The unexpectedly quick rise in commodity prices after the downturn has allowed many miners to paper over their balance sheet sins, says Morningstar's Dan Rohr.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Rising commodity prices have been hot news recently, and it might not be good for all industries, but the mining industry is one that could certainly benefit from these rising trends. I am here with Dan Rohr. He is an analyst at Morningstar. We're going to take a look at the credit quality of some miners and see how rising commodity prices will affect that.
Dan, thanks for joining me today.
Daniel Rohr: Thanks for having me, Jeremy.
Glaser: So, how have the mining companies recovered from the depths of the downturn?
Rohr: Well, it's been quite a roller-coaster ride for the mining industry. In the days leading up to the financial crisis, if you would recall back to the first half of 2008, commodities were doing phenomenally well. Then financial crisis hit. Commodities fell through the floor, and the balance sheets at a lot of these companies deteriorated rapidly. Then of course, as we all know, commodity prices rebounded quite a bit quicker than most folks thought, primarily attributable to a massive surge in Chinese fixed asset investment.
As we stand today, this surge in commodity prices has allowed these firms to paper over perhaps some of their balance sheet sins of the past, such as acquisitions made at the top of the market. And leverage-coverage metrics look excellent, pretty much across the board and at least among the issuers that we cover on the credit side.
Glaser: So now has there been any differentiation between different types of commodities? Have some done better than others?
Rohr: Sure, sure. Some have done better than others; copper, probably more than any other has been star of the show. You could put metallurgical coal in that bucket, as well. While copper is down a little bit from the highs it reached in February 2011, it's well, well above historical norms. It's trading around $4.20 a pound I believe, which is quite a bit more than the cost of digging the stuff out of the ground.
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Glaser: Of course, we certainly don't know exactly what's going to happen with prices in the future, but what's your outlook for these commodity prices during the next, let's say, a few years?
Rohr: Yeah. It's really varied by commodity as you touched on previously. In the case of copper, in the near term, we're probably looking at a rather tight supply situation. Miners would like to bring on additional capacity in the near term, but they simply aren't able to do so.
There are quite a few large projects, greenfield and brownfield projects, in the works across the copper industry. Ultimately, we expect that that supply will come on line and push copper prices down from the heady levels at which they trade today, but we wouldn't expect to see that supply-driven decline in prices manifest until perhaps the back half of 2012.
Glaser: So let's go ahead and take a look at some individual issuers. Who do you think is better positioned right now? Who do you think has the more attractive financial position?
Rohr: I mean you look at the balance sheets, you look at the leverage, and everyone looks great. That's not surprising given more commodity prices are today, how much debt these companies have been able to pay off. When we look at credit quality of Morningstar, in the mining industry, we really like to differentiate based on their relative cost position in each commodity and that really ties into the methodology that we apply across our coverage universe more broadly.
Through that lens, one name we particularly like is the company called Southern Copper. As the name might suggest it's a large copper producer, and among the large miners, it has the absolute lowest costs in the industry. So this is a company that we would expect to fare very well whether copper continues to trade about $4 or falls below $3.
In fact, in contrast to many miners during the downturn, Southern Copper remained robustly profitable, and wasn't forced to go hat in hand to its creditors seeking out solution or to the capital markets seeking additional funds. That's a name we really like. Its bonds currently trade around 170 basis points over the Treasury curve and for a BBB+ name, which is what we rate them, that's a decent absolute value.
Glaser: On the flip side, are there any companies' bonds which you're less excited about right now?
Rohr: One name that comes to mind is Teck Resources. They, like Southern Copper, produce copper, and they also produce metallurgical coal. It's a name we recently upgraded to BBB. So it's not to say we dislike them from a credit-quality perspective, it's simply that we think the bonds are trading too tight at the moment. They are currently trading around 100 basis points over the Treasury, say on their 8-year note or 10-year note, and that's really a level we would expect to see from an A rated consumer goods producer, not someone that digs coal and copper out of the ground.
We don't see much room for further spread-tightening in this name. In fact, we would expect spreads to widen over the long term. Our concern is that these spreads are basically pricing, and today's commodity prices are to perpetuity, whereas experience tells us that you can't demolish the cycle particularly in a highly volatile and cyclical industry like copper and metallurgical coal.
Glaser: Sounds like a bit of irrational exuberance there.
Rohr: Perhaps.
Glaser: Dan, thanks for joining me today.
Rohr: Thanks, Jeremy.
Glaser: For Morningstar, I'm Jeremy Glaser.
