Miners in the post-COVID-19 world

Given the aggravating COVID-19 disruption, the AlphaValue mining universe has witnessed a major sell-off. However, the base metal pricing correction continues to be less severe. One reason could be markets’ preference to hold on to physical assets – with relatively better (demand) visibility. Moreover, unlike the previous crises, many miners are better-positioned to withstand market uncertainty. Hence, there could be selective plays within the sector.

This note is a continuation of our Latest titled ‘Are there opportunities in a COVID-19-infected mining sector?’ published on 11 March 2020. Some of the key strengths/USPs of the sector and/or companies have been reiterated. Moreover, in this piece we also delve into some sector-specific aspects vs. the previous crises, and why some companies (despite their might) could still be laggards, while the smaller and more-agile firms may do better.

Over the past one month, while China has done exceedingly well to contain the COVID-19 outbreak, the developed world – primarily the US and EU – has been caught on the wrong foot, with their COVID-19 infections and mortality increasing exponentially. Hence, the possibility of a global recession is now imminent. As a result, massive stimulus packages have been announced by various countries. Below is a snippet of how miners (diversified + non-ferrous) and key base metals have fared since the beginning of 2020.

Miners vs. Base Metals vs. STOXX600

Given miners’ deep-cyclicality, it isn’t surprising that their fall exceeds the broader markets. However, the relative resilience of base metals – particularly iron ore (+2.2% ytd) and aluminium (-2.1%) – is intriguing. So what is the explanation for this sustained out-performance?

While earnings growth expectations have been hammered across the board – including for defensives like pharmas, and more severely for macro-sensitive miners, the market’s flight to metals can possibly be explained by the following:
1/ safety of holding physical assets, unlike ‘uberised’ business models – where cash flows are backed by intangibles, whose value may vanish rapidly during acute economic stress;
2/ better long-term demand visibility, unlike oil – where environmental factors shall sooner or later precipitate a material switch to cleaner alternatives;
3/ relatively fragmented global production and, hence, lower risk of price wars, unlike oil – where Saudis have a vested interest in maintaining their production dominance; and
4/ China – consuming >40% of major base metals – so far doing better to contain the COVID-19 outbreak, along with the massive stimulus already underway, supports the case for a relatively-quicker revival of metals as an asset class.

Unlike the last crises of 2008-09 and 2014-15, AV universe miners are better-positioned to withstand prolonged market difficulties due to the following factors:

1/ balance sheets are healthier; 2019-end gearing of 29% vs. 57% and 54% in 2008-09 and 2014-15, respectively;
2/ progressive dividends and hefty share buy-backs were dumped in the last downturn; hence, any dividend rationalisation / suspension in line with profitability erosion may not be very surprising; and
3/ capital spend has been well-under control, with not many (greenfield) projects under development; moreover, biggish acquisitions have been avoided, thereby lowering the risk of impairments.

Below is a quick summary of the respective miners in AV coverage:

BHP Group
Its iron ore exposure is the sole near-term benefit; the new CEO has the challenging task of dealing with coal and oil assets – with divestment / turnaround plans possibly hitting a roadblock; restoration of healthy / stable copper operations should be a key priority.

Rio Tinto
Material iron ore dependence is a blessing in disguise; better-positioned to maintain attractive dividends and scout for attractively-priced growth opportunities; backing of Chinese state-owned Chalco (largest shareholder) could be a tactical advantage vs. other Australian iron ore exporters.

Glencore
COVID-19 macro mess may possibly moderate the extent of on-going regulatory scrutiny; given the market volatility, trading could yet again be a saving grace; however, management needs to figure out a way of dealing with the mess in coal and oil markets, and Copper Africa; current scenario could result in a delayed departure of Ivan Glasenberg.

Anglo American
Resurfacing coal market headwinds, operational difficulties in PGM South Africa and COVID-19 induced further weakness in diamonds are pertinent concerns; while the balance sheet is in a much-better shape vs. the last crisis, ownership of relatively less-cost competent assets may force strategic uncertainty; reconsideration of abandoned disposal plans cannot be ruled out.

Norsk Hydro
Further material performance weakness is inevitable; however, dominance across the value chain supports the long-term green aluminium proposition; oil weakness-induced NOK tailwinds should render some cost comfort; despite operational mayhem, Norsk has one of the strongest balance sheets; presence of the Norwegian State as the largest shareholder is a critical support.

Rusal
Similar to Norsk, further material near-term performance weakness is inevitable; however, an integrated (and greener) business structure – with a big focus on value-added products – is an important long-term USP; oil weakness-induced rouble tailwinds should render cost support; stake in Norilsk Nickel is a prized investment – especially given its healthy dividends, partly compensating for cash flow weakness in core aluminium operations.

Antofagasta
Unlike many large-cap diversified miners, Antofagasta has done well both on the production and (unit) cost front; given copper’s (relatively) controlled supplies, also due to frequent outages and lack of new major growth projects, any sustained sell-off seems difficult; with major growth projects already completed, the group has the flexibility to defer expansions – which may help maintain balance sheet strength, also supported by liquid investments worth >$1.5bn.

Boliden
Strong balance sheet, which is a function of high-quality (and diverse) mining plus smelting assets – no major impairments in more than a decade, and a gearing cushion; while the group’s acute European business dependence has now become a cause for concern – with COVID-19 causing major disruption in the region, simultaneously a weaker Swedish krona (SEK10/USD) and moderate inflation should render an ample near-term cushion.

Eramet
While a degree of recovery is expected in China, nickel prices are expected to stay under pressure; manganese too could face headwinds with steel production curtailments in Europe and the US; the group’s balance sheet is worrisome – forcing us to factor in a c. €300m capital increase; the lithium project in Argentina could (at least) be postponed in our view.Out of all the stocks discussed above, Rio Tinto, Boliden and Antofagasta are still better-positioned in the current macro environment. The aluminium majors Norsk Hydro and Rusal are also pretty compelling at current levels, however, their re-rating should be a function of when a market balance is restored – a scenario which cannot be averted for very long.

While the risk of more earnings rationalisation remains pertinent, miners are perhaps not as bad an investment proposition – given that the world should sooner or later continue consuming base metals, with a lower risk of substitution, for varied economic activities.

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