Income Report / Miners – should we BUY for yield? (BHP, AWC)

By Market Matters 30 August 17

Miners – should we BUY for yield? (BHP, AWC)

Income Portfolio 30/8/17

The MM Income Portfolio added  +0.20% over the course of the week versus the ASX 200 which was down -0.98% or -56pts. The range bound nature of the market and the current reporting season has seen us long analysis and short action!

One of the very obvious themes through this reporting season has come from the miners, the majority missing in terms earnings but beating (some substantially) in terms of capital management.  According to Shaw’s Mining Analyst Peter O’Connor, who we rate very highly (and this is a common view in the mkt), we’ve now had around 75% (~18 companies) of the top 25 miners report with all the S&P 50, S&P 100, and most of the S&P 200 miners. 80% of companies reporting have MISSED consensus Net Profit After Tax (NPAT) expectations.

That said, every company has meet/beaten on capital management, ranging from dividend beats, new dividend policies (4x – NCM, EVN, FMG, WHC) to buy back top ups (2x – RIO and S32). Clearly, the message here is (i) significant cash generation, (ii) balance sheet deleveraging pretty much done (70% of the top 25 miners have net cash), and (iii) confidence in the outlook.

This leads us to ask the obvious question – should we  be looking at these companies more closely as part of our Income Portfolio? The short answer is yes, and we already have Alumina in the portfolio as a result.

Miners – should we BUY for yield?

Firstly, we know underlying earnings are dictated heavily by what commodity prices do, and as such, volatility in earnings will play out and will feed some volatility in dividends. If we buy resource stocks solely for dividends, then this reality must be acknowledged. As mentioned above, the miners dividend policies revolve around a payout of earnings with varying ranges. This might seem simple however cast your mind back to the ‘progressive’ policies of the past, which in hindsight seem ludicrous. Because they pay a percentage of earnings, we should simply focus more on earnings, the outlook for those earnings and the dividends will look after themselves.

Source; Bloomberg consensus – we are looking for a slightly bigger dividend from AWC

Commodity prices are a function of supply and demand. Demand is a function of growth, and growth largely from emerging markets like China. Data out last week indicates that Chinese growth looks like it may hit the highest level in 4 years – which is obviously a positive for commodity prices.

In terms of supply, the outlook is obviously different for different commodities, however collectively, miners are spending less on future development and more on capital management, like dividends, hence future supply will be constrained.

Once again, sourcing Shaw’s Peter O’Connor, the below series of charts are useful in thinking about how we approach the sector. In terms of yield, BHP, FMG, RIO & Alumina are the clear standouts and still represent some value, however they are not the compelling proposition they once were…

Alumina (AWC) – Currently resides in the MM Income Portfolio with a BUY price of $1.96. Yesterday the stock paid a 5.32c fully franked dividend representing a 2.71% dividend on our purchase price for the half. Dividends are expected to increase in the periods ahead and interestingly, AWC has held this dividend reasonably well. We remain bullish Alumina will a price target ~$2.30 in the income portfolio targeting a combination of capital growth and yield.

Alumina Daily Chart

BHP Billiton (BHP) – This is not held in the income portfolio (although it is in the MM Platinum Portfolio) and they reported well last week. The clear takeout is that they’re producing a huge amount of cash and that is likely to continue. Last year they reduced debt by $9bn plus they paid out near $4bn in dividends. Net debt now sits at $16bn and they have guided to a target range of $10-$15bn – so, still some way to go but not the extend of reduction we saw in FY17. They also flagged asset sales headlined by US Shale which should yield somewhere between  $6-$10bn, however there is more like $10-$18bn of potential sales on the cards, so clearly asset sales could get net debt into their targeted range opening up the likelihood of a ‘lot’ bigger dividends in the years ahead – particularly with capital expenditure (capex) capped for the next 3 years.

We will look at BHP in the income portfolio below ~$26

BHP Billiton Daily Chart

Conclusion (s)

The fundamental picture looks very good for the miners while the price of iron ore and copper for example remain strong - most local resource stocks have simply become printing presses BUT as we said above there are obvious risks chasing the sector for yield. Iron ore has doubled since early 2016 and copper is 50% higher from recent lows - any pullback in these currently strong markets will be a clear negative to the Australian resource sector and remember, miners are price takers, not price makers.

While we are comfortable holders of Alumina in the MM Income Portfolio, we would only consider adding to our ‘resource’ exposure for yield into weakness. Patience grasshopper!

Iron Ore Weekly Chart

Copper Monthly Chart


Market Matters may hold stocks mentioned in this report. Subscribers can view a full list of holdings on the website by clicking here. Positions are updated each Wednesday.


All figures contained from sources believed to be accurate.  Market Matters does not make any representation of warranty as to the accuracy of the figures and disclaims any liability resulting from any inaccuracy.  Prices as at 30/08/2017.  10.40AM.

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