We are cutting our long-term price forecast for nickel to $6.50 per pound in real 2015 dollars, based on our expectation of lower marginal cost of production. We think demand growth for nickel will decelerate as China’s appetite for the metal wanes and growth from the rest of the world remains tepid. We expect abundant supply growth as nickel projects started in prior years come on line and Indonesian exports – the largest supply source – return to the market.
Since we expect sufficient supply to meet demand in mid-cycle conditions, long-term prices should be set at the marginal cost of production. Slower demand growth amid faster supply increases suggest that lower prices can clear the market. The marginal cost of production also falls since the entire cost curve shifts down with local cost deflation and producer currency depreciation. For example, the Indonesian rupiah has fallen 17% against the dollar compared with its 2014 average.
We are lowering our fair value estimates for mining companies with nickel exposure. The reduction is most significant for First Quantum, since nickel makes up a large portion of its cash flows. We are also lowering our fair value estimates for Vale, Glencore (GLEN) to £1.60 from £1.70, and Anglo American (AAL) to £7 from £8.
BHP Earnings Fall but Dividend Remains
BHP Billiton (BLT) reported lower-than-expected underlying fiscal 2015 earnings, down 47% to $7.1 billion, versus our $8 billion forecast. Net operating cash flow and free cash flow both exceeded our forecasts, due to lower income tax and higher asset sale proceeds.
BHP paid a final 62 cent dividend, the minimum as expected under the progressive dividend policy, and a hefty 93% full-year pay-out. BHP will likely use its balance sheet to support payment of an unchanged $1.24 dividend in fiscal 2016 on an even bolder 200%-plus pay-out.
At the current weakened share price, sustaining the dividend would place BHP on a very attractive prospective 7%-plus yield, nearly unheard of for a miner.
It is a clear catalyst for convergence of the challenged share price towards our unchanged AUD 30 per share fair value estimate. Long-term volume and commodity price projections are unchanged. We are yet to update our near-term earnings forecasts, but we don't anticipate meaningful changes. BHP is undervalued.
We retain our narrow moat and medium fair value uncertainty ratings, as we still expect returns on invested capital to improve from cyclical lows of 4% in fiscal 2016, exceeding the cost of capital within 10 years.
