The big picture for the big miners

The top five miners are cash-flow generating machines. Collectively BHP, Rio Tinto, Newcrest Mining, Fortescue and South 32 are projected by Bloomberg to generate net profits after tax of $33.5 billion in the 2020 calendar year, or close to $100 million per day. 

This supports an eye-watering c.$27bn in free cash flow; that’s operating cash after tax and after deducting sustaining and growth capital expenditure. They have low debt and the cash conversion is a very high 80% of net profits, reflecting high depreciation levels and conservative levels of capital expenditure.

The story behind this wall of cash flow is really driven by the Australian iron ore mines owned by BHP, Rio Tinto and Fortescue, with some 55% to 60% of net profit after tax (NPAT) sourced from these assets, driven by iron ore demand from China. 

So clearly the health of the Chinese economy is the most important factor for the major miners in 2020 and a slowdown in construction spending would quickly impact this picture. We expect iron ore prices to moderate in 2020, with Vuma consensus prices expected to fall from US$91/t to US$80/t, as supply restarts from Vale’s operations in Brazil. So iron ore is incredibly important for next year. 

No less important will be the gains to be made in ESG matters, as resource companies seek to persuade communities, investors and society in general that they can deliver the resources required to support a modern society (transport, housing, manufacturing, renewable energy), but in a way that creates value for all concerned. This is a big ask and how the likes of BHP and Rio Tinto shows signs of delivery will be closely watched. 

Free cash flow for this group ranges from 8% to 12%, with sustained dividend yields around 7% and the potential for special dividends or buybacks with further asset sales or sustained iron ore prices.

Global fiscal stimulus likely to be a key driver

Luke Smith, Ausbil Investment Management 

The natural resources sector is likely to still be dominated by the ongoing trade war between the US and China over the course of 2020. The outlook is more promising, with the potential for a phase-1 deal to be finalised in the near term, however, we remain cautious given the history of false starts in negotiations. More certainty with regards to trade and the resultant stability in economic growth should be supportive for commodities demand.

The potential for global fiscal stimulus has the potential to underpin global commodities demand, and this is likely to be a key driver for the natural resources space. In general, supply for most commodities is constrained in the short to medium term, and therefore fiscal stimulus would support commodities demand, leading to higher pricing. Fiscal stimulus is possible within China, should the economy deteriorate further, while western world rhetoric is also increasing.

Finally, updates on key projects will be the third key driver for the large-cap diversified miners. 

• For Rio, the focus is likely to be on the troubled Oyu Tolgoi Copper development in Mongolia. The project has experienced complicated issues mid-development, with a resolution yet to be understood by the company and the implications on capital expenditure and timeline overruns similarly uncertain.
• While for BHP, the market focus will be on the potential sanctioning of the Jansen Potash stage-1 development. The market perceives this development to be value destructive and, unfortunately, it appears all but certain that the company will progress with the project.

The large miners continue to generate significant free cash flow in the current environment, and the focus from boards remains on capital management, a theme we expect to continue.

3 key drivers next year

Peter Gardner, Plato Investment Management

Three of the biggest drivers for the big miners next year include:

1) The iron ore price: We are expecting the iron ore price to gradually reduce as supply comes back online, but by less than the market seems to anticipate, based on the current prices of BHP, RIO and FMG. We think Chinese infrastructure spending will stay high or even increase as their economy weakens, which will increase demand for steel and thus iron ore.

2) New marine standards for fuel: The new marine standards for shipping fuels (aiming to reduce sulphur content) increases the cost of shipping. This is a relative advantage for Australian iron ore producers compared to Brazilian producers, given the much shorter distance to ship to China.

3) Various development projects: FMG is developing a new mine with a high-quality iron ore to mix with existing lower quality ore. If that process can be successful, then it reduces their risk going forward.