The Rising Influence of Rising Affluence

[DewDiligence]

Big-3 Global Mining Stocks: 2011 Outlooks

[I like two of these three companies: VALE (#msg-60355492, #msg-58849134, #msg-56677555) and BHP (#msg-60136197), which I prefer to own in the form of BBL. I’m less fond of RIO, which has a sloppy balance sheet and a track record of value-destroying M&A transactions.]

http://www.thestreet.com/print/story/11023317.html

›By Scott Eden
02/25/11

NEW YORK (TheStreet) – Vale (VALE) is full of triumphant glee. BHP Billiton (BHP) is afraid of spies. And Rio Tinto (RIO) has a view to the eventual end of the record-breaking rise of iron ore. Those were three possible takeaways, at least, from an eventful fourth-quarter earnings report season within the mining-and-metals sector. Here are a few others:

China: As it has increasingly over the last decade, the People's Republic looms large over the business of extracting ores from the earth's crust, processing those ores into substances suitable for smelting into other, stronger metals or malleable enough to form shapes, and then selling that stuff to manufacturers all over the planet. China has more of those manufacturers -- steel mills, aluminum plants, copper foundries -- than any other nation.

Judging by their fourth-quarter reports, the big miners collectively feel that China's industrial might will only continue to grow in 2011. This bullishness comes despite all the public handwringing about inflation, and how the moves by Chinese officials to stem that inflation will lead to a dreaded "hard landing" for the world's favorite economic growth engine. Demand out of the Middle Kingdom, the big miners say, will therefore support elevated prices for metallic raw materials, if not sharpen their angle of ascent. It's obvious but it bears repeating: the commodities boom of 2010-11 depends almost completely on China.

You know miners are bullish when they announce such enormous capital-expenditure plans. Billions upon billions of dollars will be spent in 2011 to increase their mining capacity, especially in iron ore. Vale, for example, said it expects the global mining industry to spend some $120 billion total this year.

Who is the most direct beneficiary of these moves, other than out-of-work mining professionals or canary bird keepers? Those companies that manufacture such items as walking draglines, longwall shearers, blasthole drills, hydraulic excavators, rope shovels, feeder-breakers, crushers, conveyers, shuttle cars, and 400-ton off-highway mining trucks. In the U.S., that means Caterpillar (CAT) and Joy Global (JOYG).

The commodities cycle will eventually come to an end, of course. There's no such thing as a perma-rise. The seeds of the next bust have already been planted. It's similar to the famed "hog cycle" of agriculture -- and of human nature itself: rising prices and happy times convince people to produce more to take advantage of those rising prices. Eventually, they produce so much that they cause a glut, and prices come crashing down. Take iron ore: so much capacity will come online starting in 2012 and 2013 that eventually supply will catch up to demand, no matter how crazily China grows.

Company-specific notes

Vale

General Outlook: In a word, effusive. Maybe it's their Brazilian-ness, but Vale's executives tend to be more emotive than their Anglo-Australian peers. There was a barely contained excitement riding underneath the company's extensive "Business Outlook" section of its annual report. The scribe in Vale's corporate-communications department who penned the report was ebullient enough to invent new words. "Growth in global economic activity now has more sectorial and geographical breadth than in the first leg of the recovery from the Great Recession of 2008/2009." Also: "For the first time since mid-2003, when global GDP was expanding above 5% per annum, there is a synchronized acceleration in the manufacturing and services sectors, indicating a broad-based pickup in final demand which adds strength to growth sustainability."

Capex: Vale won the prize here, promising to spend a whopping $24 billion in 2011 alone. That's roughly the GDP of Latvia. (Last year, the company spent $11 billion.) Where will all that money go? About 80% will be spent on exploring for minerals and developing mines and expanding existing ones around the world. The headliner is probably Vale's iron ore plan. The company wants to boost its production of that crucial steel feedstock to 522 million metric tons by 2015, up from the 311 million it expects to extract in 2011.

China: Vale doesn't expect growth at its most important customer to slow. The moves by Chinese authorities to stem inflation won't impact demand for Vale's minerals. In this regard, Vale again might be slightly more bullish than most. The conventional wisdom among economists is that Chinese GDP will grow by 8% to 9% in 2011. Says Vale: "We expect China's growth to remain above 10% during the first half of 2011, mainly driven by domestic demand, with a softening in the second semester. The demand for minerals and metals is expected to remain strong not only due to rapid economic growth but also to restocking."

BHP Billiton

General Outlook: In two words, "cautiously optimistic." The company sees short-term risk coming from the so-called European "periphery" -- i.e., the sovereign debt problems faced by the countries that sit geographically at the edges of the Continent, especially the Iberian peninsula and Ireland. "While we expect a slowdown in the growth rate of global commodity demand in calendar year 2011, the economic environment still underpins a robust near term outlook for our products," the company said in its earnings report, released Feb. 16.

Capex: BHP plans to spend $15 billion in 2011. That's part of an almost shockingly large $80 billion capex plan, which the company aims to spend through 2015. Most of the 2011 sum -- a little more than $8 billion -- will go toward expanding mines that are already in production. The company will spend only $1.3 billion on exploration, which likely means that the company will look to acquire promising assets of smaller concerns. Witness BHP's recent deal to buy the shale-gas assets of Chesapeake Energy (CHK) for about $5 billion [#msg-60162987].

But don't look for any mega-deals. After having whiffed on three huge deals over the last several years, including 2010's failed attempt to subsume Potash Corp., BHP's CEO, Marius Kloppers has strove to assure investors that his company will spend on organic growth and smaller deals.

China: BHP is worried about inflation in the People's Republic, but in the end it doesn't believe the tightening measures taken by authorities there will hurt commodities demand. "We expect that the Chinese government will continue to control loan growth as it strives to dampen investment from unsustainable levels while restructuring its economy from being investment driven, to consumption led. Calendar year 2011 GDP and capital spending growth in China is expected to remain strong in absolute terms, despite growth rates decelerating from 2010 calendar year levels," the company said. "We expect a slower but more sustainable economic growth model to lead to a reduction in resource intensity per unit of GDP, however absolute demand for our commodities is likely to remain strong."

Rio Tinto

General Outlook: In a word, risky. "Looking toward the remainder of this year and into 2012 we expect global macroeconomic conditions and commodity supply conditions to support elevated average prices while simultaneously generating elevated risk," the company said.

What does that mean? Rio Tinto believes that monetary and fiscal stimulus props -- for instance, the U.S. Federal Reserve's quantitative-easing programs -- are responsible to some degree for the commodities-price surge over the last year or so. With the global economy recovering, those props will need to be removed for fear of inflation. Thus: the recovery is creating demand for metals, and the supply situation for much of those commodities are tight. But once the props are removed, there's a risk that demand will fall.

Capex: Rio Tinto's 2011 spending plan calls for $13 billion in allocations all over the world. Most notably, though, the company wants to expand its crucial iron-ore mines in the Pilbara region of Western Australia. A good portion will also go toward the company's investment in the Mongolian copper mine Oyu Tolgoi, the key project of Ivanhoe (IVN), which Rio Tinto has helped bankroll.

China: Rio's forecast for China was more vague than its peers. As usual, the company's lead economist, the interestingly named Vivek Tulple, issued a lengthy outlook report to go alongside Rio's earnings results. In it, he didn't provide much in the way of predictions, suggesting only that China's inflation-fighting moves will likely govern commodities demand more than any other factor in 2011.

One interesting detail in Tulple's report: Rio Tinto will be watching the Chinese housing sector as a leading indicator for the direction of the economy as a whole. That's especially the case since several rounds of credit tightening by the government "have not been very effective, with new home prices going still up quickly in many cities." Rio expects the sector to remain strong in 2011, however, which would seemingly offer support to commodities prices through the year.‹