BHP, Rio And Copper

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

– BHP and Rio growing increasingly reliant on copper
– Rio has the edge over BHP?
– Iron ore pricing forecast

By Andrew Nelson

With iron ore expected to sooner or later (probably sooner) retreat from current price levels, copper is becoming an increasingly important driver for both BHP Billiton ((BHP)) and Rio Tinto ((RIO)). Good news for both, as analysts at Macquarie like copper about the best of all of the base metals.

The broker notes that copper currently accounts for 15% of BHP’s valuation and 22% of earnings, while for Rio the number sits at around 20% of valuation and 35% of earnings. Importantly, copper remains a higher margin business for both.  

Macquarie notes BHP’s copper portfolio boasts better grades and less underground production.  Annual copper production growth is expected to remain over 10% at least until the end of FY15, with much of the upside coming from Escondida. However, the longer term picture is a bit different given the maturity of BHP’s assets, the indefinite deferral of Olympic Dam and a reluctance to take on major new projects given the current environment.

On the other hand, the broker gives a bit of credence to Rio’s claims it has the best copper assets in the business, citing low costs and the quality of growth options. Despite falling grades and rising underground production, operating costs remain low because of by-product credits.

Thus while BHP is a much larger copper producer, Macquarie thinks Rio’s copper portfolio is a bit better, as while BHP may have the larger mines, higher grades and more open pit operations, Rio rakes in significant benefits from these aforementioned by-product credits, while a higher level of underground expertise means Rio’s copper work is not only higher margin, but enjoys more momentum in its longer term growth options. 

This is why the broker expects copper to remain a driver of revenue for Rio, while it otherwise thinks BHP’s copper contribution will fall over the rest of the decade. 

Yet while Rio may be edging ahead in the copper game, it is having some issues with met coal. At least on the supply side, with stocks becoming increasingly difficult to get to market. All you have to do is look at the $3bn write-down on the Mozambique coal operation to see exactly how tough it is.

Over the past couple of years, demand, or the lack thereof, was the big problem. But with 2013 looking like it will be ex-growth on 2010 numbers, Macquarie sees supply becoming more of an issue. And with premium stock likely to become harder to come by, the broker sees hard coking coal trading at around a US$200/t sustainable price.

The broker reckons growing the supply side will be increasingly difficult, noting 50% of seaborne trade already comes from Queensland, although floods, industrial action and falling productivity will limit any uplift from the state. Macquarie sees this overreliance on Australian coal only getting worse in the coming years. In fact, on the broker’s numbers, Australia is expected to supply 80% of seaborne export growth through 2017.

And speaking of iron ore…. Analysts from UBS expect the roller coaster ride to continue a little longer and then for prices to settle down in a US$130-US$160/t CFR China price range. The forecast assumes that short-term activity in China remains quiet given slow progress in the property and infrastructure sectors, both being key drivers of China’s steel demand.

The stocks with leverage are Rio and Fortescue ((FMG)), while the broker advises to stay away from stocks whose value depends heavily on undeveloped projects.
 

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