Material Matters: More Revisions To Forecasts For Bulks, Base And Precious Metals

This story features BLUESCOPE STEEL LIMITED, and other companies. For more info SHARE ANALYSIS: BSL

By Chris Shaw

Last week JP Morgan adjusted earnings estimates for Australian steel plays to reflect changes to its currency forecasts and steel price expectations (see Material Matters: Copper, Aluminium, Gold And Steel) and the broker has not been alone in updating expectations in the sector.

BA Merrill Lynch has also lowered its earnings forecasts for both BlueScope ((BSL)) and OneSteel ((OST)) modestly in FY11, which reflects the impact of still depressed regional demand on prices. RBS Australia has similarly trimmed its earnings estimates for both companies in both FY11 and FY12 by 3-11% to reflect ongoing weakness in steel margins.

In ratings terms, BA-ML has a Neutral recommendation on BlueScope and a Buy on Onesteel, while RBS Australia rates both stocks as Buys at current levels. This compares to Sentiment Indicator readings according to the FNArena database of 0.9 and 0.4 respectively.

Elsewhere in the bulks, UBS notes Australian exports of iron ore remain at solid levels, as on an annualised basis exports are tracking at a level of around 388.8 million tonnes. This represents growth of around 7% in year-on-year terms.

Exports of both hard coking coal and thermal coal have been solid, helping offset a slump in PCI exports in August. Potential issues for Australian coal and iron ore plays in coming months according to UBS are unseasonal rains in Queensland and the potential for China to reduce power consumption. This would be likely to have an effect on raw material demand from that country.

On the plus side for coal, UBS notes industry figures suggest below average inventory levels, so any prolonged disruptions to supply could create some coal shortages in the broker's view. This could support prices, a view shared by Morgan Stanley given the broker remains above consensus with its bulk commodity price forecasts following its fourth quarter update.

RBS Australia also remains bullish on the bulk commodities, the broker lifting its long-term hard coking coal and iron ore price forecasts to reflect expectations of higher operating costs in the future. The broker's long-term forecast for hard coking coal has risen to US$145 per tonne from US$125 per tonne previously, this despite minor cuts to short-term price estimates.

For iron ore, RBS Australia now forecasts long-term fines prices of US$60 per tonne FOB, up from US$51 previously, while for lump material its long-term forecast has increased to US$115 per tonne from US$100 previously.

Macquarie has also lifted its iron ore estimates for both the shorter and longer-terms, the latter reflecting expectations of higher capital intensity and rising operating costs for greenfield operations forcing prices higher. For 62% spot fines CFR China, Macquarie has lifted its long-run price forecast by 18% to US$71 per tonne.

Base metals in general enjoyed solid price performance in September, Macquarie attributing the gains to more positive market sentiment towards copper in particular. This improvement in sentiment has lead to ongoing short-covering and fresh long positions being put in place.

Macquarie also points out inventory build, in what is typically a seasonally weaker demand month for base metals generally, was much lower than was the case in the same month in either of the last two years.

As with the bulks, RBS Australia has revised its base metal price estimates, lifting its long-term copper price forecast by 11% to US$5,000 per tonne. This reflects the view that from a relatively balanced market position this year, copper is likely to slip into deficits in coming years to the extent of a cumulative deficit of 1.2 million tonnes through 2014.

RBS attributes this mostly to supply side issues as copper utilisation rates globally are low at 78%, head grades at mines are falling and smelters are short of concentrate feedstock. As well, there are simply no new really large copper mines coming on stream in the next few years.

Macquarie has also lifted its copper price forecasts by 9% in 2011 and by 17% in 2012, the broker also expecting the market will move into deficit in 2011 as global inventories continue to be depleted.

Aluminium's outlook is also positive according to RBS, as an upturn in the global business cycle is expected to see a draining of inventories from 2012-2014. The broker expects over that time frame prices will challenge the US$3,000 per tonne level, which compares to prices of around US$2,400 per tonne now.

Less positive are the outlooks for nickel and zinc, as RBS expects the fundamentals for both metals will weaken in the shorter-term in particular. Macquarie largely agrees as it sees downside risk to nickel prices in coming months thanks to rising supply and remains neutral on the zinc price outlook.

In precious metals, while gold has recently traded at record highs the better performance has come from the silver and palladium markets. Macquarie expects a continuation of strong performance for palladium prices given strong market fundamentals such as limited supply growth and high leverage to the gasoline-powered emerging market economies of Asia.

Macquarie is forecasting an average palladium price in 2011 of US$644 per ounce, which compares to current prices of a little below US$600 per ounce. For silver, Macquarie now expects average prices in 2011 of US$19.50 per ounce, up form a previous forecast of US$16.90 per ounce.

With respect to gold, Macquarie now expects average prices of US$1,265 per ounce in 2011, up from US$1,165 per ounce previously, while in 2012 the broker has lifted its forecast to an average of US$1,165 per ounce from US$1,000 per ounce previously. Similarly, RBS Australia has made some minor increases to its shorter-term gold price estimates, while lifting its long-term gold price to US$975 per ounce from US$825 per ounce previously.

Given such an outlook, RBS Australia has listed its key picks for the various commodity sectors. As a large cap play RBS Australia continues to prefer Rio Tinto ((RIO)) , this given a current discount to peers in the sector and a better than 20% discount to net present value on its numbers.

As a pure iron ore play RBS likes Fortescue ((FMG)), especially given a number of potential positive catalysts for the stock in the medium-term as production is ramped up.

Among the coal plays RBS likes Riversdale ((RIV)) given its leverage to the tight hard coking coal market, while Equinox ((EQN)) is attractive as a pure copper exposure as it too is highly leveraged to prices and production results are encouraging.

As evidence of expected outperformance, RBS has recommended switching out of Oz Minerals ((OZL)) into Equinox as relative value appears better in the latter. The broker has downgraded Oz Minerals to a Hold while upgrading Equinox to a Buy rating.

In gold RBS likes Regis Resources ((RRL)) as an emerging mid cap gold producer, especially given the potential positive catalyst of increased resources as exploration work continues.

Morgan Stanley's preferred picks among the Australian commodity plays are Fortescue, PanAust Limited ((PNA)), Western Areas ((WSA)), Citadel Resources ((CGG)), Ivanhoe Australia ((IVA)) and Newcrest Mining ((NCM)).

Given lower growth expectations Morgan Stanley remains underweight on Iluka ((ILU)), Equinox ((EQN)) and Gloucester Coal ((GCL)). Both Iluka and Equinox have been downgraded to Underweight ratings by the broker to reflect recent share price performance, while Oz Minerals has been downgraded to Equal-weight. Alumina ((AWC)) has been upgraded to Equal-weight by Morgan Stanley following its review of the sector.

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