China, the biggest driver of global commodity demand, has just reported the slowest quarter of growth for 27 years. Does this mean that investors should steer clear of FTSE mining companies like Rio Tinto (RIO), BHP (BHP), Anglo American (AAL), which supply raw materials in vast quantities to the country?
Setting aside China’s faltering growth story, it’s hard to ignore the chunky yields on offer by the biggest names: share prices of the FTSE 100 mining giants have had a strong year but yields are still between 3.5% and 5% for Rio, BHP and Anglo. Company cash positions are strong after years of belt-tightening – JPMorgan Natural Resources manager Neil Gregson says the miners, which have istorically been cyclical bets, can now be considered as “boring” dividend payers.
While lustrous gold and sparkling diamonds may sound more exciting, it is the high price of iron ore remains central to commodity firms’ production plans. Iron ore, which is used in Chinese steel production, has defied expectations of a fall in price for a few years now. After a subdued 2018 coinciding with the start of the US-China trade war, the price of iron ore has spiked to a five-year high of nearly $120 per tonne. This has encouraged miners to pump out more. Supply of the commodity has been tight this year: a dam disaster in Brazil and cyclones in Australia have hit production. Morningstar analyst Mathew Hodge estimates that 100 million tonnes of iron ore, or 6% of global supply, has been lost so far this year.
"With production costs less than $20 per tonne, iron ore miners are printing money at current prices," he says.
According to production reports this year, BHP produced 63 million tonnes of iron ore in the past three months, an increase of 12% on the previous quarter. But Anglo and Rio were hampered by production problems at mines, while bad weather held back Rio's iron shipments out of Western Australia.
BHP is the biggest holding in JPMorgan Natural Resources. Manager Neil Gregson says that, while we are close to or at “peak steel” already, iron ore prices will remain tight in the coming years beacuse of steady Chinese demand, supporting miners’ profits. Even if iron ore prices fall back, he argues, mining firms will still make decent profit margins.
Olivia Markham, co-manager of the BlackRock World Mining Investment Trust (BRWM), argues that while iron ore has been partly boosted by short-term supply disruptions, the price is unlikely to fall back to where it was at the start of the year.
A booming gold price, helped by a weaker dollar and geopolitical anxieties, has also given shares in diversified miners an extra uplift.
Share Prices Rises and Dividend Yields:
- BHP shares up from £16.31 to above £20, a rise of 22%. Dividend yield is 3.79%.
- Rio Tinto shares up from £36.90 to £48.27, a rise of 30%. Yield is 4.77%
- Anglo American shares up from £17.10 to £22, a gain of 28%. Yield is 3.48%.
- The FTSE 100 is up 11% in the period.
Are these yields sustainable? Rio Tinto’s dividend cover is over 2, which means that its profits are more than double the level of its payouts, and BHP is one of the world’s biggest dividend payers, according to the Janus Henderson dividend report, having paid more than $21 billion back to shareholders in 2017 and 2018 – a special dividend of $1.02 per share was paid in early 2019.
Of the FTSE 100 mining companies, Morningstar rates BHP, Rio, Anglo American as overvalued with no economic moat, or sustainable competitive advantage. Analyst Matthew Hodge believes the mining sector as a whole remains overvalued, but that income opportunities abound: he says the near-term earnings outlook for Rio is very strong. “It’s likely dividends will be the outlet for excess cash” instead of share buybacks, he says, although pay outs will likely start to tail off from 2023 onwards. Hodge believes that BHP will also increase dividends rather than opt for buybacks. BHP is less overvalued than Rio, he argues, given that it is less exposed to the iron ore price.
The Longer-Term Outlook
Beyond this year, slowing global growth could knock miner’s profits. Wealth manager Killik & Co remains neutral on BHP shares, for example, due to uncertainty over demand for iron ore and coal, which make up more than half of the firm’s pre-tax profits.
Hodge argues that China has responded to the US trade tariff by pumping more money into the economy. But this economic stimulus cannot last forever: with most of the country already urbanised, he argues, pumping money into roads, railways and construction projects gets less and less effective over time.
But Markham thinks the Chinese economy could be more resilient in the coming years as it “has the tools to continue successfully managing a gradual slowdown”. Any genuine progress in trade talks between the US and China could also help mining companies.
Even if there is a global slowdown, JPMorgan's Gregson argues that the miners’ “absolutely rock solid balance sheets” should see them through to the other side.
