’s ‘midpoint level’ cash costs on its exposure to copper and zinc concentrates – through its operating mines and concentrators in north Queensland – that currently offer good margins at existing commodity prices.
The immediate demand outlook for mineral sands and moderate to
low zircon inventories also bodes well for Iluka Resources (ILU) – which experienced 80 percent of its zircon sales in the December half-year as ordering resumed. Based on certainty over near-term demand, cash flow and zircon price increases, Wilson’s expects Iluka to out-performance in the short-term. With an upside to its target price ($5.71) of 22 percent, the stock also looks significantly undervalued from a long term perspective.
|Company||Code||Share Price||Target Price||Share price discount to target|
|Mount Gibson Iron||MGX|