Greater discipline when it comes to production will deliver a double-edged boost to the mining sector and ensure there will be no repeat of the crash that hit it in 2011, according to Tom Holl, manager of the BlackRock Commodities Income IT.
The FTSE World Mining index fell by more than 70 per cent between the start of 2011 and 2016 after the major mining companies stepped up investment and M&A. This had the twin effect of weakening balance sheets and flooding the market just as demand from China began to slow.
Performance of index over 5yrs
Source: FE Analytics
However, Chinese stimulus measures kickstarted a recovery in the sector in 2016, with the index up 131.54 per cent since the start of that year, and Holl said this rally has a lot further to run.
“What we’ve really seen is the effect of a lack of investment in new capacity,” he explained. “Capital expenditure was slashed in the period 2013 through 2016, and you are now seeing that start to bite in terms of a lack of new supply additions from western world companies.
“Meanwhile, you’re seeing demand continue to tick along nicely. Chinese demand growth, although a lot lower than it was pre-financial crisis, is still relatively attractive in a world where supply is growing at between 0 and 2 per cent in most metals. And it’s very rare that you see a bad environment for natural resources stocks where you have synchronous global growth.”
In light of the increased demand and faced with “a wall of free cash flow”, the industry now finds itself in the same position as in 2011. However, Holl said it has learned from the mistakes of the past and that while there was a spike in project approvals back then, today it is hard to find a management team willing to increase capital expenditure.
“This is going to have that dual effect of supporting commodity markets and allowing companies to build cash on balance sheets and return it to shareholders,” he continued. “And you have seen that with Rio Tinto, which had several buybacks last year as well as very strong dividends, and there is the potential for many other mining companies to do the same.”
Holl admits there is some scepticism from the market about whether the mining companies are just paying lip service to shareholders and there is a feeling that as soon as the cash flows start, “they are going to want to dig another big hole and build another train set because they like big shiny yellow equipment”. However, early indications suggest his claims are being backed up by figures.
For example, today Rio Tinto reported a record full-year dividend of $5.2bn and an additional $1bn share buy-back – it paid £2.5bn in dividends in 2017.
Justin Cooper, chief executive of Link Market Services, said this reflects a new policy that links dividends more closely to profits than in the past.
“That inevitably means shareholders will have to get used to more volatile income from Rio Tinto and other miners, but the sun is shining on the mining sector at present, so investors should make hay,” he added.
“If the other mining companies follow suit, we can look forward to upgrading our forecast for UK dividends in what was otherwise shaping up to be a bit of a dull 2018 for payouts.”
Holl said the real proof that “the leopard has changed its spots” isn’t what is written at the top of the company press releases, but in their pay packets.
“Ultimately they are driven by their own bottom line as much as anything else,” he explained. “Whereas before most mining companies had their remuneration KPIs driven by volume growth, now most of them are focused on margins and total shareholder return.”
Data from FE Analytics shows BlackRock Commodities Income IT has lost 10.11 per cent since Holl and his co-manager Olivia Markham took charge in January 2014, compared with losses of 14.08 per cent from its IT Commodities & Natural Resources sector.
Performance of trust vs sector over managers' tenure
Source: FE Analytics
It is currently yielding 5.31 per cent. Data from FE Analytics shows an investor who put £10,000 into the trust 10 years ago would have made £3,774.67 in income alone over this time.
The discount currently stands at 3.76 per cent, compared with 5.13 per cent and 1.57 per cent from its one- and three-year averages.
BlackRock Commodities Income IT is 6 per cent geared and has ongoing charges of 1.36 per cent.