Drilling
In assessing the demand for drilling services UBS consulted several companies, which have indicated Canada and Australia are close to full capacity. South America and Asia continue to face delays and disruptions related to the pandemic.
The improvement in demand is being supported by the strength in commodity prices, particularly gold and copper, elevated capital raisings and the need to replace depleted reserves.
Nevertheless, UBS ascertains that to meet the increased level of demand will be a challenge as there is a shortage of drill rigs in some regions. Boart Longyear ((BLY)) highlighted border closures and travel restrictions are the main reasons for the skill shortage.
The implications for the lab testing volumes of ALS ((ALQ)) are significant and ALS plans to add around 15% in laboratory capacity to its network in FY22.
In assessing supply/demand on mining services, Canaccord Genuity initiates coverage on DDH1 ((DDH)), Emeco Holdings ((EHL)), MacMahon Holdings ((MAH)), all with Buy ratings, and NRW Holdings ((NWH)) with a Hold rating.
The broker anticipates a sustained increase in mineral investment, which should provide plenty of demand for services through the cycle, from exploration through to construction and production. Moreover, the balance sheets of major miners are stronger than they have been for a decade although labour costs have risen and availability has tightened.
Hence, Canaccord takes a cautious stance regarding the industry’s cost base and its estimates are generally below consensus for FY21 and FY22 yet believes there is still plenty of value on offer in the sector.
Thermal Coal
Credit Suisse has revised up its Newcastle thermal coal price estimate to US$100/t in FY22 and reviewed both Whitehaven Coal ((WHC)) and New Hope Corp ((NHC)). The Japanese reference price, traditionally reflecting a small premium to spot, was recently settled at US$109.97/t and both sell 40-50% of their thermal product to Japan.
Additionally, as the global market is stretched, the broker anticipates pricing/earnings upside if supply problems linger. Whitehaven Coal has downgraded FY21 production guidance to 20.4mt as output from Narrabri has continued to experience operational issues.
Nevertheless, Credit Suisse believes current thermal coal prices should provide enough of a buffer to offset the potential volume risks, and the decline in the share price is too punitive. The broker upgrades New Hope to Outperform, supported by favourable supply/demand fundamentals and the expectation thermal coal prices will remain strong into 2022.
Base metals
Despite a sharp increase in commodity prices in the June quarter, UBS does not believe a commodity super-cycle is occurring. The broker asserts that rising US bond yields amid declining inflation expectations could be a negative environment for industrial metals.
UBS notes China is planning to sell strategic copper/aluminium/zinc reserves, highlighting a willingness to use tools at its disposal to deflate commodity prices. While remaining fundamentally constructive on copper over the medium term, the broker expects prices will retrace a further -20% and US$3.50/lb is a more attractive entry level for the red metal.
Furthermore, UBS believes, while LME (London Metal Exchange) inventory is not as useful an indicator of industrial inventory as it has been in the past, a lift in June potentially signals the end of restocking and does not point to physical tightness in the copper market.
In aluminium, the broker expects a fundamental deficit in 2022-23. Nevertheless, confidence that China will limit output at 45mt has increased over the last 6-9 months and this has improved the outlook for aluminium.
For zinc, exchange inventory is up around 40%, driven by inflow to both LME and Shanghai warehouses. The broker acknowledges the lack of reliable data for non-exchange zinc inventory and suspects a lift in LME inventory highlights the existence of significant unreported zinc.
In contrast, Ord Minnett increases forecasts despite the news China will look to sell stockpiles to cool the market. The broker increases 2022-23 copper price estimates by 10% and aluminium price estimates by 7-10%.
The broker observes forward curves for gold and silver have moved up, boosting earnings by 4-18% and retains a preference for Newcrest Mining ((NCM)) and Northern Star Resources ((NST)) in the sector.
In the current environment, UBS does not recommend buying gold, expecting declining inflation expectations and rising bond yields will result in increases to real rates, leaving the risk/reward for gold skewed to the downside.
Iron Ore
UBS downgrades Rio Tinto ((RIO)) to Sell from Neutral, noting the stock has generated a total shareholder return of 79% over the past year, driven by the strong iron ore price and record cash returns.
The broker believes current cash flow in dividends are not sustainable, anticipating the iron ore price will fall by more than -50% over the next 12-18 months, and does not consider the stock compelling at a normalised iron ore price.
The near-term risks for commodity complex are increasing as the US Federal Reserve turns more hawkish and China takes action to deflate commodity prices. Iron ore is approaching an inflection point, UBS asserts, noting Brazilian supply is lifting and iron ore inventory at China’s ports is now higher compared with both 2019 and 2020.
Ord Minnett notes iron ore prices have averaged US$207/t since the beginning of May and, while taking account of upgraded demand from China, lifts forecasts by 11% to US$180/t in 2021 and by 20% to US$150/t in 2022.
Apparent steel demand in April rose 14% in China as record steel production occurred. This comes despite finished steel exports rising 18mtpa to 83mtpa, the highest since December 2016.
Ord Minnett expects China’s steel production will decelerate in the second half of 2021 amid tougher comparables. Meanwhile, Vale has now suspended 15mtpa of iron ore production because of stability concerns at the Xingu dam.
While there was no update on guidance for 315-335mt in 2021, the curtailment is a sign of ongoing risk to volumes from Vale and Ord Minnett flags the only major source of new supply in 2021 is a recovery in Vale’s production. Tight supply/demand conditions for iron ore are expected until Simandou (Rio Tinto) comes on line in 2026.
The broker continues to envisage upside for BlueScope Steel ((BSL)) and Sims ((SGM)), which have materially underperformed offshore peers. Ord Minnett downgrades its rating on Iluka Resources ((ILU)) to Hold from Accumulate as the stock is trading in line with valuation.
Potash
BHP Group ((BHP)) hosted a potash briefing, ahead of a decision on Jansen. The company expects demand will grow 1-3% and the market will move into deficit in 2030, after which a price of around US$350/t should be required to induce more mining projects in Canada.
BHP Group remains confident in the capital expenditure budget for Jansen of US$5.3-5.7bn, with production expected to start in 2027. UBS considers the risk/reward for BHP Group is balanced but not compelling, given the downside risk implied by its iron ore view.
