World Economy

Black Hole in Mining Sector Profits

Black Hole in Mining Sector ProfitsBlack Hole in Mining Sector Profits

Miners have unearthed a billion-dollar black hole in profit forecasts for next year as a result of tumbling commodity prices. The hoped-for bumper cash returns from the sector have all but vanished.

Investors chasing capital gains and dividend income should be wary of the rally caused by the Chinese central bank’s stimulus measures at the end of last week. They had the whiff of panic about them and investors are now exposing themselves to a permanent loss of capital as the Chinese economy starts to crack, MSN Money reported.

“[Mining] investors hoping for special dividends or share buy-backs stand to be disappointed unless commodity prices rally strongly,” warned Hunter Hillcoat, an analyst at Investec. The chance of a sustained rally in commodity prices looks like wishful thinking, with iron ore having fallen 48% this year, oil down 20%, coking coal used in steel production down 20% and copper down 7%.

Only four months ago, mining sector experts were mulling the prospect of bumper special dividends and increased share buy-backs at the likes of Rio Tinto, BHP Billiton, Glencore and Anglo American.

The speed and the depth of the fall in commodity prices has surprised everyone in the intervening period. The prospect of investors receiving extra cash returns has now “almost vanished”, according to Hillcoat.

 Rewarding Investors

BHP Billiton had been expected to reward investors with a special dividend next year, which could have been as much as 55 pence, on top of the basic dividend at around 127p. But that belief was born when iron ore prices were well above the $80 per ton mark; at current prices, the forecast special dividend tumbles to about 9p.

The iron ore price has collapsed from $140 per ton at the start of the year to $71.8 per ton at the end last week, a fall of 48%. The impact on mining revenues is devastating.

Rio Tinto, the second largest producer of iron ore behind Brazilian giant Vale, is the FTSE 100 miner with the greatest exposure to the iron ore price. Iron ore represents 51% of revenue, 80% of earnings and 78% of its net asset value, according to broker Davy.

Rio Tinto is expected to produce about 340m tons of iron ore next year, so every $1 fall in the price wipes $340m off forecast revenues.

The fall in the iron ore price during the past four weeks was about $10, down from $82 to about $71.8 per ton. That means if prices remain where they are, Rio would make about $3.4b less in revenue next year.

If prices remain at these depressed levels, then the big four FTSE 100-listed miners, BHP Billiton, Rio Tinto, Anglo American and Glencore, could have a $19b hole in their collective earnings forecasts for next year, and if prices don’t recover in 2016, that hole in forecast earnings grows to a staggering $34b.