Material Matters: Strategy, Coal, Manganese, Steel And Aluminium Scrap

This story features BLUESCOPE STEEL LIMITED. For more info SHARE ANALYSIS: BSL

-Time for more miner exposure?
-Coking coal tailwind to come
-Manganese upside limited
-Improved price traction in Oz steel
-Chinese aluminium scrap growing
 

By Eva Brocklehurst

Strategy

JP Morgan has been cautious for some time when it comes to commodity equities but is now advising to tactically add exposure, upgrading mining to Overweight and energy to Neutral. Bearishness on China has prevailed but there are some signs of improvement in the data, while a move on rates by the US Federal Reserve could act as a positive catalyst, providing clarity.

The broker believes the risk/reward is improving, as the mining sector has been the worst performer in the year to date. The iron ore price has picked up since July and is now 30% above its lows. JP Morgan expects commodity prices to be range-bound next year and as earnings downgrades in the sector have already been severe, the downside for equities is likely to be limited.

Commonwealth Bank strategists believe the primary driver of slowing Chinese commodity demand is the weak property sector. New construction activity in lower-tier cities has been hampered by poor demand. The strategists also question how much of China’s infrastructure development will translate into incremental commodity demand. Activity in these lower-tier cities appears vital for a rebound in commodity prices.

Stimulus to date is not showing up in China’s commodity-intensive sectors because Beijing is largely geared towards safeguarding and reforming the financial sector. As a result, the strategists downgrade commodity price estimates over the next three years, particularly for base metals, coal and energy.

Coking Coal

Metallurgical (coking) coal markets are into a price deflation cycle with prices now well into most cost curves. UBS does not expect prices to gap lower from here, although a gradual easing in US dollar prices is possible. This should be softened by lower producer currencies, which will translate to flat or higher local margins.

Metallurgical coal trade values are falling as China steps away from imports and marginal US and Canadian producers exit the market. A rebalancing of supply is needed in the presence of weak demand, UBS maintains, but falling costs and producer currencies are combining to keep more tonnage in the market for longer.

Still, with the downturn in global mine capex, UBS suspects the future supply pipeline could be dry in a year or two. Then, the coking coal market will capture a cyclical tailwind. Nonetheless, the broker warns, this is not imminent.

Manganese

Manganese ore is being used less intensively per tonne of steel output these days. Currently, 95% of demand for the ore is from the steel industry. Macquarie therefore expects little growth in demand over the next five years. Without meaningful cuts to supply, the broker believes the market will remain in surplus through 2017.

There are arguments that the market may re-balance more quickly than for coal or iron ore, given the prevalence of private miners, which are more constrained in terms of their balance sheet, in the top half of the cost curve. Still, Macquarie believes there is little reason to trade out of the cost curve and investors should limit any manganese exposure to those companies with top assets.

Steel

Goldman Sachs has become more constructive on the Australian steel industry following the restructuring announcements of the major producers, and feedback from recent channel checks. Domestic demand continues to deteriorate but price-led competitive intensity has eased. This results in improving price traction downstream.

The broker’s preferred exposure is BlueScope Steel ((BSL)) as it plans to undertake $200m in cost reductions for Australian steel product. The company’s exit from structural steel is seen as positive for profitability and this has helped consolidate the number of competing interests in the market.

A global surplus of seaborne steel has provided opportunities for traders to acquire large volume at deep discounts but many have now become wary of the anti-dumping investigations and the heightened risk of holding product when a ruling or investigation is announced.

Aluminium Scrap

On Macquarie’s analysis, the returns from the aluminium scrap market are likely to have a significant impact on ingot and raw material consumption by the end of this decade. Usually, scrap tends to be an inelastic source of metal supply and, at least over the shorter timeframe, price sensitive. Benefits from recycling tend to be increased productivity and lower energy consumption in refined metal production.

This is particularly the case for aluminium, given the electricity-intensive nature of smelting. Macquarie believes aluminium scrap recovery now looks set to outpace demand growth. In the broker’s view, Chinese aluminium scrap production is likely be one of the fastest growing areas of the global metals markets, with the resultant implications for primary consumption being both significant and under appreciated.
 

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