The sharp downturn in the commodity markets since the start of the year has pulled down the shares in many mining companies to near record lows.
Looking ahead, investors should not expect a quick rebound as the fundamentals are weak. Analysts expect that the prices for most metals — in particular iron ore, copper and nickel — will remain low throughout the rest of the year and possibly beyond, putting pressure on company valuations and dividend outlooks.
Possible dividend cut
BHP Billiton (LSE: BLT) could announce a dividend cut when it announces its interim results on 13 February. Its revenues and cash flows look set to drop dramatically this year, and its dividend would need to be mostly funded by additional borrowing, rather than organic free cash flow generation. Such a move may already be anticipated by the market, as its shares already yield more than 12%.
Instead, a dividend cut could be positive in the long term. Commodity assets have substantially fallen in value over recent months, and BHP could take advantage of these lower asset values to beef up its dominant market position and look to gain from synergies and improve cost efficiency.
The company has already done much to reduce costs and increase production volumes on its own. But making further cost cuts and squeezing more production whilst keeping capital spending under control will become more difficult, as the easier choices have already been made. In order to improve its operating efficiency and lower costs further, BHP may need a new strategy.
Near term, I expect there would be few catalysts to help its share price. Valuation multiples are unimpressive and the dividend uncertainty does not help. Analysts expect the company to generate 34p a share in underlying EPS, which gives it a forward P/E of 24.0.
Rival Rio Tinto (LSE: RIO), which currently yields almost 9%, should be able to maintain its dividend for at least a year or two. By focussing heavily on iron ore, it has benefited from more resilient profitability and stronger free cash flow generation. This is because iron ore prices have been more resilient lately and the margins for the metal in low cost regions is generally much wider than that of other metals.
Rio Tinto’s shortfall in free cash flow for its dividend and capital spending needs will likely be only in the hundred of millions this year, rather than multi-billion figure that BHP will likely face. What’s more, Rio has much less debt than BHP and almost all of its large-cap rivals. Its net debt to adjusted EBITDA ratio is just 0.6x, compared to BHP’s 1.1.
Its valuation multiples are more appealing too, and it could be cause for further outperformance relative to its peers. Analysts expect the company will earn 173p per share in underlying earnings, which gives it a forward P/E of just 12.1.
Small-cap silver miner Hochschild Mining (LSE: HOC), which recently raised £64.8m through a rights issue, is ramping up of production from its Inmaculada mine. This has done much to lower its overall all-in sustaining production cost, which fell from $17 per ounce in 2014 to around $13-14 by the end of 2015.
This is still barely above today’s spot price of $14.30 per ounce, but the company has hedged just under half of its 2015 production at $17.75 per ounce, and 41% of this year’s expected production at $15.93 per ounce. Furthermore, productions costs are expected to continue to improve, and, in the medium term, the company expects to achieve an all-in sustaining production cost of around $10.4 per ounce.
This should mean that Hochschild will return to profitability by this year, but unfortunately valuations are still pricey. Hochschild trades at a huge forward P/E of 83.9 and so there appear to be better opportunities elsewhere.