Bull? Bear? How about dragon? China often defies simple market characterisation, but it is clear that the anticipated recovery once the Covid-19 restrictions were lifted has been a disappointment. Industrial and real estate activity is down, judging by recent Purchasing Managers Index (PMI) data, which could well have a direct impact on the dividends paid by mining giants Rio Tinto (RIO) and BHP (BHP), given their reliance on iron ore prices for earnings. Both major miners cut payouts after the fall in metals prices in the six months to 31 December 2022, but the question is whether they will fall again.
Iron ore is down to $105 (£85) a tonne from a recent high of $130 in March. This comes as manufacturing PMI hit a five-month low in May of 48.8, below the 49.2 seen in April and the 49.4 expected by economists. These numbers point to “a rapid deceleration in growth” in the current quarter, according to analysts at Barclays. The steel segment was particularly weak in sentiment terms – PMI was 35.2 against 45 in April.
There are some positive indicators too – the Caixin PMI number, which charts smaller-scale manufacturing sentiment, turned positive in May. But now investor attention will turn to the prospect of stimulus from Xi Jinping’s government to get things moving again. The People’s Bank of China has form in this regard, too – it has cut rates before when PMI surveys stayed in contraction (sub 50) territory. “More property loosening and quasi-fiscal supports are also likely, in our view,” said the Barclays analysts.
The other point of view – more amenable to mining dividends – is that this is all seasonal.
Iron ore prices went up in March because that is when Chinese buyers come into the market after winter and the new year break. Now, with stocks high, prices have retreated. This trend has been exacerbated by the Covid-19 rule relaxation.
“Of all the commodity markets we cover, it is China’s vast iron ore/steel supply chain that exhibits the strongest seasonal behaviour,” said analysts at investment bank Liberum. This is seasonal in the true sense of the word – China’s real estate sector ramps up after winter, while iron ore exports from Australia and Brazil change more variably given wild weather is more common across December and January in both countries.
This view only applies to Rio and BHP, given the importance of iron ore prices to their profits. Anglo American (AAL) and Glencore (GLEN) have broader portfolios.
It’s clear that the optimism of mining bosses earlier in the year about China’s rebound has not been borne out. But analysts are still bullish on free cash and payouts – the consensus forecast for Rio's free cash flow for this year has climbed from $8.4bn in March to $8.7bn as of this week, and the dividend forecast has rebounded as well.
The variable is how much Xi will put into reversing the poor sentiment and getting China to its gross domestic product (GDP) growth goals. It’s not a sure bet, but we wouldn’t wager against the dragon taking flight again soon.
Additional reporting by Ali Al Enazi
