Rising costs, royalty demands and deflated iron ore and copper prices have seen analysts slam the brakes on earnings growth forecasts at BHP (BHP) and Rio Tinto (RIO) after two years of record numbers and payouts for investors. There are some bright spots through new projects and the hope that Chinese stimulus will bring back the iron ore price in the second half, but the overall picture is for a straightened period to come.
Beyond the obvious drop in copper and iron ore prices, key macroeconomic indicators are not going the miners’ way. Last week, China's National Bureau of Statistics announced June quarter GDP growth of just 0.4 per cent, the lowest since Q1 2020. This is a key metric for miners as the construction and industrial sectors are drivers of China’s GDP growth and the major source of steel demand.
BHP also warned shareholders about rising costs hitting next year’s earnings and the impact of a new coal royalty in Queensland. “Broader market volatility continues and we expect the lag effect of inflationary pressures to continue through the 2023 financial year, along with labour market tightness and supply chain constraints,” said chief executive Mike Henry, who was optimistic on the prospect of Chinese stimulus coming through in the second half of this calendar year.
The energy crisis hit costs through the high price of diesel (one of the top risers this year in commodity markets), but BHP held on to gains from this through its coal production, although Henry also hit out at the Queensland government for raising its royalty rate (at current high prices) from 7 per cent to 19 per cent.
Another positive for the Big Australian was a good year for copper production, but overall it was not happy reading for investors.
“In what was a fairly monumental year for BHP with the successful unification and petroleum spin out, today’s result will take the shine off of this to an extent heading into its financial year results on August 16,” said RBC Capital Markets analyst Tyler Broda. He pointed to disappointing iron ore numbers, as well as new guidance for the 12 months ending June 2023. In this past year, iron ore came in below expectations in terms of tonnage (down 2 per cent in the fourth quarter against consensus forecasts) and price, which was $5 down on the forecast of $118 a tonne.
In its own outlook, Rio said economic stability was a focus of Xi Jinping’s government but that headwinds were “considerable from restricted labour and goods movement and a slowing external environment”.
Rio did not have a coal boost after selling out of the fossil fuel and steelmaking ingredient, and it has higher exposure to the iron ore price.
In its first half the miner celebrated the start of production at the Guidai-Darri iron ore mine in the Pilbara. It was another negative report for Broda, however. "Another period with a lack of operational momentum doesn't help in this type of market," he said.
What next
The key, as always, is Chinese demand going into the second half of this year.
But BMO Capital Markets analyst Colin Hamilton notes a year-on-year demand drop in the first-half for steel, aluminium, copper and zinc indicates a correction has been on the way for some months. “It is perhaps surprising that metals prices remained so strong for much of the year before the recent collapse,” he added.
President Xi has the reins, as usual, so the miners can control their costs and try and keep the margin erosion to a minimum. Both Rio and BHP have been running at over 50 per cent for the past year thanks to the metals bull market, so there is room to breathe. This is even ahead of during the early 2010s mining boom, according to FactSet data. For iron ore, this figure goes to over 70 per cent for both companies.
In terms of share prices, BHP and Rio are the "most priced-in for a recession" out of the majors, said Bernstein analyst Bob Brackett. Recessions usually saw metals prices drop below the majority of the sector's cash costs, therefore shutting down supply as mines get too expensive to operate, and eventually pushing prices back up again. That is unlikely this time: "Given the tightness in the physical market (low inventories, supply chain issues) and the continuing energy crunch, metal prices should be supported at or above the 90th percentile cash costs," Brackett said. "If metals do fall considerably below cash costs it could prove to be a generational buying opportunity for the sector."
We are bullish on BHP and see more risk in Rio's portfolio. Buy BHP, hold Rio.
Last IC View (BHP): Buy, 2,473p, 15 Feb 2022
Last IC View: (Rio Tinto): Hold, 5,705p, 23 Feb 2022
