Antofagasta cuts dividend amid sector downgrades

Battling against historically weak commodity prices, Antofagasta has followed heavyweight peers and axed its final dividend to protect its balance sheet. Pre-tax profit crashed from over $1.5 billion (£1 billion) to just $259 million in 2015 and the share price has plunged by over 10% Tuesday. The news also comes as the wider sector hands back recent gains and one top number cruncher has made some significant downgrades.

Early operating disruptions didn't help Antofagasta and revenue slipped by a third to $3.4 billion last year, as copper sales volumes slipped 9% to 643,000 tonnes (kt) and gold volumes sank 18% to 219,000 ounces (koz). As cash flow from operations fell by two-thirds to $858 million, foreign exchange headwinds and money spent cutting costs caused net cash costs to rise 5% to $1.5 per pound (/lb).

Managing to cut operating costs by $245 million and slash capital expenditure by a third to $1 billion over the year, the group is targeting another $250 million of cuts in 2016.

And Antofagasta's dividend decision doesn't breach its policy to pay out at least 35% of annual earnings. However, shareholders will only get 3.1 US cents per share this year compared with 21.5 cents in 2014.

Ready for a squeeze

Things are looking up, though, as the group waits for full Zaldivar production to be realised and for Antucoya to reach its 85kt per annum target output this year. Broker VSA Capital has pencilled in copper production of 710-740kt and gold output of 245-275koz.

"We believe that the copper market is well positioned for a squeeze, given the improving market fundamentals following cuts to supply in second-half 2015 and falling inventories, as well as the recovery in China's housing market," said the broker. "We believe that ANTO offers the most attractive copper exposure globally, given the high operational and financial leverage of peers."

The market doesn't seem convinced, however, and the shares fell 11% to 477p in early deals. After bottoming at 341p mid-January, Antofagasta's shares bounced 74%, testing 600p resistance (see chart) for the first time in six months. There's strong technical support at 482p.

Sector valuations thin

While the mining sector bounced hard from January lows, valuations are starting to look a bit thin across the industry. In fact, Haitong Securities has made some pretty important downgrades.

Commodity prices have rebounded sharply over the past few weeks, and Haitong has upgraded its 2016 iron ore price forecast from $38/t to $45/t. Granted, industry-wide market fundamentals aren't as gloomy as they were in January, but are they as good as current prices and stockmarket valuations suggest?

No, reckons Haitong. Driven by restocking at Chinese steel mills, the recent spot iron ore price is unsustainable and the price will likely unwind. There are four factors influencing this long-term cycle: lack of acquisitive strategy, misplaced capital allocation, an inventory hangover and unwinding capital expenditure cycle.

Initially triggered by a flurry of closing short positions, retail investors who want exposure to mining stocks have piled back in. This sentiment will run its course as valuations rebound to arguably unjustified levels, says Keen, downgrading BHP Billiton, Glencore and Anglo American. 

The analyst explains: "The sector has been operating in a vacuum in recent months - generalists had largely abandoned the sector by the fourth quarter 2015, leaving the higher beta names (GLEN, AAL) vulnerable to shorts. What started as a short-covering rally has spread more broadly, with many investors seeking to cover underweight positions out of fear that commodity prices could rally strongly.

"This will need some fundamental underpinning if it is to continue through the second quarter. Although the longer-term fundamentals are improving, the overriding problem remains that there is too much overhang in Chinese construction in the near term to lead to a surge in commodity demand."

Here we run through Haitong's positions:

BHP Billiton - Downgrade to 'neutral'

Despite changes to its dividend policy, BHP has rallied strongly since January and now Keen sees limited potential for further upside. With a slow decline in net debt expected, there's little room for top-ups to the 50% pay-out ratio. Its fair value has inched to 864p, representing 5.9% upside.

Glencore - Downgrade to 'neutral'

Although Haitong has increased the miner's target price from 121p to 142p, the stock has been downgraded after its recent bull run fuelled by generalists covering underweight positions. With 1.6% downside, Keen says: "This has removed the discount Glencore had attracted due to the structure of its balance sheet."

Anglo American - Downgrade to 'sell'

Haitong isn't breaking the mould here. In fact, it's joining 18 other 'sell' recommendations. But, after enjoying the recent rally, Keen is confident the shares are trading for a third more than its 343p target price.

"Anglo has been a turnaround story for too long, and we see potential for disappointment in 2016; selling assets you don't want is always difficult at the bottom of the cycle."

Rio Tinto - Maintain 'buy'

With good assets, a nice balance sheet and conservative strategy, Rio Tinto falls short of higher beta names in the sector. However, with underestimated quality cash generation and a new dividend policy, Haitong is optimistic - although the finer dividend details need to be worked out. With a 2,515p target price, the shares have 26% upside.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.