Bad Times For Integrated Mining Companies
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The signs are out there that the great fiscal cliff of January 2013 is already having an impact. Various reports are being released by the Congressional Budget Office and the like that if Congress does fail to act this year on matters of expiring Bush era tax cuts and automatic across the board spending cuts, we are sure to see a recession in the first half of 2013. While it is likely that Congress will not allow this to happen, each week that passes makes it more likely that the virtual paralysis in Washington will continue and that inertia (an object at rest tends to stay at rest) will cause draconian economic calamities to ensue.
If that happens, among the first and most vulnerable companies will be the cyclical, capital intensive companies. Such companies are already under pressure from weakened commodity prices that, in the second quarter, helped the overall market to post its weakest quarter in three years. Of course, not only is the large United States' economy staring down a recession, the European market is suffering markedly, and there has been a slowdown not just in China, but in other developing economies as well.
In my view, it would not be all bad news if lost tax cuts and spending cuts do occur. The federal budget deficit would be slashed from somewhere near $1 to $1.1 trillion in fiscal 2013 to about $640 billion, and few would argue that lowering the budget gap is a desirable feature. But the pain of a recession is hard to gauge, as is its length, and most would prefer a more orderly way of attacking our budget gap.
There is no surer sign of the expectation of a slowing or receding worldwide economy than a slackening in the price of core industrial elements, such as bauxite, aluminum, coal for energy and steel making, and various rare earth elements. Big mining companies such as BHP Billiton (NYSE: BHP) and Alcoa (NYSE: AA) have seen the same signs, and are cutting back on capital expenditure plans.
What is going on in China is not just a matter of a slowing economy, but also a genuine effort to clean up what has become the leading producer of carbon dioxide in the world. China has committed $372 billion over the next 42 months toward energy conservation and anti-pollution measures. That is part of its broader plan to cut “energy intensity”, or the amount of energy needed for a constant amount of gross national product, by 21% by the end of 2015 from where it stood at 2010. The country plans to reduce carbon dioxide emissions by at least 40% from 2005 levels by 2020. And China is even launching a version of “cap and trade” in several cities across the country, as a prelude for a national program by 2020. In all, it is not a good time to think of increasing coal exports to China, and it is a model of responsible activism that we do not have in America.
The world's largest diversified mining company is BHP Billiton, with leading positions in copper, silver, bauxite, molybdenum, and many other materials. One of the company's crown jewels is its Australian mine known as Olympic Dam, which is the world's largest source of uranium and fourth largest source of copper. A planned $20 billion expansion of the band was part of a longer term, $80 billion capital expansion plan that was to go to the Board of Directors for approval in the fourth quarter of this year. The company announced that owing to low prices for most commodities, it was suspending indefinitely the Olympic Dam expansion, casting the entire big ticket capital expenditure program in doubt.
BHP's earnings in its second half of fiscal 2012 came to $7.16 billion. While that total beat analysts' expectations for the quarter of $6.96 billion, it still represented a 35% drop from the same period of 2011. Analysts see BHP earnings plowing ahead at about a 10% annual clip. I am not so sure about that, as it as the mercy of the worldwide economy. I like this company more than any other diversified miner, but not enough to buy it myself or suggest to you buying it at this time.
One cannot make usable alumina without bauxite; most of Alcoa's supply comes from mines it controls in Western Australia, from which it extracts 32 million metric tons a year and tries not to destroy the forested lands upon which it drills. Alcoa's business is alumina, key in many commercial applications, and aluminum, a ubiquitous commodity in both industrial and retail markets. Alcoa can therefore be something of a proxy for the near term expectation of the world economy and the stock is stuck in the same patch of mud it has been in since the recession last decade. After trading at over $40 per share in 2008, the stock collapsed in the fall of that year, and has traded in a narrow range for the four years since.
Earnings for Alcoa have virtually flat lined, as it took adjustments in the second quarter to push earnings up to three cents per share. GAAP earnings were flat. Yet analysts see earnings at about $0.30 per share this year, and near $0.75 cents per share in 2013. I just don't see it. Aluminum prices have already been falling, from about $1.20 per pound to a more recent $0.83 per pound. Further falls are likely if the world economy continues to slide.
Freeport-McMoRan (NYSE: FCX) is the largest American based diversified mining company. It has operations across four continents, and mines a variety of metals, including gold, silver, copper and cobalt. Its second quarter profits fell 50% from the second quarter of 2012, to $710 million, or $0.74 per share. The company blames this on delays in getting its massive Grasberg complex, where long-term labor woes may still persist. The mine is the world largest gold mine and third largest copper mine and Freeport owns an over 90% share of it.
Freeport is no less at risk of declining metals demand and prices than are any other of these companies. Commodity metal prices have much further to fall if there is a worldwide recession. I would stay on the sidelines for now. The same goes for Rio Tinto (RIO), Vale (VALE), and other big mining concerns. Check back in when we got to the bottom of a recession, not at its potential beginning.
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