ASX Resources sector: Cash Cow Boom II
THIS TIME IT IS DIFFERENT – By Henry
Resources – the new formula:
DEBT DOWN + COSTS DOWN + DIVIDENDS UP + NO ACQUISITIONS + SWEAT ASSETS + HIGH COMMODITY PRICES = HAPPY SHAREHOLDERS
This time it is different – How many times have we heard that about markets or a commodity. It is usually a sign that things are no different at all. But looking at the resource sector, maybe it really is different this time, for the immediate future anyway.
There has been a serious change in the resource sector. They have all been listening to shareholders and rewarding them rather than repeat the typical ego-driven dopey acquisition strategy that has tripped them up so many times in the past and risks wasting vast sums of shareholder value.
Fortescue Metals (FMG) is the poster child for this. A one commodity company. It has stuck to its knitting and not heeded the siren call from fee-hungry investment bankers to buy other stuff. Just dig out that iron ore. And it does it very well.
It has been ruthless in driving down costs to around US$13 per wmt and shareholders are now reaping the benefits. Shareholders (Twiggy included) are being showered with dividends. Special, interim, final. It is a bonanza. Luck has played its part in this generosity with the tragic Vale dam collapse in Brazil driving a very strong iron ore price.
This is FMG compared to the iron ore price – an incredible correlation – it begs the question…why bother analysing FMG – it doesn't make a blind bit of difference – if the iron ore price doesn't go up, FMG doesn't go up.
But what is so different this time (for the moment anyway) is that FMG has stuck to its strategy of paying down debt and rewarding shareholders. Nothing fancy. Good management, cost control and a tail wind on the iron ore price. The company will pay around 100c in dividends this year. That is a pretty handy yield.12.5% fully franked. Not quite an income stock because it is cyclical, not reliable (dividends depend on a volatile commodity price) but its certainly an income stock when the iron ore price goes up, because they have decided to hand the cash back to shareholders, and that is the new bit. And they are not Robinson Crusoe either. There are other large dividend payers.
In large-cap land Woodside (WPL) has been a high yielding oil and gas play for some time. 5.5% fully franked from WPL. Great way to play growing oil tensions plus a good yield to keep you interested.
BHP too has listened to its activist shareholder in Elliott Advisers, and is now also rewarding shareholders – they have driven down costs paid back debt and avoided dopey acquisitions. It now pays 4.5% fully franked. It has sold underperforming assets (as Elliott wanted them to) and rewarded shareholders. Special dividends and buybacks a plenty. Could be due for a rally back towards 4000c. Still quality.
RIO too has kept its hands in its pockets. Maybe it learnt from its stupid Alcan purchase at the top of the market. Plus, its Riversdale acquisition (paid $3.9bn and got next to nothing for it) was problematic from the start. It too now pays a 4.3% yield and again fully franked. Heading back to 10000c.
I even heard on Yourmoney TV yesterday that fund managers were now considering miners as income stocks (dangerous thinking – fund managers might but not retirees). They are not. At least not forever. They are not banks. They are cyclical, long duration trading stocks, and not set and forget and pass to your kids. Things do change. You cannot take commodity prices for granted. This is not a sector you buy and hold for the next twenty years.
Many investors do not like mining companies. Setting aside the ethical issues with miners for a minute, the biggest concern is always that it is so hard to predict commodity prices, but on that front, the mining companies have two things going for them:
- Every day there is a published commodity price. You have transparency of the trend in their drivers. Far easier than guessing JB Hi-Fi margins for instance. You can spot the changes in fortune.
- For the companies – commodity prices and production profiles can be hedged. That is what commodity futures are there for.
How easy is it for a widget maker to hedge the price he gets for the product? Not that easy.
For a country that is a huge beneficiary of the mining industry, investors need to embrace the sector at times – it is a simple sector now. We seem happy to embrace the tech sector and pay PE's of hundreds for APT and WTC, but some investors will ignore this now simple, Australian sector which is digging up Australia (literally) and selling it to the World. Shouldn't we all have a piece of that?
For the iron ore price, I have written for some time on the effect that spot prices would have on valuations. There is research going around now, research that we haven't seen since the resources boom, that values our resources stocks using spot instead of forecast prices. On that basis everything is cheap.
Can you buy now? The answer is in the commodity prices – they don't have to go up, BHP, RIO and FMG are cheap if prices just stay where they are. So the question is – how long will prices stay here around US$90. If they go up…that's just icing the cake.
Vale last night announced it was going to spend $3.5bn to expand its 'dry processing' capacity. 'Dry processing' does not use the tailings dams. Is this a tacit admission that 'wet processing' (using dams) is going to be problematic forever. Are we at a process pivot point in iron ore production? If so, that iron ore price is going to be, dare I say it, it was the death knell of the resources boom last time – "stronger for longer". An expression that one CEO turned into "stronger forever" – THAT was the death knell of his share price.
We will see US$100 iron ore soon. It seems inevitable. Some analysts have a valuation over 1000c for FMG if these prices stay here (now 814c).
Remember that the miners produce stuff at US$13 wmt. Sell it for US$100. Pretty good margins and every day it stays here means that commodity analysts will eventually get dragged screaming and kicking into upgrading their forecasts.
One thing is for sure, Twiggy and his excellent team will be just raking in the money. What will they do with it? A decade ago they would blow it on ambition – now they give it to you (which means Twiggy also hands it back to himself). If the iron ore price stays here, there are more dividends to come. FMG are now cum a 60c fully franked special.
And if the iron ore price doesn't keep going up? Unlike JB Hi-Fi's margins, you'll spot it…its quoted for you every single day. All you need is a chart.
Small company footnote:
Looking down the quality list is a company called Jupiter Mines (JMS), which has a cash machine in South Africa in its Tsipi manganese mine. The mine is extremely profitable, and the company just pays out all the profit to shareholders. It has a 100-year mine life. It made a net profit of $142m last year. Record sales of 3.5m tonnes. Manganese prices remained robust. Its payout ratio is 93%. The trouble is that the market just takes these dividends as a capital return and knocks it off the share price. That should change. Good management too and the SA election out of the way.