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BlackRock sees good year for commodity stocks
VARIOUS signs are pointing to commodity stocks doing better this year, said asset manager BlackRock's global head of commodities Evy Hambro.
The sector might have bottomed out last June, he said. Now, companies are being managed better, free cashflows are improving, dividend yields are more attractive and supply shortages might emerge in the next few years.
"The sector is always cyclical . . . companies make lots of money, take the money and invest in new mines, oversupply the market, prices go down, they stop spending, prices pick up again," he said in a media briefing yesterday. "Right now, it's very clear to us that the cycle is starting to form a bottom . . . investors are starting to rotate back."
Mr Hambro is chief investment officer of BlackRock's natural resources equity team and is in town for client meetings. He is overweight on copper producers. The World Mining Fund he runs, for example, is 21 per cent exposed to copper.
Commodity companies are now more focused on earnings instead of growth, he said. "Companies are behaving better, they are more disciplined in allocating capital, and no longer building big new mines at the same speed as they were in the past."
The new focus comes after a slew of management changes. Resources giants such as BHP Billiton, Rio Tinto and Anglo American all changed their chief executive officers in 2013. Many other mining CEOs have also stepped down in the past two years.
Shareholders had been unhappy over the costly mega deals they made, before the world economy sputtered and demand plunged. Two more giants, Glencore and Xstrata, merged last May to form Glencore-Xstrata - which was more like a Glencore hostile takeover as Xstrata senior management left and Glencore CEO Ivan Glasenberg began a cost-cutting exercise. Last year, Rio Tinto announced a US$14 billion write-off for its 2012 financial year relating to aluminium and coal assets.
Mining companies have scaled back their development plans. Credit Suisse estimated on March 7 that mining capital expenditures are expected to fall by 40 per cent in 2016.
Now, most importantly, free cash flows are improving. A good sign is how operating cash flows are increasing while capital expenditures and mergers and acquisitions spending have decreased, Mr Hambro said.
Free cashflows are calculated by deducting capital expenditure such as on new mines from operating cashflows. Investors watch the metric as a sign of sustainable profits. "What are the companies going to do with this free cash? They have already paid down debt, their balance sheets are going into strong territory, they've promised us they're going to start paying out big dividends, and they have delivered on that promise. If companies deliver, investors will be buying shares," he said.
Rio Tinto, for example, announced a 10 per cent increase in underlying earnings to US$10.2 billion, and a 15 per cent increase in its full-year dividend in its recent 2013 results.
Dividend yields, meanwhile, are now at 3.5 per cent or so, similar to what is offered by the market. "This is the protection to the downside. Most investors today are desperate for income," Mr Hambro said.
The price of copper, a key metal that markets watch as a signal of how the world economy is doing, has plunged in recent months on China slowdown worries. But inventories have also been coming down on the supply side even as growth in demand has been steady, Mr Hambro said. "There is a war for talent out there, with shortages of engineers, geologists and equipment . . . it is difficult for the world to grow supply."
People tend to forget that overall commodities demand might have slowed, but it is still growing, he said.
"The growth in demand for steel last year was . . . 7 to 8 per cent, copper at 4 to 5 per cent. China accounts for 35 to 40 per cent of the copper market in the world today, . . . adding 1.5, 2 per cent to world demand. That's a lot of metal, hundreds of thousands of tons that need to be produced," he said.
Gold, meanwhile, will remain range-bound, with a floor based on the all-in cost of production of around US$1,100 to US$1,150 an ounce and its upside limited by US tapering its monetary stimulus amid an economic recovery. The precious metal is trading at around US$1,300 an ounce.
"I'm hoping that gold prices stay low. This forces companies to change . . . they grew for the sake of growth," he said. High gold prices have caused companies to over-invest in mines and mine from ores that did not contain as high a proportion of the metal, he noted.
Overall, commodities companies are "hugely under-owned". Last year was the third year in a row the sector underperformed and had negative returns.
"We've never had four years in a row," he said.