Value case still valid for the mining sector?
The mining sector has come a long way in the last couple of years, and not just in terms of share price moves. Ian Butler considers whether the value case is still valid within the sector.
In early 2016, many stocks were on their knees after a very weak metals price environment had crushed earnings and cash flows and balance sheets were in dire need of repair. Dramatic restructuring, capital raises and cost cuts ensued and with the benefit of hindsight it was a fantastic opportunity for any brave value investor to start buying (price to book multiples had fallen to almost historic lows).
With the sector more than doubling since the low (and in some stocks’ cases more than quadrupling) you might think that the value opportunity is no more. However, at the end of June 2018, using spot metals prices (and UBS research) all diversified miners have a free cash flow yield in excess of 11% for 2019 (with an average of almost 14%)1. The average Price/ Earnings (P/E) (again using spot metals prices) is just over 8x for 20191. This means the sector’s free cash flow yield is close to double that of the FTSE All-Share and is trading much cheaper than the market’s P/E of c. 13x2.
These very high free cash flow yields do beg the question as to what will the companies do with all this surplus cash? For one, we have seen the return to higher shareholder returns, both through dividends and share buybacks. But we could also start to see M&A once more as management teams look to achieve higher growth. Last week we had the news that Volcan’s bid to buy all the remaining shares it doesn’t already own in Vedanta was recommended and it would be no surprise to see more deals in the coming months and years, something which would likely share prices higher for the entire sector.
Of course, an investment in a mining company isn’t without risk as we saw recently with the news that US authorities had demanded Glencore hand over documents about its business in the Democratic Republic of Congo, Venezuela and Nigeria as part of a corruption probe. The stock fell by 8% on the day of the announcement, wiping c. $5bn from the company’s market cap3. To put this in context, the largest fine that has historically been charged by the US Department of Justice for a breach of the Foreign Corrupt Practices Act has been just under USD1bn suggesting the market’s reaction may well have been overly harsh. When you consider the valuation support of the stock coupled with the recent positive operational momentum, one could argue there is an opportunity for the brave value investor once more.
Ian Butler is portfolio manager of the JPM UK Strategic Equity Income Fund within J.P. Morgan Asset Management's UK Equity team. Read more about the fund>
1Source: UBS as at 30 June 2018
2Source: Factset and Bloomberg as at 30 June 2018
3Source: Bloomberg as at 30 June 2018
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