Material Matters: Is Australia’s Resource Sector Losing Its Global Relevance?

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– Australian mining sector losing relevance
– Any further slowing in global growth to impact on miners
– JP Morgan expects base metal prices will edge higher in 2012
– Precious metals prices expected to do the opposite

By Chris Shaw

Over the past decade the Australian mining sector has seen deals adding up to $114 billion, with 43% attributed to foreign investment, 35% from domestic consolidation and 22% from outward investment. Through the global mining boom Citi notes Australia has been a net seller of assets.

Emerging markets have also evolved in recent years, meaning the domination of the developed world's ownership of mining assets has fallen. This means from developed mining markets accounting for about 84% of listed global mining enterprise value at the start of the super cycle, this has now fallen to around 61%.

A shrinking relative size means Australian mid-cap miners lack the scale needed to become global players, so Citi expects the gap between the big players in the sector and the rest to continue to widen.

At the same time as Australian mining assets have been acquired they have been replenished by a number of small IPOs. As Citi notes, the past decade has seen 588 IPOs in the sector with an average deal size of just $7 million. This equates to 50% of all global mining IPOs by number but just 7% in value terms. 

Given many of the IPOs have been exploration companies, the quality of replenishment in the sector is declining in Citi's view. This means in global terms the Australian mining sector is losing relevance, as taking out BHP Billiton ((BHP)) and Rio Tinto ((RIO)) would leave the remaining enterprise value as only slightly larger than that of India. 

To Citi this means foreign merger and acquisition money is likely to continue to flow into Australia but at a slower rate given the premium assets have already been acquired. Some targets remain in the Australian market, the most attractive being those with quality, scalable, long-life assets. 

Citi suggests the core local M&A candidates are Whitehaven Coal ((WHC)), Mirabela Nickel ((MBN)), Perseus Mining ((PRU)), Regis Resources ((RRL)) and Atlas Iron ((AGO)). The FNArena database shows Sentiment Indicator readings for these companies of 1.0 for Whitehaven, 0.8 for Mirabela, 0.7 for Atlas, 0.5 for Perseus and 0.3 for Regis Resources.

Given the ongoing uncertainty with respect to the global economic outlook, RBS has undertaken a bear case scenario analysis to consider the impact on metal and mining stocks were global growth to slow further.

The analysis sees RBS factor in flat prices through the balance of 2011 and 2012, which is a more bearish scenario than the broker's central case of a more constructive price outlook in the year ahead.

From a valuation perspective RBS notes in a steady growth environment valuation metrics such as earnings multiples or EV/EBITDA (enterprise value to earnings before interest, tax, depreciation and amortisation) are often used.

In a cyclical downturn Price to Book (PB) valuations become more relevant and applying trough PB valuations to steel and base metal companies suggests significant downside potential to valuations of as much as 15-33%. Coal companies in contrast have a more stable earnings stream backed by reserves.

JP Morgan has similarly factored in the current economic environment in adjusting commodity price estimates, for the most part numbers being lowered. The changes don't imply a return to levels seen in 2008 as no massive de-stocking event is expected and a number of metals continue to deal with ongoing drags on supply.

But at the same time JP Morgan suggests a quick re-emergence of a commodity supercycle is unlikely as industrial activity is now expected to be consistently lower than previous forecasts for at least another 12 months. This implies a return to relatively recent prices seen for the likes of copper and tin is unlikely in the next year or so and may not occur for the next five years. 

In general the JP Morgan view is for base metal prices to consolidate in the final quarter of this year before edging higher relative to current levels through 2012. While shorter-term prices could fall further on negative macro news, the bottom for prices is probably not far away according to JP Morgan.

What supports this view is that monetary policy remains very accommodating and is expected to be loosened further. At the same time, JP Morgan expects capital allocated to commodity markets and commodity infrastructure to remain at solid levels, which will offer plenty of scope for excess tonnage to be soaked into the LME warehousing system. This will help insulate stock levels and so prices. 

For the specific metals, JP Morgan takes the view it is unlikely copper prices have hit their cyclical low, which implies further falls in the shorter-term. Medium-term the outlook remains solid, largely as a result of ongoing supply side issues.

In aluminium recent price weakness is generating support as marginal producers are hurting at current levels, while warehouse demand from the US in particular has made the market act like it is in an under-supply situation. This should help support prices through next year in the view of JP Morgan.

Chinese nickel pig iron, new mine supply and stainless steel demand in China will be the big drivers of the nickel market according to JP Morgan. The first two factors should keep the market in surplus but the third is likely to be enough to stop too severe a decline in average prices in 2012 relative to 2011 expectations. 

While there is no sign of any shortage of lead in China demand elsewhere remains reasonable, something JP Morgan expects will see a tightening in the market over the next 12-18 months. As a result, prices are unlikely to weaken significantly in the coming year.

Zinc inventories have risen since 2007 but JP Morgan notes demand has generally held up better than the price of the metal would suggest. A move into a meaningful supply/demand deficit is not expected prior to the middle of the decade, which limits potential upside for the metal in the medium-term.

An opposite view is in place for gold and silver, with JP Morgan anticipating prices will gradually ease through 2012 in line with an easing of risk factors that have helped drive prices higher over the past few years.

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