Blue chip sell-off could spur junior valuations

Published at Jan 7, 2016, in Features

Commodity market turbulence on the back of weakening Chinese demand has led to very sluggish share prices for almost all resource companies.

However, given the vast size and operational capacity of large, mature miners such as BHP Billiton and Rio Tinto, there could be good times ahead for budding juniors as blue chip giants look for bargains to restock their asset portfolios.

“The ‘blue chip’ large cap miners, i.e. BHP and Rio, could consider raising equity to be ready to acquire distressed tier-one assets” according to a Bank of America research report. In the report, analysts go on to say that, “We think there is no time like the present. Strengthening balance sheets would give flexibility if/when tier-one assets come to market.”

BHP could end up raising as much as $15.4 billion and Rio $5.7 billion later this year, to curb reliance on debt.

Given the cyclical nature of the mining sector, combined with smaller explorers struggling for funding, large miners are likely to be on the lookout for value assets that could be developed into producing assets at a later stage when commodity prices recover.

The Australian Fiancial Review (AFR) also reports that “a capital raise by ‘blue chip’ players in the space might hasten the onset of distress of other more leveraged companies including Anglo American, Fortescue Metals and Teck Resources.”

Anglo American was the worst performer on the UK’s FTSE 100 benchmark index last year, falling over 75% as copper and iron ore prices collapsed by over 70%. Late last year, Anglo American said it would scrap its dividend and cut the number of mines it owns and operates as part of a broader cost-cutting drive that has seen staff reductions from 135,000 to 50,000 – a decline of 62%.

Rio and BHP tend to be a common stock pick for many Australian investors, especially superannuation funds given their strong commercial performance over many years amidst booming commodity markets.

The obvious problem for investors looking at commodities and resources is that given the extreme declines already seen in both commodity prices and resource companies’ share prices there may be more to come. Or have markets hit a floor?

Click on image to enlarge

Prices of iron ore, aluminium, coal, copper, uranium and oil – the most important commodities for BHP and Rio – have suffered harsh and prolonged declines thereby undermining their stock prices.

For now, it seems, there is more to come.

In Wednesday’s trading, both BHP and Rio share prices were as much as 7% lower, seeing multi-year lows as Chinese stock market volatility again buffered global stock markets.

Entering just its third trading day of 2016, both Rio and BHP shares are down 3% and 2%, respectively.

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