JP Morgan has upgraded its outlook for mining stocks, advising investors to move overweight the sector after being bearish for the last two years.
FTSE 100 heavyweights Rio Tinto, BHP Billiton, Anglo American and Fresnillo also received a boost last month on the news, and although they have since bounced around on macro news flow, the sector's performance has shown a marked improvement over the first half of the year.
When upgrading its rating, JP Morgan pointed out the Chinese economy is showing signs of improvement. Many investors have been concerned because of the uncertainty over the demand outlook from China, the world's largest consumer of commodities. Some miners have responded by honing their businesses, cutting costs and selling off unprofitable parts.
According to a recent report by the Boston Consulting Group (BCG), Value Creation in Mining 2013: The Productivity Imperative, which analysed 42 mining companies over a 10-year period, they do need to do more to improve productivity.
Alexander Koch, partner at BCG and co-author of the report, said: ‘Sometimes managers pursue incremental improvements and miss opportunities to apply innovative technologies or new ways of thinking to operating an asset. Or, managers may ignore the organisational structure, culture, or management systems, all of which are needed to enable change.’
David Smith, co-manager of the Henderson High Income Trust, sees opportunities in the sector, particularly Rio Tinto, as miners start to focus more on improving their processes and reducing spending.
‘Over the last few years, the mining industry as a whole has been guilty of wasting capital on expensive acquisitions and projects with low returns. But as the price of commodities such as iron ore have fallen, as demand for steel has slowed, new management teams have been pressured to tackle the sins of the past and become more efficient. The name of the game now is better capital allocation and increased capital returns,’ he said.
'As such, Rio is focused on dramatically improving its operations and selling off underperforming assets. They have also cut back on capital expenditure to concentrate on only those projects that deliver the highest returns. We like the result – better free cashflow – because it should lead to strong dividend growth.’
Ed Legget, manager of the Standard Life Investments UK Equity Unconstrained fund, said his team has significantly increased exposure to the mining sector in the past nine months. He highlighted low valuations, growing demand and, in some cases, falling supply, and improving cashflows as reasons for this move.
‘We saw some intrinsic value starting to appear there,’ he said. ‘Commodities are very much a supply and demand-driven market. Over the past few years, you’ve had too much supply in most commodities, but underlying demand has been continuing to grow. As we look forward over the next two or three years, supply is actually starting to decline in some materials, such as zinc.’