(The opinions expressed here are those of the author, a
columnist for Reuters.)
By Clyde Russell
JOHANNESBURG, Feb 15 Reuters) - Mining company super profits
appear to be back on the agenda as earnings stand to be
turbo-charged by higher-than-expected prices for iron ore and
other metals, while volumes are also likely to be strong.
It's the stuff of dreams for mining company bosses: high
prices and strong production that can be sold into a rally.
Iron ore has been the standout so far in 2017, and as the
steel-making ingredient surged to its highest level in three
year above $90 a tonne, so too will profits at the three major
producers, Brazil's Vale and the Anglo-Australian
pair of Rio Tinto and BHP Billiton.
Investors have already had a little taste of what may come,
with Rio raising its dividend above market expectations when it
released results last week.
The miner increased its payout to $1.70 a share and
announced a $500 million share buyback, meaning it is paying out
about 70 percent of its underlying earnings to shareholders.
If the company continues with that sort of payout ratio,
shareholders may be in for a bonanza, so long as iron ore, which
accounts for about 90 percent of Rio's earnings, holds up.
A back-of-the-envelope calculation looks something like the
Rio aims to produce about 340 million tonnes of iron ore in
2017. Given a cash cost per tonne under $15 a tonne, it's likely
that Rio can get a tonne delivered to China with all taxes,
royalties and charges paid for something under $30 a tonne.
If the iron ore price averages $75 in 2017, which so far
looks to be a conservative forecast, it means that Rio could
potentially make a profit of about $45 a tonne.
That translates into total profits from iron ore in the
region of $15.3 billion, equating to about $11.17 a share.
Now, it's unlikely that Rio would decide to return all that
cash to shareholders, with some likely to go towards retiring
debt or funding new capital expenditure.
But what is clear is that if iron ore holds its gains in
2017, Rio, and its main competitors, are likely to be extremely
strong generators of cash.
WITH CASH COMES RISKS
Perhaps the Big Three can now even live up to the promise of
strong returns made in the period around 2010-11, when iron ore
prices were strong and instead of returning cash to shareholders
the miners decided to relentlessly expand production.
This resulted in five years of declining iron ore prices,
and struggles for the shares of Rio and its competitors, with
Rio dropping from above A$88 ($66) a share in February 2011 to a
low of A$37.03 in February last year.
Rio shares have enjoyed robust gains since then, jumping 85
percent to a close of A$68.40 on Wednesday in Sydney. It's a
similar story at BHP, with its shares having gained 84 percent
from its January 2016 low to Wednesday's close of A$26.53.
However, while the current situation is clearly bullish for
the iron ore miners, there are risks.
The main risk is that iron ore prices slip back to what the
market believes is more sustainable in the long run, somewhere
around the $60 a tonne mark.
The key is to watch China's imports and any signs of its
domestic iron ore mining sector reviving.
So far imports are holding up well, with January's 92
million tonnes the second-highest on record and a 12 percent
gain from the same month a year ago.
But inventories are high and there are signs that the
authorities in Beijing are serious about cutting excess steel
capacity and limiting pollution from burning coal in blast
furnaces to make steel.
Even if iron ore prices retreat, it's unlikely they will
return to the lows of last year when they came precipitously
close to $30 a tonne.
This means the miners will still likely have plenty of cash.
Investors will no doubt be keen to get their hands on some
of it, given the long wait for returns to arrive, but what
happens once dividends have been lifted.
Money tends to burn a hole in one's pocket, and mining
companies have proven no different to feckless individuals when
it comes to spending.
Equity analysts are likely to start pressurising mining
bosses to show where the next stream of growth is coming from,
and just running operations as efficiently as possible is
unlikely to sate demand for executives to be seen to be doing
something to boost growth.
We may well end up with a repeat of the situation of
ill-advised mergers and acquisitions, or heavy capital spending
on commodities where there is a perceived undersupply, thus
driving them into oversupply.
There is no doubt mining and selling commodities is a
cyclical business, and we may just be at the start of the next
cycle of rising profits followed by investment decisions that in
hindsight look somewhat dodgy.
(At the time of publication Clyde Russell owned shares in
Rio Tinto and BHP Billiton as an investor in a fund.)
(Editing by Tom Hogue)