The headquarters of BHP Billiton in Melbourne, Australia. BHP and Rio Tinto shares have lost about 10% over the last month, but the impact of the iron ore price slump has been stronger on smaller miners, with African Minerals and London Mining slumping 70% and 50% respectively in the past two months.
Reuters
Investors are facing up to a decline in their lucrative returns from mining shares, as falling prices for iron ore and copper are set to force mining companies to cut their generous dividends.
The change in thinking comes as investors reassess the potential for European shares in general. A multi-year rally has begun to sputter, economic recovery has weakened and $1tn of cash that companies have piled up is coming under scrutiny.
The iron ore price has plunged nearly 40% in 2014. It dropped to a five-year low of $82 a tonne last week on worries over the pace of growth in China - which buys around two-thirds of the world’s iron ore – and a glut of low- production-cost ore from big players like Rio Tinto, BHP Billiton and Vale.
“The fact that iron ore prices have fallen so much and metals prices are weaker – miners will face the pressure to cut their dividends. And this could be more painful for relatively smaller producers,” said John B Smith, senior fund manager at Brown Shipley.
The damage from weaker copper prices, down about 7% this year, and falling iron ore prices on miners’ margins is seen hurting fourth-quarter margins and could spark a wave of dividend cuts, strategists and analysts warned.
The price drop is prompting equity analysts to slash their profit forecasts, in contrast with an overall improving earnings momentum for European companies overall.
According to Thomson Reuters Datastream, mining companies have seen earnings growth slow to its worst in 11 months. Revised earnings per share estimates over a rolling three-month period have been deteriorating since March, and some warned the wave of downgrades is not yet fully reflected in share prices.
“A scenario of iron ore prices staying at around $70-$80 a tonne for a few years is certainly not priced in currently,” Hunter Hillcoat, mining analyst at Investec, said.
“You will see a pressure on margins, cash flows and their ability to return cash to shareholders.”
The UK-listed mining companies feature among the European stocks with the biggest dividend yields, making them must-haves for long-term institutional investors and pension funds. But slumping iron ore prices might change their status, analysts said.
Rio Tinto – whose iron ore division contributes to nearly 70% of the firm’s operating results, according to Barclays analysts - offers a yield of 3.7%. BHP Billiton offers a yield of 4%. Both exceed the average yield of 3.3% for the broader STOXX Europe 600 index.
Rio Tinto’s total dividend rose to $2.8bn in 2013 from $2.1bn in 2011 and BHP Billiton disbursed almost $2.3bn each year in the past three years.
Iron ore’s prices have plunged further and faster than initially expected. Goldman Sachs recently warned the commodity had entered a new phase, saying that 2014 is the inflection point where new production capacity finally catches up with demand growth.
“The end of the Iron Age is here,” Goldman analysts wrote.
The investment bank kept its 2015 iron ore price forecast at $80 a tonne, but slashed its 2016 estimate by 4% to $79 and its 2017 projection by 8% to $78. Rio and BHP shares have lost about 10% over the last month, but the impact has been stronger on smaller miners, with African Minerals and London Mining slumping 70% and 50% respectively in the past two months.
“If you really want to see whether damage has been done, look at small-cap miners like African Minerals or London Mining. It’s hugely negative,” Paul Gait, mining analyst at Sanford Bernstein, said.
The drop in prices claimed its first casualty last week in Australia, sending fledgling miner Western Desert Resources Ltd into administration after it had failed to reach a deal with bankers over its debt. Analysts warned that many other small to medium-size producers could soon feel the pain of the price slump.
UBS estimated at current prices junior Australian miners Gindalbie Metals Ltd, Grange Resources Ltd and Atlas Iron Ltd were making losses.
“Life will be difficult for the smaller players as the bigger ones will reduce capex and investment for some time to come,” Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets in Brussels, said.
