Material Matters: Mineral Sands, Iron Ore, Steel, Oil, Nickel And Agriculture

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-Macquarie cuts mineral sands forecasts
-Chinese iron ore commands premium
-Interest in oil M&A re-ignited
-CS prefers mid cap nickel miners
-Near-term outlook positive for Oz agri stocks
 

By Eva Brocklehurst

Mineral Sands

Macquarie has reviewed mineral sands pricing forecasts. Subdued demand is evident, particularly from China. This is weighing on most commodities and while supply discipline for zircon has kept prices buoyant, the broker believes over-capacity will suppress material price increases as demand recovers. In titanium dioxide there is a brighter outlook for high-grade chloride feedstock but Macquarie still makes significant cuts to forecasts. Rutile price forecasts are reduced by 15-20% over the next five years and ilmenite by 20-40%.

On the back of the changes to the outlook for mineral sands Macquarie downgrades Iluka Resources ((ILU)) to Underperform from Outperform. The broker maintains a Neutral rating for the other large mineral sands producer, Rio Tinto ((RIO)), but reduces cash flow expectations for the next few years, observing that Rio Tinto’s progressive dividend is now only just covered by free cash flow in 2015 and 2016.

Iron Ore

China plans to cut power prices and iron ore resource taxes. Macquarie does not believe the tax reductions will be too significant as current iron ore prices are probably not low enough to drive further displacement of domestic iron ore. The mechanism China operates for its iron ore resource tax is complicated but, based on conversations the broker has had with miners over the last six months, there is unlikely to be any meaningful sequential impact. Local governments have already been offering reduced tax rates to miners and the broker believes the policy could be interpreted as the central government formalising a policy already in place.

Other costs to miners are coming down too, such as falling diesel prices and lower consumables prices as well as, potentially, a reduction in power prices. Macquarie notes, despite the cuts to costs in China, it was not enough to keep pace with price falls. As a result, a significant proportion of Chinese iron ore mining capacity has left the market. Still, the broker assesses there is around 190mtpa of domestic ore being consumed and, at current prices, with the the relatively small cost reductions most of China’s cost curve is under water. Why the remaining mines are hanging on is that domestic ore prices are commanding a premium to imported ore.

Several reasons are proffered for this premium. Macquarie notes lead times on domestic iron ore are much shorter than for imported tonnage and therefore there is much less price risk involved in ordering a cargo. Domestic ore can also be purchased in smaller parcels. Moreover, the broker suspects there could be some scarcity premium being built into the market. Mills typically use domestic concentrates for pellets. The final reason relates to financing as mills can be much “looser” with payments to domestic miners.

Steel

Weakness in Chinese steel output is continuing. The latest data for late March reveals member mills of the China Iron and Steel Association are producing at the lowest level since January 2013 and Macquarie observes this is 10% below levels seen at the start of the year. Moreover, mill inventory rose further, which suggests very weak sales volumes that are 12% below the equivalent period in 2014.

Oil

UBS is raising 2015 Brent forecasts to US$56.25/bbl from US$52.50/bbl. The revised estimates reflect modestly higher-than-forecast first quarter prices and only minor revisions to supply/demand forecasts. 2016 oil price forecasts are unchanged. In tandem the broker has also reduced long-term Australian dollar assumptions to US75c from US80c, which has a more material impact on valuations of key oil stocks.

UBS moves Oil Search ((OSH)) to a Buy from Neutral after recent share price weakness and retains Santos ((STO)) as a top pick among large caps, thanks to its future positive free cash flow yield in a recovering oil price environment. Australian dollar reporting companies such as Santos, Beach Energy ((BPT)) and Drillsearch ((DLS)) should have some protection from the falling Australian dollar. The broker upgrades Tap Oil ((TAP)) to Neutral from Sell after a 42% fall in its share price since the start of the year.

The broker considers Shell’s bid for BG has re-ignited M&A interest in the sector but discounts the large cap stocks as target, although consolidation among smaller players is anticipated.

Mid Cap Nickel Miners

Credit Suisse has become more optimistic on base metals and prefers the mid cap nickel miners to the large cap iron ore players. However, given a nickel floor price defined by nickel pig iron (NPI), the availability of the Philippines ore to sustain 350,000t of NPI output and modest deficits forecast from 2016 the broker does not expect large price rises. Credit Suisse looks for nickel to recover to US$8.50/lb rather than the previous forecast of US$9.50/lb for FY16-17. The broker does not expect prices will become “supercharged” and encourage more high-cost supply.

Higher cash flows and recent share price underperformance also mean the broker upgrades nickel miner Sirius Resources ((SIR)) to Outperform from Underperform. Western Areas ((WSA)) retains an Outperform rating. Higher Australian dollar-denominated nickel prices helps increase the cash flow of operating mines. Multi-metal miner Independence Group ((IGO)) is upgraded to Outperform from Neutral as the biggest beneficiary of the broker’s revised price deck which includes unchanged gold price forecasts, accompanied by a lower Australian dollar.

Agriculture

Bell Potter observes Australian agricultural stocks have some of the best leverage to a falling Australian dollar, especially farming operations which typically have a high proportion of Australian dollar costs and and US dollar selling prices, The broker has downwardly revised Australian dollar forecasts to US75c for FY16 and US77.5c for FY17. Webster ((WBA)) and GrainCorp ((GNC)) have the most direct leverage.

Rural confidence is now at the highest level for three years and the near-term outlook for winter sowing is for above-average rainfall. Bell Potter considers this a material profit period for merchandise operators such as Elders ((ELD)) and Ruralco ((RHL)).

Meanwhile, dry conditions in California suggest almonds, walnuts, dairy and wine grapes are the commodities most likely to be impacted, with the state representing in excess of 3.0% of global supply in these commodities. The broker likes Webster, Australian Dairy Farms ((AHF)) and Bega Cheese ((BGA)) as exposures to this thematic.
 

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