KEY POINTS:
The mining boom, which has given a huge boost to the Australian economy and sharemarket, has created a big dilemma for investors.
Their option is either to realise profits or hold on with the view that the boom cycle still has some distance to run.
In the past few weeks the world's three largest diversified mining groups, Anglo American, BHP Billiton and Rio Tinto, have released profit figures for the period ended December 31. The results have been spectacular with all three companies more than doubling net earnings over the past two years.
London-based Anglo American reported underlying net earnings of US$5471 million (NZ$7776 million) for the December 2006 year, a 46.4 per cent increase over the December 2005 year.
The star performer was base metals (copper, zinc and nickel), which had a 113 per cent profit leap and contributed 43 per cent of group earnings. The other big improvers were platinum (20 per cent of group earnings) and gold (3 per cent).
The group generated huge positive cash flow and announced a share buyback of US$3 billion (NZ$4.3 billion). This follows a US$7.5 billion buyback in 2006.
As far as the 2007 outlook is concerned, chief executive Tony Trahar had this to say: "European markets are improving and emerging markets, in particular China and India, are growing strongly. Continued growth in these regions in 2007 is likely to largely offset weaker US growth. This should provide a supportive climate for commodities in the near term".
BHP, incorporated in Broken Hill in 1885, and Billiton, established in Holland in 1860, merged in 2001. The combined group announced net earnings of US$6168 million for the six months ended December 31, a 41.3 per cent increase over the same period in the previous year.
For the 12 months ended December 2006, which includes the second half of the group's June 2006 year and the first half of the current year, BHP had net earnings of US$12,254 million.
The main contributors to operating earnings in the latest six-month period were base metals, 32 per cent, petroleum, 18 per cent, and stainless steel materials, 16 per cent. The stainless steel division reported a 284 per cent surge in operating profit because of higher nickel and cobalt prices and base metal earnings jumped 53 per cent.
BHP, which also announced an additional US$10 billion share buyback, had this to say about the future: "China is set to continue as the main driver of demand, but more mature markets may also lend support, especially Europe and Japan. The global impact of a slowdown in the US is expected to be lower than generally assumed and we do not anticipate a return of [commodity] prices to longer term [lower] averages over the medium term".
Rio Tinto reported underlying net earnings of US$7338 million for the December 2006 year, a 48.1 per cent jump on the previous year.
The main contributors to net earnings were copper, 49 per cent, and iron ore, 31 per cent. The copper, iron ore and aluminium operations raised net earnings by 76 per cent, 32 per cent and 90 per cent respectively, compared with the December 2005 year.
The result was in line with expectations although analysts were disappointed the group didn't expand its unutilised US$2.5 billion buy back in the United Kingdom.
Rio had this to say about 2007: "We expect some moderation of global economic growth, although confidence in Japan and Europe is increasing. Growth in China, which is critical to the demand outlook for many of our products, remains strong and well balanced.
"We continue to view the overall outlook for commodities as positive, with prices remaining well above their long run averages."
Analysts are also optimistic about the outlook for Anglo American, BHP Billiton and Rio Tinto and most of them have a buy recommendation on all three stocks.
Anglo American is expected to raise earnings by between 10 per cent and 20 per cent in the current year because of higher iron ore, nickel, zinc, platinum and gold prices.
Analysts believe that BHP Billiton will achieve net earnings in excess of US$12.5 billion for the June 2007 year and the mean consensus forecast for the following year is in excess of US$13.5 billion. This places the company on a prospective 2008 year P/E (price/earnings) ratio below 10.
Rio Tinto is forecast to raise net earnings to approximately $8 billion for the December 2007 year because of continuing strong global growth, particularly in China. Most analysts have a buy recommendation on the stock because of its low P/E, strong balance sheet, huge cash flow and ability to have further share buy backs.
The share prices of all three major mining groups have remained relatively static over the past 12 months even though earnings have soared and most analysts believe they are undervalued. Investors may regret this cautious approach if the buoyant economic conditions in China continue for a few more years.
Although the New Zealand sharemarket had its origins in the 19th century mining towns of Thames and Reefton the sector no longer plays a meaningful role as far as the NZX is concerned.
A number of developments have occurred in recent years that have reduced the size of the NZX mining sector including:
* Otter Gold Mines was taken over at the beginning of the mining boom in 2002. It is now producing significantly more gold under foreign ownership at its Waihi and Australian Tanami mines.
* The float of the New Zealand Oil & Gas Pike River coal project has been continually delayed because of corporate governance problems.
* The highly successful coal miner Solid Energy, which had net earnings of $85.8 million for the June 2006 year, is government owned.
* Macraes Mining was taken over under controversial circumstances in 1998 and relisted as OceanaGold in 2004. The Melbourne-based company is now trading more than 20 per cent below its 2004 IPO price of A$1.00 a share.
On Thursday, OceanaGold announced net earnings of A$11 million for the December 2006 year compared with a loss of A$1.8 million for the previous year. These figures are before unrealised hedging losses and goodwill write-offs.
OceanaGold's only operation in 2006 was the Macraes project in North Otago, which produced 182,288 ounces of gold compared with 170,019 ounces in the previous year. Macraes had an average cash margin of A$388 per ounce compared with A$283 an ounce the year before.
The group's other New Zealand operations are the new Frasers underground mine in North Otago and the Globe Progress project in Reefton. Frasers is expected to begin production in the June quarter and Reefton is forecast to produce between 55,000 and 60,000 ounces in 2007, its first full year of operation.
The future share price performance of OceanaGold is highly dependent on the Didipio gold and copper project in the Philippines, which was acquired through the merger with Climax Mining in November 2006.
This is a high risk project with significant earnings potential.
Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
bgaynor@milfordasset.com
