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No end in sight to slide in base metals mining profits
By Eric Onstad
Reuters
Monday, January 26, 2009
LONDON - Earnings forecasts for major
diversified mining firms have tumbled but calling a bottom
may be premature due to risks from further falls in metals
prices, output cuts and asset writedowns.
With some prices appearing to have stabilised and company
valuations at rock-bottom, investors may be tempted
to restock portfolios with mining shares.
But even a small further fall in prices will increase the strain
on profits, compounded by lagging effects from pricing
formulas and annual contracts.
"We still see significant downside risk to prices and earnings
for the sector," Citigroup analyst Heath Jansen said.
"Calling the depth and severity of this downturn may be
near impossible. Nevertheless historical commodity bear
markets have lasted two to three years."
Annual 2009 earnings per share forecasts for the world's
biggest mining group, BHP Billiton, have halved over the
last six months to $2.25 from $4.53, according to Reuters
Knowledge.
For each cent per pound (lb) the aluminium price falls, BHP
says its 2009 net profit will slide by $25 million.
That means a $240 million hit to the bottom line from the
aluminium price alone over the past two weeks -- and that's
only one among many in BHP's portfolio of metals.
MORE CUTBACKS
Earnings are not only threatened by prices, but volumes are
likely to decline further as miners close more loss-making
operations to whittle down surpluses and inventories.
Among recent moves, BHP said on Wednesday it was closing
its giant Ravensthorpe nickel mine in Australia while Rio
Tinto said a day earlier it was boosting cuts in aluminium
output to 11 percent of capacity from 5 percent.
Citigroup's Jansen has pencilled in companies making further
production cutbacks for 2009 of around 5 percent.
Theory says commodity prices should stabilise when they
reach the marginal cost of production, when a certain percentage
of mine production is loss-making. Analysts peg it
at different levels for each commodity, ranging from 15 to
30 percent.
The global downturn, however, has cut input costs, lowering
the bar and potentially forcing deeper cuts.
UNCERTAIN STIMULUS, LAG EFFECTS
Some investors are counting on economic stimulus plans
by governments to kick in during the second half of the
year, but predicting a metals recovery is fraught with difficulties.
Infrastructure spending by governments may only gradually
seep through to mining since the depth of the downturn
and ongoing credit problems could create a drag on implementation.
"Given this economic downturn is unique in recent history,
we support the view that the coordinated actions of central
banks and governments should result in a rebound in the
global economy by 2010," RBC Capital Markets said in a
research note.
The impact of falling metals prices continues to hurt miners'
profits even after they stabilise due to the way some
commodities are sold under contracts, and in others because
of the way prices are revised during smelting and
refining.
The lag effect for contracts will mean that weaker prices in
iron ore and coal will only hit firms from April, when new
contracts take effect.
In metals like copper, companies use "provisional pricing"
and record the metal price in effect when shipping a concentrate
to calculate profits.
Several months later after the concentrate is smelted and
refined, typically the following quarter, final pricing occurs
and adjustments are made for any changes in metals prices.
BHP said on Wednesday final pricing during the three
months to December on 327,941 tonnes of copper would
cut earnings by $1.3 billion, which some analysts said was
higher than expected.
Xstrata, a major producer of both copper and zinc, is expected
to record large negative price adjustments in the
second half of 2008, but the effect will be less at Rio Tinto
since it sells a good deal of its copper and molybdenum as
metal rather than concentrate, BMO Capital Markets said in
a note.
In one recent extreme case, small Australian copper miner
Maxtrix Metals Ltd appointed administrators in November
when it got notices of provisional pricing adjustments and
could not afford the rebate.
Firms may also be forced to make writedowns on assets
after a wave of acquisitions when prices were much higher.
BHP said earlier this week it was writing off $1.6 billion for
the Ravensthorpe mine it closed.
Jansen at Citigroup said Rio may be forced to write down
assets for its takeover of Alcan and Xstrata may be susceptible
for writedowns after buying Falconbridge and Jubliee.
Impairments are non-cash charges, so they have no impact
on cash flow, but they hit reported profit.
The Midas Junior Canadian Gold Portfolio is up 21% since being announced on January 5th. (see below)
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