Capturing value in the blue chip mining stocks

By Gabriel Yi, Managing Director of M3 Investment Group.

Investing in blue chip mining stocks requires not only a solid understanding of the supply demand factors of the underlying commodity but also significant patience. Investors and traders can all appreciate that equity markets are irrational at times  and valuations can distort from changing sentiments. However, this distortion tends to be much more prominent in the commodity markets. Iron ore, Steel Rebar, Oil, Copper, Aluminium, Gold – they all tend to overshoot either to the upside or downside dependingInvesting in blue chip mining stocks requires not only a solid understanding of the supply on sentiment.

They are all so reactive to global data such as the PMI and GDP reads from China, the US stock pile data of crude oil inventories, OPEC movements, global uncertainty and foreign exchange volatility. With so many variables in determining commodity prices, it isn’t a surprise that distortion exists in the commodity markets. Now, the whole point of risk minimisation is to reduce the potential variables as much as possible before making an investment and one way to do this is to invest in companies with strong balance sheets, free cash flow and a proven track record of surviving through many troughs in the mining cycle. These are the bluechip mining stocks.

Some examples of blue chip mining stocks that the M3 team has targeted and continue to invest for clients include BHP Billiton (BHP.AX), Rio Tinto (RIO. AX) and Bluescope Steel (BSL.AX). Now before delving into the fundamentals of each company, we first evaluate the wider commodity backdrop and identify the drivers of commodity price movements, specifically iron ore and steel rebar. We have seen iron ore hit US$94.50 a tonne in February 2017 but has since experienced sharp drops due to fears of further tightening of credit in China, possibilities  of a ramp up of production from global iron ore producers and the potential cessation of the restocking process amongst Chinese steel producers. The iron ore price has since dropped below US$55 a tonne. So, what could be the direction of iron ore prices in the coming financial year?

Well, the Chinese government has been active in its crackdown of pollutive steel makers since 2016. They have continued to introduce capacity cuts to control the smog pollution in China and their intention was reaffirmed in May when it was announced that Tangshan city in northern Hebei, the biggest steelmaking region in China, was going to conduct a campaign between May 9 to 31 to suspend and heavily fine the steel mills that fail to meet emission standards. This pushed steel rebar prices up on the potential  of tightening supply, and iron ore prices followed suit. Amongst this tightening supply backdrop, the wider demand story seems to remain intact with China’s “One Belt, One Road” initiative and their ongoing infrastructure investments into urbanisation projects.

President Trump’s proposed “$1 trillion Infrastructure Plan” also adds to the demand story if it actualises.

Now, within the iron ore and steel sectors of the ASX, it is our view that BHP Billiton, RIO Tinto and Bluescope Steel offer positive long term outlooks due to their low cost, high quality assets and significantly improved balance sheets. After surviving the mining sector slump which culminated in multi-year low share prices in early 2016, the management teams have executed cost cutting strategies to substantially reduce the cost of production. The free cash flow for BHP and RIO remains elevated which resulted in strong dividend payouts for H1 – FY 17 and we expect high dividend payouts again for H2 – FY 17.

BHP offers the most diversified commodity exposure, leveraged to iron ore, copper, petroleum and coal. RIO has high quality iron ore, copper and coal assets, while BSL has restructured itself to become a low cost, high grade steel products company with strong global exposure. Bluescope’s Northstar asset has maintained its foothold as a top steel mill in North America and it has continued to benefit from favourable US steel spreads.

At M3, we believe that a top down approach is the most effective strategy when investing in bluechip mining stocks. It involves first identifying the commodities that are likely to have positive tailwinds and then targeting the most fundamentally healthy companies within those sectors. It is important to remember that mining stocks are cyclical in nature, so just conducting company specific research can leave investors vulnerable to being caught on the wrong end of the cycle. BFM

M3 Investment Group is a private wealth management firm specialising in Australian equities. The proactive investment approach implemented by M3 has been designed to help investors capture value in volatile markets. Visit us at m3group.com.au for more information and register your details for a complimentary portfolio consultation.

The content in this article has been prepared without taking into consideration any individual’s particular objectives, financial situation and needs. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

 



Gabriel Yi is Managing Director of M3 Investment Group.


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