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Big Miners Approach Peak Cash. Downhill From Here?

Three of the world’s biggest mining companies, BHP, Rio Tinto and Fortescue Metals Group, are approaching a tipping point which could see sharp share-price corrections as an era of rising profits and generous dividends comes to an end.

China’s slowdown caused by the mass quarantine of large sections of its economy as part of the fight against the COVID-19 coronavirus is one, but not the only problem confronting the miners.

An equally serious problem is that growth opportunities have been sacrificed in order to shower shareholders with cash rewards in the form of high dividends and share buybacks.

Dividends v Growth Trade Off

A glimpse of the dividends v growth trade off will be evident over the next few days as BHP and Fortescue, which rely heavily on iron ore sales to China for their profits, report earnings for the six months to December 31. Rio Tinto follows next week with its annual profit result.

Until mid-January investors were keenly bidding up the big miners in anticipation of fat financial returns as profits from an inflated iron ore price generated dividend yields approaching 10%.

That tempting yield at a time of super-low interest rates was made possible partly because of an iron ore shortage which followed a series of accidents in Brazil that limited shipments to China with the result being that a long forecast fall in the iron ore price was delayed.

Iron Ore Heading South

Instead of contracting back to around $60 a ton the steel-making mineral clung to $90/t, but if the latest forecasts are correct a decline to $60/t might have started as China’s demand for steel slows and stockpiles of ore are replenished.

The net result of what’s happening is that investors have continued to buy BHP, Rio Tinto and Fortescue as they chase yield from the dividends to be paid from earnings generated last year and despite signs of a significant profit slowdown this year.

Investment banks are growing increasingly wary of the big miners even if small investors continue to buy in the belief that the dividend streams can be maintained.

RBC Capital Markets, a Canadian bank, was one of the first to call time on the dividend-hunting game, warning clients late last week that iron ore prices are likely to fall significantly this year, cutting profits and share prices.

The Coronavirus Bites

“Following an assessment of the impact of the coronavirus we no longer expect a high iron ore price environment in the first half (of 2020),” RBC said.

Before it published its latest view of Rio Tinto, RBC had been tipping a decline in the miner’s share price from around $65 to $56, but after assessing the impact of the virus the bank cut its price forecast to $50 and advised clients to sell.

Perhaps most tellingly, RBC said “rolling off the high iron ore prices leaves a financial situation more reflective of the long-term.”

In other words, the good times created by Chinese demand and Brazilian export restrictions have come to an end with the primary share-price support now resting in the miners being able to continue paying high dividends, an increasingly difficult task as cash is returned to shareholders and not invested in new mines.

Peak Maturity

Another investment bank, Citi, waded into the dividend v growth debate earlier this week in a report which hinted at the big miners reaching “peak maturity” in the commodity price and earnings cycle.

“We’ve argued in past (research) notes that the large diversified miners are rapidly becoming, or have become, low-growth cyclicals,” Citi said.

The bank argued that BHP and Rio Tinto had been able to outperform smaller miners over the long term because of their ability to grow their production bases.

“But we don’t see this going forward,” Citi said, before posing a question: “so, should investors now own BHP or Rio Tinto?”

Buy Only If Dividends Can Be Maintained

The answer from Citi was ambivalent: buy only if dividends can be attractive enough, “and that requires sustained high payout ratios which will re-affirm low production growth rate, in our view.”

A final parting shot from Citi equated the big miners with major oil producers.

“This debate feels all too familiar. Did anyone mention big oil?”
Source: Forbes

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