Talking Top Twenty: Commonwealth Bank (CBA.ASX) & Westpac (WBC.ASX)
​Talking Top Twenty: National Australia Bank (NAB.ASX) & ANZ (ANZ.ASX)

​We remain of the view that the significant tailwinds for commodities in general will endure for some time yet given global impetus towards the green transition and fiscal expansion (which, despite roadblocks in the form of inflation, looks set to continue). We first published this view even before the recent Russian invasion of Ukraine and it has only been affirmed since. Further detail on this can be found here.

Perversely, the relentless upward pressure on the price of both WTI and Brent, despite jawboning from policy makers and the Biden administration, may in fact create a tailwind for base metals and commodities in general. Without going into too much detail, the price action not only increases global reserves (defined as economically retrievable oil) but also increases the economic incentives to speed up the energy transition (i.e. demand destruction). Even in the short-run we are likely to see tremendous momentum for iron ore (driven by demand for steel), coal (especially coking coal, steel again), copper (i.e. transmission and electric vehicles), uranium (i.e. nuclear power generation), natural gas (i.e. bridging power generation during the transition) and agricultural commodities such as potash (both fertilizer demand and uses in shale production).

With that, some price targets for the above categories over the next 12 months:

Iron Ore (63.5% Fe content – Tianjin Delivery): 220 USD/T
Coal (Newcastle Coal Futures): 350 USD/T
Copper: 12000 USD/T
Uranium: 120 USD/LBS
Natural Gas: 8 USD/MMBtu
Potash: 580 USD/Mt

Those interested in how we reached these price targets, please don’t hesitate to get in touch.

Finally, we have seen rather disappointing price action from the yellow metal; accounting for the current geopolitical uncertainty, it could be argued that the shiny metal has shown meagre performance given its traditional status as a safe haven in times of uncertainty. Despite this and given the above prices and inflation implications (along with implications for real yields), we could argue that it may still be reasonable bet on the balance of probabilities. Price target: 2200 USD/Oz (this may seem optimistic for the more cynical amongst you given recent performance).

Note: We have intentionally left out some other crucial commodities (rare earths along with the likes of nickel, cobalt and lithium) given the group of securities being discussed discussed. We are looking towards the largest revenue streams for the companies in question.

More than pleasing results from BHP with EPS of 211cps US (up +77%) and margin of 64%. Most importantly for the yield hunters, an AU $4.55 p/s dividend (estimated). For us, the company has seemingly learnt from its mistakes in terms of balance sheet discipline (many of you may remember the Capex bonanza during the peaks of the China-driven iron ore boom). The company has reduced net debt by 49% to $6.1bn US, though the payout ratio of 78% seems overly aggressive in our view. The market has seemingly rewarded the performance, the share price returning close to 20% since the beginning of the year.
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Digging a little deeper into the strategy side, we maintain that the sale of the petroleum assets was a great move and allows the business to shift focus to core assets while the move into potash is rational, especially given reductions in global crop yields (we will see another long term tailwind here). On the sale front, we are certain that longstanding shareholders would be pleased given the performance of their scrip which has returned close to 50% since the beginning of the year. Looking at the segment breakdown, beats across all three major segments; Metallurgical Coal, Copper and Iron Ore. We were slightly disappointed with the EBITDA margins on coal but with a 71% margin on Iron Ore, this may be overlooked. Unit costs on the Escondida deposit of 1.2 USD/lb, well within guidance.

Red Flags & Risks: We were disappointed that the company has been rather slow in looking to new projects, especially in the copper space (has the company gone to the opposite end of the spectrum in terms of risk appetite?). The election of Boric in Chile adds a new element of risk for the Escondida mine, which remains the flagship project for the business, while headline price volatility based on newsflow from Russia could also see some risk.

My Expectations: Cost front continues to be pleasing and, while any short term peace talks with Russia could see some selling pressure in commodities, we still think the business offers a good risk reward given our outlook on prices across both iron ore and copper. For the dividend investor, certainly a better proposition for the financials. Still a hold with a price target of AU $63.

Dividend Yield: Assuming a share price of AU $51.41, then BHP has a great dividend yield of 8.2% (i.e. as expected).

The last time we wrote about this particular company we were at AU $22.26 and were of the correctly of the opinion that the business was too expensive (for those astute investors who then bought the stock close to $14 – well done). But, with the share price having bounced back to similar levels now (AU $21.66 at time of writing), it no longer seems so. What’s changed? For one, we continue to see disciplined management; the number that stands out here? Guidance of 180-185 mt shipments (this will be a new record on top of the one set last year) and 70% realisation of the Platts 62% CFR Index (this bodes well for discounts given historically lower grades). The addition of Iron Bridge, with its average 67% grades, should be beneficial in the long run for margins (i.e. lower grades and higher coking coal costs means higher discounts compared to peers whereas the opposite is true with higher average grades). In the long run, the company’s well touted ESG ambitions should make the business more palatable for bigger valuation premiums. These ambitions include carbon neutrality by 2030 and Net-Zero Scope 3 emissions by 2040 (something which we were concerned about given historic low grades).
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With that, to the numbers. EBIDTA of US $4.8bn. Importantly (and rather pleasingly), gearing came in at 23% (given FMG’s history this is one metric that has been satisfying to see). The business continues to rapidly cut costs in order to keep up with peers, including BHP and RIO. Operating cashflow stands at US $2.1bn while the payout stood at 70% of NPAT.

Red Flags & Risks: FMG is a leveraged exposure to the iron ore spot price and Chinese growth. As such, the biggest risks will be a potential slowdown in Chinese growth, escalation in Covid related policies and property related slowdown (i.e. construction). While spot prices were certainly catalysed by sanctions on Russia, we still feel that any pullback, even in the most optimistic of scenarios around peace, will be short-lived.

Expectations: FMG seems to be ticking all the right boxes and, with Vale (VALE3.BVMF) still going through its own issues, we think that the medium to long term outlook for the price of ore remains promising. What must be watched however is China (to give some context about where they are in the cycle, the PBOC is the only outlier amongst major economies in terms of having an expansionary monetary policy). The price also remains somewhat at a premia compared to peers but this may just be a long-term investment. We remain fans of Liz Gaines.
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Dividend Yield: The current dividend yield stands at an exceptional 8%, assuming a price of $21.66 AUD (as expected).

Disclaimer: FMG is currently held in TAMIM individually managed account (IMA) portfolios.