Mining stocks back in vogue with investors eyeing large cash returns

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This was published 6 years ago

Mining stocks back in vogue with investors eyeing large cash returns

By Darren Gray

Mining companies are back in vogue with investors, with the stocks of a number on the verge of a 12-month high and with analysts recommending, for many, "buy".

Riding the wave of bullish sentiment mid-tier miner South32 closed on Friday at a record closing price of $3.12 per share. And the nation's biggest miners, BHP and Rio Tinto, are in striking range of their 12-month high, even though BHP went ex-dividend just days ago, and Rio went ex-dividend four weeks ago.

BHP closed on Friday at $27.29, compared to a one-year high of $27.89; while Rio closed at $68.50, compared to a one-year high of $69.38.

Optimism has grown in mining stocks as confidence builds about the Chinese economy, strong demand and healthy prices continue for commodities such as iron ore and coal, and the miners and analysts send confident signals about their outlook.

BHP chief executive  Andrew Mackenzie.

BHP chief executive Andrew Mackenzie.Credit: Wayne Taylor

The share prices of resources companies notably outperformed other sectors during reporting season, as the market absorbed some hefty mining profits and shareholder returns.

In a recent report Morgan Stanley Australia's head of equity strategy, Chris Nicol, summed this up.

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"Resources outperformed the market through August by 5.2 per cent, helped by resilient Chinese and global growth momentum, a plateau (above consensus forecasts) in the commodity price deck, and generally positive results augmented by strong cash generation and an increased focus on shareholder returns," he said.

"Among the miners, Rio and S32 delivered strong results, while BHP was forgiven for an EBITDA (earnings before interest, tax, depreciation and amortisation) miss given its strong FCF [free-cash-flow] yield and intention to divest its US onshore petroleum business," he said.

In an interview with Fairfax Media Mr Nicol said miners offered leverage to strong global growth, better commodity prices, and better cash flows, which ultimately resulted in higher returns to shareholders.

"Mining stocks have rallied pretty hard since the middle of July," he said.

"We saw some weakness in the stocks in the early part of the year, as we saw the iron ore price, in particular, retracing. The big difference in the second half of the year is that we've got stability in the commodity deck, and what that allows you to do is take a much firmer view on valuation and also possibly more importantly at this point, a much firmer view on cash generation, and free cash flow yield," he said.

"The commodity prices are supportive, and even at spot prices today there's valuation upside for most of the stocks," he said.

"You're entitled I think as a shareholder of these stocks, to expect and probably receive better dividends and better cash flows, and not over-spending on capital expenditure for things that don't generate returns," he said.

The substantial cash returns unveiled by mining companies last month, and in prospect over the next year or so, are undoubtedly contributing to investor demand. Over the next few weeks miners will pay billions in dividends to investors. In addition, South32 and Rio unveiled major increases in share buybacks.

Even bigger returns are possible in the future, given the emphasis the miners placed on shareholder returns as they reported buoyant commodity prices and some high-profile asset sales.

Rio Tinto had a giant payday on September 1, when it received $US2.45 billion in cash for the sale of Coal and Allied to Yancoal. More cash will flow Rio's way under the deal in royalty payments, including an extra $100 million in 2017.

In a research report released last week UBS analyst Glyn Lawcock said miners were poised to deliver substantial cash returns to shareholders.

"Investors have historically bought mining companies for growth not yield, given the finite nature of their assets, which requires the miners to continually invest in new mines to sustain operations. So while miners may not have the stable cash flow stream of an industrial company, and thus may not be able to sustain high pay-out ratios, we do see the potential for the miners to provide high returns for investors over the next 18 months, perhaps longer.

"Inevitably we believe the call to invest or acquire will become too strong and the industry will follow the path of prior cycles, but until that happens we believe the sector is poised to return a substantial amount of cash to shareholders given prices and margins are driven by supply restraint and not demand," he said.

The outlook for gold miners also seems buoyant, as investors around the world react to the global uncertainty arising from the aggressive behaviour of North Korea, and invest in gold and gold miners.

Australian gold miners are benefiting from this. Shares in Evolution Mining, for instance, closed at $2.66 on Friday, a price not seen since August last year.

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