Time to drill down on miners

Resource companies that are hoarding cash now are setting up conditions for future tightness in the supply of key commodities.

After three tough years in mining, the sector has had to go through significant restructuring.

This transformation has seen the sector move away from its reputation of ‘grow at any cost’ to now being generally in a state of strong capital conservatism, meaning companies are in great financial shape, with buoyant earnings, growing cash flow and robust balance sheets.

Regardless of the gains being made, broader market sentiment has remained decisively ‘yield-centric’, which has seen the majority of the mining sector uncharacteristically divert capital away from pursuing growth in an attempt to bolster shareholder dividends and protect lazy balance sheets.

The long-term impact this will have on future supply of key commodities will be substantial regardless of global economic conditions, and essentially is already lining up the next commodity boom. It will not be long before market forecasts start to reflect tighter future supply conditions.

The best exposure to this scenario is to remain invested in commodities where; 1) no substantial surplus global supply exists and/or plans for new projects are being shelved, 2) consumption growth occurs early in the economic cycle, and 3) where high-margins are common and sustainable.

The three sectors within materials that most readily meet the above criteria are (ranked):

  • Copper
  • Oil & gas
  • Iron ore

Stock exposure:

Amongst the large-cap diversified miners, this preferred commodity exposure can be gained entirely through investing in BHP, while its global peer group of mining majors remain either less diversified or more exposed to less favourable commodities.

Among the pure plays, the same exposure can be gained through investing in the likes of PNA (copper), OSH/SXY/BPT (Oil & Gas) and FMG/BCI (Iron Ore). 

We maintain a more cautious view on the rest of the resources index, where individual stock-picking is required to derive value at this point in the cycle.

Ben Potter is the Retail Editor at Baillieu Holst Ltd