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Will Miners Survive a Commodity Slump?

Emma Wall

Emma Wall: Hello and welcome to the Morningstar Series 'Ask The Expert'. I'm Emma Wall and I am joined today by Matt Hodge, Morningstar Equity Analyst to talk about mining stocks.

So how have mining stocks fared in 2017, Matt.

Matthew Hodge: 2016 and 2017 have been really strong years for the resources side. There have been a couple of themes; China really pushed the stimulus in 2016. You've seen debt grow pretty rapidly in China.

Debt-to-GDP… that’s what they have used to finance that continued growth and over time their economic growth has become even more reliant on the fixed asset investment part of the economy. Construction, building roads, building buildings that kind of thing.

What we see now is you've got a whole bunch of commodities that are trading well above their marginal cost. So, aluminum, steel, steel making materials, so iron ore and coke and coal, alumina, manganese all well above average. And China supply side, coal as well.

China's supply side disruption has been important part of that as well. What they are doing internally and in coal and steel that it produces locally. Conditions now are very, very positive for the miners but we don’t think that can continue forever given the foundation that it's built on which is around pretty rapidly rising debt and continued investment in things that aren’t generating strong returns in China. The reason why we are talking about China, is because China is basically half of the world's consumption of all of these groups.

Wall: And how does your outlook for commodity prices influence your opinion of a particular mining stock?

Hodge: In general, we're most negative on the steel making materials, particularly iron ore and coke and coal. And we're kind of more positive on oils, more consumption focused needs to be replenished because there is natural fare decline which means you need capital. Which means you need a price to incentivise that new investment.

If you look at Glencore (GLEN) and Anglo (AAL), they generally sit on a higher position on the cost curve relative to BHP (BLT) and Rio (RIO). So, they are more leveraged and by extension given that commodity prices are quite high right now, they are the ones that are most overvalued, the 11 names – they are most overvalued as we see commodity prices coming lower. They'll be impacted disproportionately.

Between BHP and Rio its really about the commodity mix. So there BHP is got a greater exposure to oil less on iron ore it's still significant, but Rio Tinto is really dominated by iron ore, it's bit of aluminum, bit of copper. So, given that we think of the four, that BHP's value is still overvalued within the group, but Rio Tinto next and then the more laboured names are most overvalued.

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