EUR 850.00 For Business Accounts Only

Morningstar | Bulk Commodity Prices Defying Longer-Term Risks and Major Miners Remain Overvalued

We still see significant risks for the miners and think the stocks overall are overvalued. Buoyant commodity and share prices do not reflect the inevitable shift in China’s economic growth toward less commodity-consuming activities, and the market has taken too much comfort from the stimulus-fuelled recovery. The underlying sources of instability--poor-quality lending in China and growing leverage are yet to be addressed. We see the greatest overvaluation among the bulk miners--those exposed to iron ore, coking coal, and thermal coal. Prices for those commodities remain elevated.

Overall, we still see the sector as overvalued. The global major miners Anglo American, BHP, Glencore, Rio Tinto, Teck Resources, and Vale trade at an average 38% premium to our fair value estimates, based on Oct. 11 closing prices. Of the major miners, Vale is now the most expensive given its exposure to higher-grade iron ore, which is enjoying premium pricing. The London-listed shares of BHP, at a 13% premium to our fair value estimate, are the least expensive of the major miners, reflecting oil exposure where we are relatively more optimistic and less exposure to iron ore relative to Rio Tinto and Vale.

All these mining firms are rated no-moat. We raise our fair value estimate for Rio Tinto plc by 4% to GBX 2,800 per share, reflecting higher near-term iron ore prices. For Vale, it increases 6% to $9.40 per share with higher near-term iron ore prices and pellet premiums. Our Anglo American valuation is up 3% to GBX 1,150 per share, with increased near-term coal prices and a higher spot palladium price, partly offset by a lower spot platinum price. Our valuation for Glencore falls 4% to GBX 240 per share with higher near-term coal prices outweighed by average declines in the spot prices of nickel, zinc, lead, and cobalt of 13%. Our BHP Plc fair value estimate is unchanged at GBX 1,380 per share.

The bulk-focused miners have generally withstood recent market volatility so far, most posting share price gains since the end of June thanks to strong underlying prices for iron ore and coal. Vale has been a stand out, up 20% since the end of June, reflecting the continued strength of the iron ore price and elevated premiums for high-grade ores and pellets. Base metals-focused miners Glencore and Teck are down 11% and 5%, respectively, since the end of June with weakness in the price of zinc, lead, nickel, copper, and cobalt weighing.

We now think Vale is the most expensive of the large miners, trading at a 59% premium to our $9.40 per share fair value estimate. The overvaluation reflects Vale’s high exposure to iron ore and bloated premiums for high-grade ore and pellets, which we think are unlikely to last once steel margins in China normalise. We are most bearish on iron ore as we expect China to reduce its steel consumption and for a growing amount of steel to be made from scrap. BHP plc is the least expensive of the large miners, and trades at a 13% premium to our GBX 1,380 per share fair value estimate. We think BHP is less expensive given a smaller exposure to iron ore, and the addition of oil to the portfolio where we are relatively more optimistic on the outlook. The Australian listed shares of BHP and Rio Tinto continue to trade at substantial premiums at least 15% to the London listed plc shares.

The changes to our fair value estimates for large diversified miners have been relatively small, averaging a 1.6% rise. The increases are noticeably higher for the Australian listed shares with the lower AUD/USD exchange rate of 0.71 a benefit for these share classes on translation of U.S. dollar earnings and commodity prices. The largest change was for Rio Tinto limited shares, up 8% to AUD 52 per share now.

The main changes to our commodity price forecasts have been to incorporate higher near-term prices for coal and iron ore, due to strong seasonal demand from China and disruptions to their domestic coal supply, and the reduction in spot prices for some base metals such as nickel and zinc.

The key changes to our base metals’ forecasts are increased near-term aluminium and alumina price forecasts and lower lead, zinc and nickel spot prices. The latter have declined 15%, 3% and 10% respectively. The last few months have been volatile for base metals with copper selling off more than 20% from early July highs, only to recover some of the losses more recently. Overall, though we’ve not made any changes to our near-term or longer-term copper forecasts. Aluminium has yo-yoed on news around potential supply disruptions, tariffs and a broader economic slowdown in China and global trade. Nickel and zinc have sold off on concerns around supply, with China investing heavily in Indonesia to boost output of nickel and zinc supply increasing in response to recent decade-high prices.

We’ve increased our near-term bulk commodity price forecasts, reflecting strong steel output this year and coal production interruptions in China. We’ve increased our metallurgical coal forecasts by 6% on average to 2020, for iron ore by 10% on average to 2020 and for thermal coal by just 3% in 2019. However, longer-term we see the bulks as having the greatest downside as steel production in China slowly contracts and a greater proportion of steel is produced from scrap, at the expense of demand for iron ore and coking coal. We also expect China’s coal supply to normalise as environmental and safety disruptions work through and new mines are added.

Thermal coal prices have been very favourable, thanks to buoyant import demand from China. The hot summer created seasonally strong demand while a tightening in its own domestic supply on environmental and safety grounds necessitated demand from the seaborne market. Coupled with the weaker Australian dollar, thermal coal prices in Australian dollars are above the previous China-boom high. Steel production has also been strong in the lead up to winter curtailments in China. This has supported iron ore prices. Metallurgical coal prices have also benefited from a reduction in domestic output from China as well as disruptions to supply such as the fire at North Goonyella.