The Australian Bureau of Statistics recently released the preliminary data on international trade in goods, wherein, the total value of both exports and imports of goods increased in the month of Jun’20. The increase followed a decline in value of exports and imports for two consecutive months, i.e., April and May.

During June 2020, the value of exports increased by $2.35 billion or 8% over the previous month, driven by exports of iron ore. Exports of iron ore increased at a rate of 8% or by $757 million in absolute terms, and came in at $9.92 billion, the highest export value of iron ore on record. The increase in June pushed total 2019-20 iron ore exports to more than $100 billion, with China being the main market accounting for 87% of iron ore exports during 2019-20. Apart from iron ore, exports in June 2020 were also driven by non-monetary gold and petroleum. Notably, non-monetary gold exports for the month stood at $2.29 billion, up by 67% or $916 million over the previous month. Petroleum exports came in at $651 million, representing an increase of $208 million or 47% on the previous month. The value of goods imported increased at a rate of 6%, majorly driven by an increase in imports of petroleum by 29% to $1.51 billion.

Exports Driven by Rising Iron Ore Demand: The increase in demand for iron ore comes in after the rising need for steel in China to boost infrastructure construction and accelerate recovery of the coronavirus-hit economy. In the latest update, China’s GDP for the quarter ended 30^th June 2020 rose by 3.2%, partially driven by a boost in industrial production. The demand for iron ore in China has improved progressively after the country witnessed lifting of restrictions in May and increased production. During the second quarter, the manufacturing industry’s capacity utilisation rate was 74.8%, up 7.6% on the utilisation rate in the first quarter. Industrial output in China has started recovering, with production of steel picking pace. Moreover, a rise in demand for iron ore from China was accompanied by a slowdown in supply of iron ore from mines in Brazil, that is currently witnessing acute economic pressure due to rising coronavirus cases. Henceforth, Australia’s iron ore export value increased to a record value during June. Apart from China, the demand for iron ore from other parts of the world remained subdued to low economic activity.

Commodity Market Outlook: The Department of Industry, Australian Government, in its June quarter report for Resources and Energy, has provided a positive overall outlook for the sector, citing resilience in iron ore earnings as a major driving factor. Moreover, gold, a safe haven in uncertain times, has witnessed a significant price surge and is set to be a strong performer. Overall, the commodity markets, that have been hit by lower consumer demand and government-imposed lockdowns, may now witness an upside due to the emerging stimulus measures. Easing of restrictions and recovery in global economic activity is expected to positively impact demand for commodities. However, threat pertaining to COVID-19 will continue to pressurise global economic activity levels until 2022.

According to the Department of Industry, Australian Government, world steel usage is expected to fall by 6% in 2020, due to the COVID-19 pandemic and resulting economic downturn. World steel consumption is forecast to rebound by 5% in 2021 and 4% in 2022, as the global economy recovers. Iron ore export values, that benefitted in 2019-20 from strong prices and a low Australian dollar, are expected to reduce to $81 billion by 2021-22 on account of a fall in prices. However, the impact of drop in prices is expected to be offset by growth in export volumes from an estimated 852 million tonnes in 2019–20 to 912 million tonnes by 2021–22. Oil export earnings are estimated to decline marginally to $9.0 billion in 2019–20, reflecting low prices late in the fiscal year. The decrease in oil prices is expected to continue in 2020-21, with export earnings expected to reach $6.8 billion, before a price rebound lifts earnings to $8.6 billion in 2021–22.

Global Iron Ore Exports Outlook (Source: Department of Industry)

Overall, Australia’s commodity export earnings are expected to reach $293 billion in 2019–20. Export earnings in 2020-21 and 2021-22 have been estimated at $263 billion and $255 billion, respectively. Notably, in 2019-2020, resource and energy earnings will be ~50% higher in real terms than the earnings reported during the global financial crisis in 2008-09. The above forecast is, however, subject to significant risks related to the second outbreak of COVID-19, rise in trade tensions, or an unexpectedly slow global recovery.

As per the above information, the demand for Australian commodities, especially iron ore, has witnessed positive trends amid these uncertain times, reflecting the resilience of the Australian iron ore suppliers and continued commitment to customers. Going forward, the outlook seems to be decent as an increase in iron ore volume supplied will offset a decrease in prices. Moreover, the ailing oil prices are also expected to witness gradual recovery, with a rebound expected in the medium-to-long term. Considering the above factors and the recent rise in value of exports, let us have a look at some of the key exporters of iron ore and oil in Australia.

1. Woodside Petroleum Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 20.03 Billion, Annual Dividend Yield: 6.5%)

Record First Half Production Levels: Woodside Petroleum Limited (ASX: WPL) is primarily engaged in hydrocarbon exploration, evaluation, development, production and marketing. During the quarter ended 30^th June 2020, the company reported record production of 25.9 MMboe, up 7% on the previous quarter. As a result, the company achieved a record first-half output of 50.1 MMboe, up 28% on pcp. Sales volume during the quarter came in at 27.1 MMboe, up 13% on the previous quarter. Revenue came in at US$768 million.

Outlook: With respect to its development projects, the company reported decent progress. During the quarter, the company continued execution of the Sangomar Field Development Phase 1, with Phase 1 subsea infrastructure and overall project planning on track for delivery of first oil targeted in 2023. Development drilling at the Pyxis Hub project is progressing well, with commencement of subsea installation work targeted for 2021. Moreover, the company expects to complete drilling activities for Julimar-Brunello Phase 2 development in the third quarter. The company recently completed a review of the carrying values of its assets as of 30^th June 2020, stating that the financial statements for the first half are expected to recognize non-cash, post-tax impairment losses of US$3.92 billion and a non-cash, post-tax onerous contract provision of US$447 million for the Corpus Christi LNG sale and purchase agreement. As a result, the company expects to report a post-tax loss of US$4.37 billion in H1 2020 results. H1 2020 results are expected to be published on 13^th August 2020.

During FY19 ended 31^st December 2019, out of the total revenue from external customers, Asia accounted for the largest share at US$4,435 million. During the year, the company progressed on the commercialisation of its international assets. Notably, the Sangomar Field Development Phase 1 targets the development of an estimated 231 million barrels of oil, with an opportunity to potentially export pipeline gas to shore in future phases. The offshore A-6 Development in Myanmar will provide a new source of energy for the region. In addition, the company is actively progressing future growth opportunities, including Kitmat (Canada) and Sunrise (Timor-Leste/Australia).

Key Risks: The company may find it difficult to deliver shareholder value if the demand for oil and gas decreases as lower-carbon substitutes take market share. Failed exploration and renewal of upstream resources may impact the operations and delivery of strategic initiatives. Moreover, the adjustment with respect to impairment losses is majorly due to factors such as the significant and immediate reduction in oil and natural gas prices assumed up to 2025, demand uncertainty due to COVID-19 and macroeconomic dynamics, which require a regular check.

Valuation Methodology: P/CF Multiple Based Relative Valuation (Illustrative)

P/CF Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs WPL (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: In the last three months, the stock gave positive returns of 3.09% on ASX and is currently trading below the average of its 52-week trading range of $14.93 - $36.28. The stock of the company went through a tough phase of COVID-19 fallout and the oil price crisis. However, the company has a decent financial position with a low gearing and high liquidity and is delivering well on its development projects, that will be the growth catalysts, going forward. We have valued the stock using the Price/Cash Flow multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $20.82, down 0.81% on 27^th July 2020.

 

2. Mount Gibson Iron Limited (Recommendation: Buy, Potential Upside: Low Double-Digit)

(M-cap: A$ 858.57 Million, Annual Dividend Yield: 5.41%)

Improved Performance Despite COVID-19 Challenges: Mount Gibson Iron Limited (ASX: MGX) is primarily engaged in mining and processing of iron ore. During the quarter ended 30^th June 2020, the company reported iron ore sales of 1.2 million wet metric tonnes. Iron ore sales for FY20 stood at 4.9m wmt. Despite the COVID-19 pandemic, the company ensured operational continuity by making required protocol changes and other arrangements in line with the Government’s advice. Ore sales revenue for all products sold amounted to $103 million Free on Board (FOB) in the June quarter and $413 million FOB for FY20. The June quarter average Platts cost and freight (CFR) price for 62% Fe fines delivered to northern China averaged US$93 per dmt, as compared to US$89 per dmt in the previous quarter. Cash and liquid investments as on 30^th June 2020 stood at $423 million.

Outlook: During FY21, the company will focus on increased mining movements at the Koolan Island, to substantially complete the planned open pit waste stripping phase. Shipment volumes are expected to decline slightly in FY21, with a significant increase expected from FY22 onwards. In the Mid-West, the low-grade sales program is expected to continue to late 2020. Moreover, the company expects the development decision with respect to its Shine iron ore project in the September quarter. Full year financial results for FY20 are expected to be released on 19^th August 2020.

The demand for iron ore has improved significantly with increased production in China. Iron ore suppliers in Brazil have suffered a setback due to COVID-19 containment measures. In such a scenario, key players in the Australian iron ore market are ramping up production to address the growing demand. Notably, during the year ended 30^th June 2019, all iron ore of Mount Gibson Iron Limited was shipped to China.

Key Risks: The company is exposed to the risk of adverse movement in the A$ compared to the US$ as its iron ore sales receipts are predominantly denominated in US$. The exposure to market interest rates arises from the company’s cash and cash equivalents, term deposits and subordinated notes, trade debtors, etc. Moreover, the forward exchange and collar exchange contracts of the company expose it to credit risk.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs MGX (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: In the last three months, the stock gave positive returns of 17.46% on ASX and is currently trading slightly below the average of its 52-week trading range of $0.542 - $1.035. The increase in demand for iron ore, coupled with the financial and operational resilience of the company are driving the stock price. As the market stabilised, the stock has demonstrated a sharp recovery, as visible in the chart above. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Buy” recommendation on the stock at the current market price of $0.730, down 1.351% on 27^th July 2020.

3. BHP Group Limited (Recommendation: Hold, Potential Upside: High Single-Digit)

(M-cap: A$ 109.23 Billion, Annual Dividend Yield: 5.75%)

Strengthened Demand in China: BHP Group Limited (ASX: BHP) is involved in the exploration, development, and production of minerals. For the year ended 30 June 2020, the company achieved record production at Western Australia Iron Ore (WAIO), Caval Ridge and Poitrel. Iron ore production for FY20 increased by 4% on pcp to 248Mt, whereas for the June quarter, production increased by 11% as compared to the previous quarter. Copper production for FY20 increased by 2% to 1,724kt. 

Outlook: Petroleum production in FY21 is expected to be between 95 and 102 MMboe. Copper production for FY21 is expected to be in the ambit of 1,480 – 1,645kt. Iron ore production for the same time span is likely to fall in the range of 244 – 253Mt. Until the time the COVID-19 situation pacifies, the business seems to be resilient to generate decent cash flows and continues to operate with a decent financial position. At the end of FY20, the company had six major projects under development in petroleum, copper, iron ore and potash, with a combined budget of US$11.4 billion over the life of the projects. The projects in petroleum and iron ore are tracking as per plan and are subject to potential impacts from COVID-19. In China, blast furnace utilisation rates have increased to 90% in June 2020, from ~80% recorded in Feb’20. The company expects to release its FY20 earnings on 18^th August 2020.

The company successfully met its FY20 production guidance for iron ore, metallurgical coal and its operated copper and energy coal assets.  After significant market volatility in March and April, conditions strengthened in May and June 2020. During June 2020, the value of Australia’s iron ore exports increased by $2.35 billion, representing an increase of 8% over the previous month, driven by demand recovery in China. In the June quarter, the company witnessed strengthened demand from China and opines that the business remains resilient and has flexibility in capital and exploration expenditure. 

Key Risks: Major economies have contracted heavily, owing to COVID-19 led crisis. While domestic industrial activity in China has been improving, the possibility of a second wave of COVID-19 poses a major risk to the positive trajectory.

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

P/E Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs BHP (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: In the last three months, the stock gave positive returns of 21.41% on ASX and is currently trading above the average of its 52-week trading range of $24.05 - $41.98. During the June 2020 quarter, the company remained afloat with its committed workforce, disciplined controls and financial strength and delivered a robust performance. The strong foundation of the business is evident in the quick recovery in stock price after the COVID-19 market fallout. So far, recovery for BHP has been in the form of continued favourable trends in stock price, given the rising demand for iron ore and strong footing of the business in key markets. We have valued the stock using the P/E multiple based illustrative relative valuation method and arrived at a target price with a high single-digit upside (in percentage terms). Hence, we give a “Hold” recommendation on the stock at the current market price of $37.4, up 0.863% on 27^th July 2020.

 

4. Mineral Resources Limited (Recommendation: Hold, Potential Upside: Low Double-Digit)

(M-cap: A$ 4.59 Billion, Annual Dividend Yield: 2.22%)

Record Performance by the Iron Ore Business: Mineral Resources Limited (ASX: MIN) is a Perth-based leading mining services company, focused on delivering innovative and low-cost solutions across the mining infrastructure supply chain. During the June 2020 quarter, the company’s iron ore business reported a record performance. The company’s total iron ore production for the quarter stood at 4.195 million wet metric tonnes (wmt), up from 3.436 million wmt on Q3 FY20 and from 2.534 million wmt in the prior corresponding period (pcp). It is worth noting that the company’s operations were not materially impacted by COVID-19. Iron ore shipments for the quarter went up by 53% sequentially and stood at 4.4m wmt. Total FY20 iron ore shipments increased by 33% year over year.

Outlook: Going forward, the company expects its existing and approved projects to drive medium-term growth and sees significant opportunity to deploy capital in long-life, low-cost, high-returning projects. The company completed the transaction to buy the Buckland Project under a series of arrangements with BCI Minerals Limited. The agreement will enhance the company’s Pilbara iron ore footprint. These agreements reflect the company’s strong partnership with BCI, providing further opportunity to increase its iron ore footprint in the Pilbara region. The company expects to release its FY20 earnings on 19^th August 2020.

During the fourth quarter of FY20, Koolyanobbing ramped up to ship 2.6m wmt iron ore. Shipments in the month of June of 1.1m wmt depicted an annualised run rate of 12.7 mtpa. Total FY20 shipments of 7.4m wmt were in line with the guidance. Notably in 1HFY20, 22.7% of the total revenue came from China. The company continues to invest in projects to develop long-term income streams and build a high-quality portfolio of mining services contracts. Total iron ore exports for the half increased by ~40% on the previous half.

Key Risks: The company’s activities are exposed to a variety of financial risks, such as market risk (including foreign currency risk, price risk and interest rate risk), credit risk and liquidity risk. However, to minimise the potential adverse effects on the financial performance of the company, MIN follows a risk management programme. The company is also exposed to climate-related risks, which might impact its ability to create and sustain value in the short, medium, and long-term.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Relative Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

A-VIX vs MIN (Source: Refinitiv, Thomson Reuters)

Stock Recommendation: In the last three months, the stock gave positive returns of 53.85% on ASX. The company’s recent agreements reflect its strong partnership with BCI and provide further opportunity for MIN’s Mining Services business to create value from stranded iron ore deposits in the Pilbara. As depicted in the chart above, the stock has demonstrated a sharp recovery in price after the market began to stabilise. This can be attributed to the resilience of the mining sector amid COVID-19 and the company’s commitment to delivery of operations and strategic initiatives. We have valued the stock using the EV/Sales multiple based illustrative relative valuation method and arrived at a target price of low double-digit upside (in percentage terms). Hence, we give a “Hold” recommendation on the stock at the current market price of $25.16, up 3.242% on 27^th July 2020.

Comparative Price Chart (Source: Refinitiv, Thomson Reuters)

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