Appreciating mineral prices - and how they affect companies' prospectsPublished by MAC on 2009-05-27
National currency appreciation in mineral-dependent states is conventionally "bad news" for mining companies, which are heavily reliant on exports priced in dollars.
While fluctuations in exchange rates have, in recent years, often not had major impacts on companies' fortunes and been dealt with fairly swiftly by national banks, the rising strength of Australian and Canadian dollars and the South African rand, is now causing the industry concern.
The Australian dollar has appreciated by as much as 23% against the US dollar since March, while Rio Tinto recently said that a mere 10% move would reduce its underlying earnings by $502-million.
So - don't believe all you're told about the recent rise in metal prices directly benefiting miners' balance sheets.
Perhaps, too, lend a little more credibility to those "analysts" who, over the past couple of years of economic recession, have suggested that currencies should returned to being backed by gold - worrisome though that may well be.
[Comment by Nostromo Research, 22 May 2009]
Strong currencies to hit mining firms' profits
22nd May 2009
LONDON - Sharply stronger currencies in metals-producing nations is wiping out much of the benefit of higher prices for mining companies, leaving their buoyant share prices vulnerable to earnings disappointment.
Currencies have shot up in major producer nations, including the top miners of iron-ore, copper and platinum - Australia, Chile and South Africa.
South Africa has seen a particularly big swing, with the rand jumping 27% over the past two-and-a-half months.
Since commodities are sold in dollars, a stronger currency where they are mined boosts costs and hurts margins.
Investors who have sent shares in the mining sector soaring on the back of a rebound in metals prices might be in for a rude surprise when they see the bottom line in upcoming results, as many analysts have not yet adjusted their earnings forecasts to account for the currency movements.
"If you look at consensus forecasts, there's a real risk that everybody is sitting with real weak rand forecasts," said analyst Leon Esterhuizen at RBC Capital Markets in London.
"The consensus forecasts are way out of the ballpark. They're going to have to halve them if the rand stays where it is."
Prices of platinum and copper, which are key for the auto and construction industries, have rebounded by 24% and 48%, respectively, this year.
Shares of mining companies have been lifted by the resurgence in underlying commodities; the UK mining index has gained 37% this year, and Rio Tinto has soared 87%.
A good deal of the revival in share prices is justified since the shares had probably overshot on the downside after the sudden collapse of demand and prices late last year, but many of the prices may not be reflecting the stronger currencies.
"Earnings momentum in the UK mining sector has stalled somewhat in the past month. Commodity prices are now drifting, plus local FX rates have gone the wrong way over the same period, making 2010 valuations look a little stretched," said analyst Michael Rawlinson of Liberum Capital.
Of the major diversified mining groups, BHP Billiton looks the most expensive in terms of its price-earnings ratio of 18,8, he added in a note on Thursday.
Anglo American had a PE of 14,5, based on estimated 2010 earnings assuming current spot prices, Xstrata was on 14,4 and Rio Tinto at 13,7, Rawlinson added.
Companies with heavy exposure to South Africa, such as the world's biggest platinum producer, Anglo Platinum, are expected to be worst hit due to the rand's sharp moves.
"It's been particularly harsh for the platinum producers," said analyst Rebecca O'Dywer at Investec Securities in London.
"Although the platinum price has strengthened, almost all the increase in the platinum price has been offset by the rand strength, so life today is almost as difficult as it was in February when platinum was less than $1 000 an ounce."
Platinum is currently around $1 150/oz, having hit a low of $732,50/oz in October.
Gem Diamonds warned on Tuesday in a trading update that its costs would be hit by the strength of currencies in southern Africa and Australia.
Of the major diversified mining groups, Anglo American is probably the most exposed due to its heavy presence in South Africa. It owns 80% of Anglo Platinum and has a 45% stake in De Beers, which operates in Southern Africa.
Last year, South Africa accounted for 42% of Anglo's revenue and 55% of operating profit.
"Anglo is likely to be more affected than BHP because Anglo Platinum is a big part of the business and Anglo Platinum is already struggling with margins. BHP has a lot of petroleum production, which has dollar costs and dollar prices," said Des Kilalea at RBC Capital Markets.
BHP, the world's biggest mining group, Rio Tinto and Xstrata have exposure to the Australian and Canadian dollars, which have appreciated by 23% and 15%, respectively, since early March.
In data provided to analysts to help model 2009 earnings, Rio has said that a 10% move in the Australian dollar against the US dollar would hit underlying earnings by $502-million, and a similar change in the Canadian dollar would make a $215-million hole.
Rio posted a 38% jump in underlying earnings of $10,3-billion in 2008.
BHP has provided background data showing that each cent change in the Australian dollar will affect its 2009 net profit after tax by $80-million and each 20 cent move in the rand will hit the bottom line by $25-million.
BHP posted after tax profit for its fiscal year to end June 2008 of $15,96-billion, up 18%.