- BHP and Rio have been able to reduce their cost of production and push higher-cost rivals out of the business.
- BHP and Rio will not only survive the iron ore shakeout, they will eventually be able to prosper from the expanded volumes.
- Uranium hopeful Toro Energy (TOE), could do well on expectations of an improved uranium price.
In trying to lock-in some spice for your portfolio in 2015, it might be worth starting with some of the resources stocks that had a horror year in 2014.
The big guns
Two obvious candidates are the big iron ore miners, BHP and Rio Tinto, which were hammered by the halving of the iron ore price in 2014. BHP lost 22% in Australian trading last year, while Rio Tinto lost 16%. Iron ore is the largest contributor to revenue for both companies – a preponderance more marked at Rio Tinto – and the commodity is well and truly in surplus, as the producers, led by BHP and Rio Tinto, have spent $US120 billion on new mines since 2011, expanding production enough to push the market into surplus in mid-2014, and heading toward a 300 million-tonne over-supply by 2017, according to Goldman Sachs, as demand from China cools.
BHP (BHP)
Source: Yahoo!7 Finance, 5 January 2015
Rio Tinto (RIO)
Source: Yahoo!7 Finance, 5 January 2015
Along with Brazilian producer Vale, BHP and Rio Tinto are trying to use their low cost of production to push higher-cost rivals out of business. UBS estimates that iron ore companies outside these big three need a price of $US90–$US100 a tonne to come into the market, and once built, these projects require about $US60–$US90 per tonne to break even.
BHP and Rio, however, are the world’s lowest-cost iron ore producers, and can make healthy margins even at the current iron ore prices in the low US$70 a tonne level.
Rio Tinto has cash costs of about US$20 a tonne and an all-in (counting all costs) break-even point estimated at about US$55 a tonne. BHP’s cash costs are below US$30 a tonne and falling, and its iron ore business is estimated to break even at US$40 a tonne.
Analysts expect BHP’s earnings to fall by 30% in FY15, although it is predicted to boost its dividend by 4%. Rio Tinto is projected to show a 13% fall in earnings per share when it reports for 2014 (it uses the calendar year as its financial year), and by 10% in 2015: but it too is expected to lift its payout, by 12% for 2014 and by 9% this year.
If all goes to plan, BHP and Rio Tinto will not only survive the iron ore shakeout, they will prosper from the expanded volumes, given their low cost of production. There are certainly some gloomy prognostications in the market concerning Chinese economic growth forecasts – and thus the iron ore price – but it appears that the worst is over in terms of price downside.
The pair can also lean on their diversified commodity portfolios – unlike their major Australian rival, Fortescue Metals. Apart from iron ore, BHP’s global production portfolio includes petroleum (22% of revenue), copper, gold, coking coal, energy coal, aluminium and nickel. The less-diversified Rio Tinto’s portfolio of assets also includes aluminium, coal, copper, diamonds, gold, industrial minerals and uranium. BHP, for example, is shifting the focus of investments in new projects to copper from iron ore to meet demand from China: it expects to increase copper sales to China more than iron ore and is investing in mines in Chile, Peru, North America and Australia (Olympic Dam, in South Australia.)
The upshot of this exposure is that the analysts who follow the companies see both BHP and Rio Tinto bouncing back in 2015. The analysts’ consensus target price on BHP is at $36.98, which is 25% above the current share price. Similarly, the analysts see Rio Tinto moving back to $71.81, which implies 23% upside on the current share price.
Oil stocks to consider
Petroleum producer Santos (STO) is another stock slammed by falling commodity prices, to the extent that it halved in value over the past year. Santos is expected to go backwards in earnings in 2014 (December year-end) and in 2015, but grow its dividends. But Gladstone LNG and the company’s domestic gas contracts decrease Santos’ exposure to oil price volatility, and the stock looks to be hugely over-sold – particularly given its 4.4% projected fully franked yield. The analysts’ consensus target price for Santos, at $12.17, equates to projected 48% upside from current levels.
Santos (STO)
Source: Yahoo!7 Finance, 5 January 2015
Similarly, the market has hammered Origin Energy (ORG), which fell from above $16 in September to current levels around $11.70. Origin is an integrated energy company with oil and gas production as well as retail power and gas distribution business: Origin is also a joint venture partner in the Australia Pacific LNG project (APLNG) at Gladstone, which is due to begin production and export to Asia in mid-2015, and start contributing to revenue.
Origin Energy (ORG)
Source: Yahoo!7 Finance, 5 January 2015
Origin is projected by analysts’ consensus to boost EPS by 29% in FY15, to 62 cents, and lift its DPS from 50 cents to 50.3 cents. But analysts expect a dividend boost to 57.6 cents in FY16, on the back of a 35% boost in EPS to 84 cents. The analysts’ consensus target price for Origin, at $13.99, implies 20% upside from current levels.
Satellite choices
At the more speculative end of the commodities space, it might be worth looking at uranium hopeful Toro Energy (TOE), on expectations of an improved uranium price. Toro has state and commonwealth approval for its Wiluna uranium project in Western Australia, and last month received a $17.5 million investment from private equity resources fund Sentient to help fund the project. Toro is targeting first production from Wiluna in 2017.
Toro Energy (TOE)
Source: Yahoo!7 Finance, 5 January 2015
Sentient joins Oz Minerals and Mega Uranium on the share register of Toro, which has entered 2015 with an estimated $24 million in cash. The stock is highly leveraged to the uranium price, which fell from US$70 a pound just before the Fukushima disaster in March 2011, after which Japan shut down its fleet of nuclear power plants, to US$28 a pound in May 2014, but has recovered slightly, to end 2014 at US$35.25.
What’s happening in uranium is that in November two of Japan’s nuclear reactors were approved to reopen. Longer-term, both China and India have big plans for nuclear power: both countries will require a steady and reliable supply source in the decades to come. China expects to generate 132 gigawatts of nuclear power by 2030, while India forecasts 25% of its energy mix will come from nuclear power by 2040.
According to the Bureau of Resources and Energy Economics (BREE), the uranium price should rebound in 2015 in response to expected higher consumption – not only in Japan but also in China. BREE forecasts a uranium spot price average of US$39.50 in 2015, which is 23% higher than in 2014. Further out, BREE expects uranium prices to increase in response to tighter market supply conditions, to about US$62 a pound in 2019 (that is in 2014 dollars). Toro Energy should benefit from this trend.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.