This article represents the views of its author and not necessarily those of ShareSoc.
The last couple of days have seen a jump in the share prices of big miners such as Rio Tinto (RIO) and BHP (BHP). They have risen as much as 5% over the last two days, after falling substantially from their peaks at the start of June. The price of BHP shares has been affected however by the free distribution of shares in Woodside Energy (WDS) on the 1st June to BHP shareholders.
I had a quick look at the current forecasts for RIO and BHP and Stockopedia gives a forward p/e of 5.1 and 6.3 respectively and dividend yields of 14.0% and 13.3%. These are not dividends that are obviously at risk because earnings cover their dividends, so surely the shares appear to be selling at bargain prices? But the reason the shares are apparently cheap is no doubt because they are heavily dependent on the price of iron ore and the demand for steel and copper. In both cases EPS are forecast to fall in 2023. The long-term outlook for copper demand is high as the world electrifies but there is short-term concern about iron ore demand and the price has been falling sharply of late. This is because construction activity in China has been falling and the Chinese Government has taken steps to reduce production of steel.
But as in any commodity market, prices are influenced by two things – demand and production. While demand can vary quickly, production cannot because developing new mines takes years. Production can only respond to demand relatively slowly – that’s why prices of the commodities have been racing ahead.
Investors have the problem of forecasting not just one or two years ahead (because the shares look good value on those horizons) but even further in the future and that is the difficulty. Will the big miners still enjoy a favourable market and political environment with high commodity prices a few years hence? That is the question that investors need to ask themselves.
But the answer is unknowable which is probably why the sector looks cheap. For example, who could have forecast the recent turmoil in the UK political scene and the abrupt departure of a Prime Minister who had won a large electoral mandate just a couple of years ago?
The cover of the BHP Annual Report states “The Future is Clear” (see image above) but that is far from the truth!
The companies mentioned are affected by political events in China which are even more unpredictable. In summary, the companies look cheap because there is great uncertainty about their future. Big miners have looked cheap in the past but then have been hit by economic recessions and investment in new production which came on stream as demand fell. It’s in essence a tricky sector in which to invest. Will big miners continue to show restraint over new capital investment or acquisitions which they have not always done in the past? Will the management forget the history of the sector and expand production based on rising commodity prices?
I already hold the companies mentioned but I am not rushing into buying more of their shares while the worldwide economic outlook looks poor. But investors who desire the dividend income may find them attractive at present.
Roger Lawson (Twitter: https://twitter.com/RogerWLawson