Reporting Season: 9 Mining and Energy Stocks to Watch

Sharemarket bulls and bears have little in common beyond the desire to make money – yet both look to earnings season reports as potentially catalytic events.

It’s not a simple matter of good or bad numbers, instead share prices can soar or plummet according to how the numbers fare relative to market expectations.

In the coming week some of our largest companies are reporting interim and full-year results.  Santos (STO), BHP Billiton (BHP), Woodside Petroleum (WPL) and Fortescue Metals Group (FMG) are stepping up.  What should we expect?

Well, if last week is anything to go by the numbers may not be great. On Friday Rio Tinto announced a full year net loss for 2012 of almost $3 billion. There was a drop in adjusted earnings of 40% – down to $9.3 billion from last years $15.5 billion.  The loss was attributable to a $14.4 billion write down of some coal and aluminum assets as well as to cost factors. Dividend was lifted by 15%.

It could have been far worse had it not been for iron ore profits. Commonwealth Bank Global Markets Research analyst Andrew Hines said two-thirds of Rio’s asset base actually subtracted 26 per cent from its earnings.

‘Or, to put it another way, Rio could divest everything except for its iron ore operations in Australia and Canada, and its flagship copper assets at Escondida and Kennecott, and it would generate a higher profit, and at a substantially higher return,’ he wrote in a research note.

‘So the challenge for Rio and (chief executive) Sam Walsh is clear – the underperforming assets either have to be improved, divested or closed.’

Prior to the release, analysts were anticipating a drop in earnings for Rio – so the news was hardly surprising – yet the share price sank by almost 3% on the result.

Management announced a planned $5 billion cut in costs for 2014 and a reduction in capital expenditures on projects to $12 billion for 2013; down from the 2012 total of $17.4 billion.

The table below lists major companies reporting between 18 and 22 February complete with some valuation and performance measures:

Although BHP Billiton (BHP) is more diversified than Rio Tinto, expectations for the company are similar.  Both companies have suffered from lower commodity prices and the perception that Chinese demand for resources is slowing.  The outsized expenditures for expansion projects and rising operating costs mean added risk for investors in mining stocks.

BHP’s share price has recovered well since the dog days of 2012. Here is its one-year chart:

Analysts are also forecasting a reduced profit given the company was the first of our big miners to cut back on capital expansion.  What market participants need to hear are plans for additional cost reductions.  Major analysts do not see commodity prices rising high enough to ensure higher profitability in the coming year, so cost control is key.  BHP’s quarterly production report released in December of 2012 was positive.  None of the big name analysts are expecting negative surprises in the upcoming release, with an analyst at UBS hinting at the possibility of an upside surprise in forward guidance. Which means if the numbers come in short, the stock will be hit.

Fortescue Metals Group (FMG) had a tough 2012 but the low P/E and very attractive P/EG of 0.44 suggest the possibility of better days ahead.  The current analyst 2-year growth forecast calls for earnings increase of 28.2%.  Although still in negative territory year over year, FMG’s share price has recovered since the low point reached in September of 2012.  Here is the chart:

However, many are still wary of FMG.  In contrast to BHP, Fortescue’s quarterly production report fell short of some analyst estimates.  More troubling is the fact production costs rose and inexplicably, the company announced an increase in capital expenditures for expansion projects after having lowered them earlier in the year.  The company said it is now planning to increase 2013 capex to U$6.3 billion, up from the earlier forecast of U$4.6 billion released in September of 2012.  This is a company with gearing at 225.97% as of the most recent quarter.  Some might view this as playing Russian Roulette, where the bullet is falling iron ore prices later in 2013.

Woodside Petroleum (WPL), Santos Limited (STO), and Origin Energy (ORG) all have big stakes in Australian LNG projects.  Once viewed as a potential new resource boom, the outlook for LNG has fallen on hard times.  Cost overruns at all major projects are to blame, and now there is a possibility the glut of natural gas reserves in the US and to a lesser extent Canada will make their way to Asian ports as LNG.  There is talk of converting facilities built in the US to import LNG into export terminals.  So far, this is just talk but one company, Cheniere Energy (NYSE:LNG) has plans to build an export terminal in the state of Louisiana.

First to report will be Woodside with Full Year 2012 results released on Wednesday 20th February.  Like most resource and energy stocks, Woodside suffered in the first half of 2012 but has been on an upward slope of late.  Here is the company’s one year share price chart:

Woodside has done well with its first producing LNG facility Pluto.  However, the most recent quarterly production report saw oil production falling short.  What’s more, major analysts anticipate a drop in LNG pricing at Pluto as initial contracts expire.  Watch for management discussion of Pluto LNG pricing as well as plans for continued development of its next LNG project, Browse.  An analyst at Macquarie noted the lack of “insight into the Browse development” from the company.  Good news there could act as a positive catalyst for the stock price.

Origin Energy reports Half Year 2012 results on Thursday 21 February.  In theory the company should be attractive to both conservative and aggressive investors.  The extensive electricity generation in Australia provides a secure revenue stream through both retailing and wholesaling.  The company is also involved in the exploration and production of oil and natural gas.  As a major player in the massive joint venture Australia Pacific Liquefied Natural Gas project (APLNG), the company seemed poised to benefit from exploding Asian demand for cleaner fuel.

The project is somewhat unique in that it combines LNG processing and export facilities with coal seam gas operations to provide feedstock, or gas to be liquefied.  As has been the case with all LNG projects, cost overruns and production delays send the partnering companies scurrying about looking for additional funding.  According to an analyst at JP Morgan, the key to the short term share price movement will be news on Origin’s plans to sell 7.5% of its stake in the APLNG project to generate needed funding.  Negative news and perhaps even no news at all about this deal in the upcoming earnings release could send the share price tumbling.  Here is Origin’s one year price chart:

Santos Limited is yet another of Australia’s oil and gas companies that bet big on the future of LNG.  Faced with declining oil reserves the company first set about acquiring coal seam gas assets.  Now it has a 13.5% stake in the Papua New Guinea LNG project, partnering with Exxon Mobil, Oil Search Limited (OSH), and Nippon Oil.  At 30% interest, Santos has the largest share of another project looking to use coal seam gas to supply LNG processing facilities, the Gladstone Liquefied Natural Gas project.

The PNG project is reportedly 70% complete and expected to become operational in 2014 while Gladstone is 45% complete and scheduled to begin shipping in 2015.  In July of 2012 Santos increased its estimated completion costs for Gladstone to U$18.5 billion, up from 16 billion.  The company refused to call this increase a cost overrun according to an article in the Mining Weekly online.  A 14 February article in the online edition of the Wall Street cites an analyst who claims that GLNG partner Kogas of South Korea is considering selling part of its stake in the project.  The article goes on to say analysts expect more cost overruns before the project is complete.

The company’s share price is still down 9% year on year, although recovering from a year low reached shortly after the announcement of the increase in the cost of GLNG.  A broker at Citi feels “the market is being far too pessimistic about GLNG project delivery.”  The broker goes on to speculate that Santos may have some surprises in store regarding “increased reserves, faster ramp-ups, and improved cost reductions.”  Watch for all those issues in the upcoming release.  Here is a one year chart for Santos:

Monadelphous Group (MND) offers a wide variety of services to the resources, energy, and infrastructure sectors.  Shareholders have benefited handsomely from the company’s ride on the resources and energy boom of the last ten years, with total shareholder return over the decade of 48.9%.  The five year return was 24.2% and the one year return was 22.2%.  Here is the company’s impressive ten year share price performance chart:

Major analysts seem to think the party is over.  The company has a 2-year analyst earnings growth forecast of 8.2%.  On 1st February 2013 an analyst at Citi downgraded the stock to SELL from NEUTRAL with the opinion share market participants should no longer expect “double digit earnings growth.”

The potential problem is the reduction in capital expenditures in expansion projects across the board in the major sectors Monadelphous serves.  Watch for management commentary on this in the report.

A one year share price chart for embattled Australian steelmakers BlueScope Steel (ASL) and the reincarnation of OneSteel, Arrium Ltd (ARI), seems to indicate many share market participants didn’t get the memo about the death of the Australian steel industry.  Here is the surprising chart:

Both companies are up 60% despite less than fully bullish analyst opinion on the success of their re-inventing themselves.  Arrium rejected a takeover bid from South Korean steel titan, Posco, in 2012.  Perhaps that explains the run-up, but this is a company logging $2.4 billion in debt at the Full Year end of 2012 in June, against net operating cash flow of $470.1 million and net profit of $57.1 million.

In a recommendation from 12th February, an analyst at Credit Suisse pointed to what the market needs to hear in the upcoming earnings release – better debt management from ARI’s board, starting with cutting back the company’s dividend.

Deutsche Bank has a BUY rating on BlueScope Steel as of 01 February 2013.  The broker cites recent increases in the price of steel in early 2013.  That coupled with rising iron ore prices makes the broker think BSL could actually finish FY 2013 without another loss, breaking even at best.

A broker at Morningstar reports company management expects a small loss for its interim result to be released on 18 February.  In the company’s words, the loss will be “approaching breakeven.”  Watch for that.

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