- Commodity prices forecast to weaken in coming year
- Brokers preview resource stocks leading into quarterly reports
- Retailers close to facing margin collapse
- Price deflation to continue to impact on retailers
By Chris Shaw
This week the International Monetary Fund (IMF) has updated its expectations for commodity prices and the eye-catching conclusion was that prices in the sector are expected to weaken during 2012-13.
In the IMF's view, weak global activity and increased downside risk to the near-term economic outlook are likely to pressure commodity prices. This in turn could slow growth amongst commodity exporters, leading the IMF to suggest in times of historically high commodity prices such as the present, commodity exporters should look to lower debt levels and create fiscal room to support a counter-cyclical response if prices do fall.
The issue is complicated by the uncertainty as to the sustainability of commodity price swings. The IMF notes in periods of temporary price moves counter-cyclical policy measures should be the response, but large commodity exporting nations can adopt less of such measures given a spillover economic impact from higher prices.
The IMF's study has found economic conditions tend to be amplified when commodity price cycles last longer or when they include sharper than average price changes. In general, energy and metal exporters have a larger impact on macroeconomic performance given a higher share of total exports and GDP.
In the view of CBA this point is significant for Australia given the two key bulk commodity exports of iron ore and coal. The value of iron ore and coal exports are forecast to reach almost 50% of total commodity exports in 2011-12.
CBA's analysis comes to a similar conclusion to that of the IMF, in that commodity prices are viewed to have peaked and should trend lower in coming months. This should put some downward pressure on Australia's export receipts.
Looking specifically at the outlook for Australia's bulk producers leading into the March quarterly reporting season, UBS notes this quarter is typically the weakest given higher average rainfall across Northern Australia in particular.
The rain should impact on bulk production and shipments for the March quarter, while there is seemingly scope for positive adjustments in the copper space. While zinc should see little variation, nickel producers look more exposed to negative quarterly pricing adjustments.
Among stocks under coverage by UBS, Alacer Gold's (AQG)) update should deliver production of around 108,900 ounces at cash costs of US$586 per ounce for the quarter. This compares to full year production guidance of 420-440,000 ounces.
March quarter production at Aquarius Platinum ((AQP)) should be around 8% better than the December quarter in UBS's view thanks largely to modest improvements at Kroondal and Marikana and something of a rebound at Everest.
The focus of Aston's (AZT)) quarterly is expected to be an update on the Maules Creek project, with UBS suggesting there could be more information with respect to the expected timing of development approvals.
Atlas Iron ((AGO)) is seen as one of the companies particularly impacted by bad weather during the period, UBS expecting production and shipments will be at the lower end of full year guidance. With its two operating coal mines in New Zealand being less impacted by the weather, Bathurst Resources ((BTU)) is expected to deliver production for the quarter of around 70,000 tonnes.
While BC Iron ((BCI)) should achieve production guidance UBS expects this is more likely to happen later in the year, so investors are likely to focus on the timing of when this is achieved. BHP Billiton's ((BHP)) quarter should be weak relative to the December quarter, this attributed primarily to bad weather and some industrial relations issues.
Production from Endeavour Mining ((EVR)) should come in at around 43,700 ounces for the quarter according to UBS, with a cash cost of US$680 per ounce. Fortescue ((FMG)) is likely to fall slightly short of production guidance for the quarter due to cyclones during the period, while UBS suggests costs may also push a little higher.
Gindalbie Metals ((GBG)) should deliver a solid production report and update on progress towards first shipments of concentrate, while UBS anticipates Grange Resources ((GRR)) will deliver production for the period in line with expectations. In contrast, Kagara ((KZL)) is expected to deliver a weak quarter given an operational restructure.
There is scope for Mincor ((MCR)) to improve from the flat production delivered in the December quarter, with UBS suggesting this comes as higher grade ore is accessed and mining efficiency gains are realised.
Results from Mount Gibson ((MGX)) should be mixed due to some rail and port downtime in the period, while UBS expects a slight increase in quarterly production from Newcrest ((NCM)) and some additional details with respect to a ramp-up of operations at Cadia East.
The Oz Minerals ((OZL)) result includes some potential for cash cost variations given increased waste movements, while UBS expects a slight increase in output from Paladin ((PDN)) relative to the December quarter.
Gold and copper output for PanAust ((PNA)) should return to more normal levels in the March quarter, while exploration updates will also be of interest. Few surprises are expected from the Panoramic Resources ((PAN)) quarterly, while UBS suggests the update from Platinum Australia ((PLA)) will be important in assessing the extent of improvement at the Smokey Hills mine.
Perseus ((PRU)) is expected to deliver a review of operational performance with its production numbers, while UBS also expects a seasonally weak quarter from Rio Tinto ((RIO)) given some bad weather during the period.
Along with production numbers Regis Resources ((RRL)) should update on exploration and development at the Garden Well project, while exploration updates from Western Areas ((WSA)) will also be of interest to UBS.
Deutsche Bank has similarly updated its view on mining companies under coverage leading into March quarter reports, in particular those in the copper and nickel sectors. For copper the broker expects prices will strengthen during the year before easing from 2013, meaning the preference is for low cost producers offering some growth potential.
This puts PanAust at the top of Deutsche's list, given an expected step up in production this year as Ban Houayxai comes on line and as operations at Phu Kham expand. From expected full year production this year of 65,000 tonnes of copper and 130,000 ounces of gold, Deutsche expects output will hit close to 100,000 tonnes of copper and 200,000 ounces of gold by 2015.
Also rated a Buy by Deutsche is Oz Minerals, this despite a flat production outlook through to 2018. The attraction for the broker is a cash balance of around US$900 million and US$200 million in undrawn debt, which offers substantial flexibility with respect to growth options going forward.
While the DeGrussa project is economically very attractive Deutsche rates Sandfire Resources ((SFR)) as a Hold, this a reflection of the view the stock is fair value at current levels until exploration success offers a positive catalyst.
With respect to the nickel sector, Deutche notes the current uncertainty in Indonesia given the potential withdrawal of that country's exports and an improving macro environment offer some reasons to be positive on the price outlook. Deutsche still expects prices to ease from next year, which means high grade, low cost assets are preferred.
Deutsche's top pick is Western Areas given it fits the bill in terms of low costs and high grade assets, while newsflow should also be positive in coming months from exploration updates and the integration of the Lounge Lizard project.
Independence Group ((IGO)) is also rated as a Buy, Deutsche attracted to diversified production and the fact issues at the Jaguar project now appear to be behind the company. The partly-owned Tropicana project may also deliver some positives from reserve and resource updates in coming months.
Turning to the industrial side of the market, Citi has analysed results from retail plays across Australia and New Zealand. The broker has concluded retailers are now operating close to the edge of margin collapse given soft sales, increasing operating costs and the potential for price deflation to be a more persistent problem going forward.
For the six months to the end of last December Citi notes discretionary retail sales rose just 1.2% despite a 6.9% increase in household income growth. This disparity is attributed to internet leakage, overseas travel and price deflation.
Citi's review shows despite significant discounting across the sector, 13 of 31 retail companies assessed reported an increase in gross margins. This was due largely to a higher hedged AUD/USD, as both wage and rental cost pressures rose.
Of interest to Citi was around 75% of retailers reported an increase in inventory days, which suggests profit margins will remain under pressure as rising operating costs will coincide with a need to lower prices.
Citi also notes there has been a divergence in sales trends, as luxury brands and leisure-driven retail categories continue to do well, while fashion apparel continues to underperform. This may reflect the lack of a clear trend in global fashion, speculates Citi.
Given the importance of price inflation for retailers, Deutsche's newly created Supermarket Inflation Index is of interest. The index is a leading indicator of price inflation, which is important given a reasonable level of price inflation provides a boost to revenues and margins across the sector.
The index follows the prices of seven discrete baskets of around 100 goods across Australia's major supermarket formats and the initial finding is supermarket prices have been broadly flat over the past seven weeks. This has been the case for both branded and private label goods.
Deutsche suggests of the major retailers Woolworths (WOW)) has the most leverage to a recovery given the size of its supermarket operations and high fixed cost leverage. This is enough for the broker to rate the stock as a Buy.
Both Metash (MTS)) and Wesfarmers ((WES)) are rated as Hold, the latter less exposed to supermarket operations given Coles accounts for only about 40% of group earnings and Metcash largely given the expectation of increased competition from the major players in the sector.
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