Go figure: Soaring mining profits drive ASX lower

Source article (SMH 28/2/17 – Myriam Robin; article here)

Katana Asset Management Romano Sala Tenna comments below.

They’ve driven one of the Australian sharemarket’s best earnings seasons in years but, if you were just looking at the share prices of Australia’s major resource companies, you wouldn’t know it.

Materials companies were the largest drag on the ASX200 in February, a month that had many of those same companies outperform expectations and boost their dividends through profit reporting season.

Business profits skyrocketed in the December quarter, Australian Bureau of Statistics data on Monday showed, and that was driven by mining companies, whose gross operating profits rose 21 per cent on the back of soaring iron ore prices and successful cost-cutting programs in the December quarter.

The remarkable turnaround by mining companies – which only a year ago were slashing dividends and earnings – played a key role in the record $72.3 billion in dividends announced this month by Australian companies and had asset managers gushing over the outperformance of the sector.

Share price retreats

But impressive balance sheets didn’t help the materials sector push up the ASX. The materials index of the ASX200 as a whole declined 4.4 per cent in February, a performance mostly driven by share price retreats at big miners BHP, Rio Tinto and South32, which fell between 7.5 per cent and 10.4 per cent over the month. Some miners, such as Newcrest Mining, BlueScope Steel and Northern Star Resources, did rise in February, but their impact on the index was gobbled up by major declines elsewhere.

BHP and Rio Tinto posted major profit upgrades and dividends well ahead of expectations, while South32 moved dramatically from a loss to a profit, while announcing a far more improved dividend.

The disconnect between earnings performance and share price losses was noted by Peter O’Connor, a metals and mining analyst at Shaw and Partners.

Underlying the February result, he said, was a picture of huge growth in equity prices across global mining stocks in the first six and a bit weeks of the year. On February 16, around the world and on the ASX, mining stocks began a marked decline.

Very macro-driven

“It’s not the reporting season driving it,” he said. “Joining the dots, it’s very macro-driven.” Cash flow, earnings and costs remained pleasing across the sector, he said, leading him to conclude the resource pull-back could be pinned on “the deflation of the reflation trade that has been running its course since the US election”.

“You had a very strong first half of February, and a very weak second half. March could be the reverse. You might see some consolidation as we digest a whole lot of macro data before resuming a trend to fresh new highs.”

Another mining analyst, speaking off the record, also pointed to the yearly rally in resources companies: off such a large run-up, surely prices were due for a moderation, he said.

Katana Asset Management’s Romano Sala Tenna, whose fund invested in South32, said markets priced in what was happening in commodity markets a lot faster than mining companies did.

With South32, he cited the volatility of the manganese price, which had trended down since December. While only a small division for South32, it was a major part of the company’s earnings.

Boost priced in

As for BHP and Rio, Mr Sala Tenna said the market had priced in the boost from commodity prices for some time.

“The bigger piece here is around iron ore,” he said. “Investors are always looking forward, nine months is a common time frame. As they look forward, they’re seeing record iron stockpiles in ports, and record iron stockpiles in mills. You don’t usually get both. And they’re looking at infrastructure spending in the United States, and realising President Trump’s spending looks relatively minor.

“You’ve had hyping on these factors, and we’re starting to face reality. No analyst report we’ve seen has calendar year prices anywhere near current spot prices.”

 

Katana Asset Management is an Australia Fund Manager with a traditional Managed Fund and a Listed Investment Company.