Material Matters: Pressure On Dividends, Steel & Iron Ore

Commodities | Apr 04 2024

Stock picks and commodity forecasts; declining payout ratios for miners; new research coverage for steel companies; and iron ore forecasts. 

-Morgan Stanley’s commodity forecasts and stock picks
-Diminishing payout ratios for miners
-New coverage of BlueScope Steel and Vulcan Steel
-Price forecasts for iron ore and regional steel 
 

By Mark Woodruff 

Morgan Stanley’s commodity forecasts and stock picks

Metals and mining equities across the globe have missed out on the record Cyclicals versus Defensives rally and have de-rated to GFC/covid lows relative to the market, new research from Morgan Stanley concludes.

To take advantage of this underperformance, Morgan Stanley's commodities team suggests investors focus on stocks with exposure to commodities that will benefit from lower interest rates and are exposed to fundamentals displaying either supply discipline or supply disruptions.

This disparity between outperformance by cyclicals and market-relative metals & mining valuations has never been this extreme, and Morgan Stanley points out a growing divergence has also emerged within the metals & mining sector fueled by a strengthening narrative around copper.

According to the broker, the market's bullish views on copper and scepticism regarding overall Chinese demand for commodities have rarely been as uniform. 

Copper moves to the top of the broker’s order of preference on commodities as supply disruptions push the market towards a large deficit. These supply challenges will be hard to resolve and the deficit will persist into 2025, while a further boost for demand is expected from data centres/AI.

This outlook for copper may support pure-play miners in the near-term, yet Morgan Stanley cautions current share prices are already pricing in steep commodity price rises. Diversified miners offer greater value over the medium-term, suggest the analysts, but a shift in China sentiment is needed.

Despite China’s current lack of appetite for iron ore, the broker outlines a compelling value case for Rio Tinto ((RIO)). Not only does the miner possess low cost/high quality assets, but Rio Tinto also maintains a best-in-class balance sheet with superior volume growth, mainly derived from copper.

Morgan Stanley is forecasting US$10,200/t for copper by the third quarter of 2024.

For iron ore, the broker has lowered its second quarter 2024 price forecast by -21% to US$110/t on stronger shipments, but sees prices rising from the second half of 2024 due to cost support and normalising inventories. FY24-FY26 price forecasts are increased by 22%, 25% and 25%, respectively.

Behind Rio Tinto in the iron ore space, Morgan Stanley prefers Deterra Royalties ((DRR)), followed by BHP Group ((BHP)), and Fortescue ((FMG)).

While Mineral Resources ((MIN)) also has material iron ore earnings, the broker recommends this company based on its lithium credentials in preference to investing in Pilbara Minerals ((PLS)) or IGO Ltd ((IGO)).

As part of its commodity strategy update, Morgan Stanley has downgraded its rating for IGO to Underweight from Equal-weight and lowered the 12-month target price to $5.95 from $7.20. The current mine plan for the company’s Greenbushes mine continues to be reworked and the analyst sees risk around future expansions.

Among battery metals, nickel is preferred due to the rapid supply side response to low prices. The analysts believe lithium share price valuations have potential to correct further, though a floor for lithium prices may be approaching.

Valuations for the lithium pure-plays on the ASX remain elevated and the broker is wary around battery supply chain inventories and offline supply which can be restarted.

Gold should also see further upside as rate cuts come through. Apart from falling real yields, strong physical demand from central banks provides a tailwind to support prices, according to the analysts. Evolution Mining ((EVN)), Regis Resources ((RRL)) and Northern Star Resources ((NST)) are the preferred exposures.

Amongst base metals, the broker likes copper (as noted) and nickel on supply tightness and, in order of preference, nominates Evolution Mining for its copper exposure, followed by Nickel Industries ((NIC)), 29Metals ((29M)) and South32 ((S32)).

While the target for Alumina Ltd ((AWC)) rises to $1.30 from $1.10 on higher forecast alumina prices in 2024/25, Morgan Stanley downgrades to Equal-weight from Overweight on valuation.

Evolution Mining is Morgan Stanley's recommended way to play both gold and base metals, noting around 30% of the company’s revenue derives from copper. 

The broker suggests investors apply caution when considering the coals. Thermal coal is thought to be lacking near-term catalysts, while improved Australian supply and a seasonal lull for Indian steel may weigh on the hard coking coal price.

Regarding uranium, here the 2024 balance looks tight on Kazatomprom's production guidance cut, but Morgan Stanley turns more cautious as supply responds to elevated prices, resulting in the 2026 forecast flipping into a small surplus.