Weekly Broker Wrap: 2013 Outlook, Coal Companies, Impairments

This story features RIO TINTO LIMITED. For more info SHARE ANALYSIS: RIO

By Andrew Nelson

With the New Year just gaining traction, analysts and economists released a deluge of 2013 prognostications last week. You know,… a run of will 2013 this, or financial cliff that and GDP will expand/contract etc. Well, we’ve had a look though it all and bring you a brief selection. We’ll also take a look at some of the issues facing coal miners and JP Morgan’s view that some major additional impairment charges must be coming up for BHP Billiton ((BHP)) and Rio Tinto ((RIO)).

Economists at Commonwealth Bank last week observed the year started off with a real sigh-of-relief after the US congress kicked the budget can down the road a few months, thus avoiding a New Year’s cliff plunge at the last hour. They had to re-write some legislation, but isn’t that what pens are for?

However, CBA notes the problem is far from fixed, with a smaller fiscal contraction worth about 1% of GDP having been agreed upon. But, warns CBA, more is coming and after a lacklustre year of 2.2% GDP growth in 2012, the bank already expects US GDP will lift by only 2.1% in 2013. So much for that forecast of a better economic year ahead.

The second chat, which is really the first chat that has been delayed and delayed and delayed, is scheduled to take place by 1 March 2013. Congress will be looking to come to some sort of agreement to address legislated public spending cuts and lift the debt ceiling. No agreement = another cliff, or to coin the media catchphrase, the ‘Mini-Me’ fiscal cliff.

BA-Merrill Lynch echoes the view of CBA, noting the seemingly never-ending debates about the US budget and debt ceiling will keep a lid on growth this year. BA-ML expects the EUR/USD to keep moving lower in 2013 and 2014. The broker also thinks the USD will continue to gain against G10 currencies this year and next.

Back to CBA, the bank believes the US government’s sovereign credit rating is still at risk of a downgrade without further corrective action. Standard and Poor’s are already on the record saying the latest agreement does little to put the US’s medium-term public finances on a more sustainable footing. Moody’s is a little kinder, saying further measures are needed to support the Aaa rating.

Not much improvement on the economic side of the 2013 story appears also the dominant theme in Citi's 2013 Investment Themes report. The bank/stockbroker’s base case for global GDP growth in 2013 sits below consensus and is essentially little changed from 2012.

Citi expects continued recession in 2013 and 2014 for the euro area, with elections continent wide not likely to help matters in the year ahead. Citi also points out the currently high levels of private sector debts and combined with high fiscal deficits, Europe is likely still staring down the barrel of more sovereign restructurings to play out in the years ahead, meaning it will be a while still before anyone can truly relax about the eurozone.

The broker’s base case for the US is a little more upbeat, predicting the US will be able to work out policy issues, leaving lower energy and transportation costs to support an accelerating industrial recovery. While Citi also expects China’s once steep growth rate to be re-based at around 7% per year, it still believes this slower growth path will leave China as a global economic powerhouse, with real GDP doubling every ten years or so. On such numbers, China alone would account for about a third of estimated global growth in 2013-17.

Citi remains positive on equities in the year ahead, neutral on credit and underweight on government bonds and commodities. The equities theme will remain one of praising share buy-backs and higher dividends, while cursing increases in capex. Returns motivated M&A and spin-offs should also pick up in the year ahead, predicts Citi.

Switching to CIMB and its outlook for the coal market, the broker notes that after a tough 2012, 2013 is also shaping up to be an uphill battle, especially for Australia-based assets. The broker notes Australian coal companies are belaboured with high capex costs, which isn’t good given every company the broker tracks is currently unfunded for Australian projects, with most being forced to sell-down stakes to be able to fund development.

In its own coverage universe, the broker likes Cokal ((CKA)) best, while it is also a fan of Bathurst Resources ((BTU)), although it does not cover the latter. It’s these two that stand out as having the best near-term  production, plus low capex and opex and more importantly, a path to market.

The broker notes a path to market is essential in developing any coal project and in Australia, getting coal on to a boat or trains is far from easy. New port developments are expensive, long dated and require long-term off-take commitments. Some difficult hurdles not faced by miners elsewhere.

Lastly, analysts at JP Morgan have come to the conclusion that both BHP and Rio Tinto are staring down the barrel of some pretty hefty impairments over the next few years. Firstly, the two combined have already reported combined impairment charges and other one– off costs of in the neighbourhood of US$30bn. While over US$18bn relates to RIO’s Aluminium assets post the US$44bn Alcan transaction, JP Morgan sees more aluminium impairment charges to come for both companies over the medium term given the current state of the industry.

The broker notes that in the case of Rio, its valuation for the aluminium assets sits at just US$13bn, which is significantly below the last reported book value of US$27bn. With results from impairment testing due before the February result, writedowns are soon expected. Charges to the tune of several billion dollars are expected, especially given the Gove refinery could be closed.

While JP Morgan isn’t expecting any major impairment from BHP in February given numerous were taken with the FY12 result in August, aluminium assets still carry a book value of US$8.5bn, which is significantly higher than  the broker’s NPV of US$5.9bn. Given BHP will likely sell these assets, any potential sale would likely trigger an impairment charge.

While JP Morgan favours Rio, it notes that the preference over BHP has narrowed over the past few months on the back of recovering iron ore prices and better share price performance from Rio.

 

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