If you are feeling a little nervous as an investor right now, I’m not surprised. There’s a been a barrage of news lately suggesting we might encounter economic turbulence ahead.
I’m always keen to read what big mining companies such as BHP Group (LSE: BHP) have to say in their outlook statements because the sector has such a vital and early-stage place in supply chains across the world. I reckon if there’s trouble ahead, the big miners are likely to see it coming first.
Big in iron ore
Chief executive Andrew Mackenzie said in today’s full-year report that BHP has started the current trading year “with positive momentum and a strong outlook for both volume and cost.” However, the cynic in me is worried about profits. Production volumes and cost-control measures won’t drive profits higher if commodity prices fall. And prices did fall in the full year to June 2019.
In terms of underlying Earnings before Interest and Tax (EBIT), the firm earned 53% from iron ore in the period, 19% from coal, 15% from copper and 13% from petroleum. So, Iron ore is important to the company, and during the period the price went higher. But after the company’s year-end, Iron ore has plunged, which weakens the outlook for profits in the current year, in my opinion.
Iron ore isn’t the only commodity that’s been falling in price. The oil price slid over the 12-month reporting period along with coal, and copper. And although copper isn’t BHP’s biggest product, I’m more concerned about the fall in its price than any of the other commodities. Indeed, some believe the price of copper is a decent early indicator of impending weakness in the global economy because it has so many uses for electrical applications and other industries.
If demand for copper tails off, goes the argument, general economic activity could be on the wane. However, that’s not a perfect rule of thumb because local factors such as supply constraints can affect the price over a shorter time frame. Meanwhile, BHP said in the report today that copper prices were “heavily influenced” by swings in global trade uncertainty in the second half of the firm’s trading year.
Yet the directors are optimistic about the copper price saying they believe the underlying fundamentals “remain sound.” Copper demand “should” grow steadily, they said, with declines in copper grades, rising input costs, water constraints and “scarcity of high-quality future development opportunities” constraining the industry’s ability to meet growing demand at low cost. That says to me there are pressures that look set to keep the price of copper elevated, but I can’t deny that it’s been in a down-trend, which could continue.
Of the all-important iron ore price, the directors expect it to be “volatile.” And looking at the big economic picture, BHP’s management reckons the growth “profile” has become unbalanced, “with robust expansion in China and the US offsetting weakness in Europe and Japan.”
BHP delivered a decent-looking set of financial numbers today. But, of course, it’s all looking backwards. I see the uncertainty in the outlook statement as something of a warning, so I’m avoiding the stock.
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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.