The COVID-19 pandemic is forcing investors who have shunned Western Australian mining companies for decades (because they prefer buying shares in banks) to smarten their game or risk being left holding yield-free assets as bank dividends dry up.
The COVID-19 pandemic is forcing investors who have shunned Western Australian mining companies for decades (because they prefer buying shares in banks) to smarten their game or risk being left holding yield-free assets as bank dividends dry up.
In what is one of the more remarkable changes linked to the coronavirus, and the economic crash caused by the global lockdown, the WA mining industry has cemented its status as the star performer of Australian business.
It’s not an exaggeration to say the switch from banks to miners as generators of reasonable returns is an event that has caught the business world unprepared because it has never happened before.
Some investment bankers, stockbrokers and financial advisers who have never recommended a mining stock in their lives are being forced to learn about the resources sector, which is one of the mainstays of the WA economy, along with agriculture.
For the first time in generations, mining and farming are getting the recognition in Australia’s commercial centres of Sydney and Melbourne because industries such as tourism, insurance, banking, and aviation have crashed.
Traditionally, banks have been seen as a safe bet, with the possible exception of events such as the 2008 GFC and the Great Depression of the 1930s.
Mining companies on the other hand have a reputation for being erratic, booming one year and collapsing the next as cyclical commodity prices take their toll on profits and dividends.
Booms and busts will always dog mining companies but right now, in a climate of ultra-low interest rates and rapidly declining profits almost everywhere else, it’s the miners that are generating the best returns as commodity prices are reinforced by widespread COVID-19 closures, especially in Africa and South America.
Those outages, such as South Africa ordering the closure of its world-class mining industry, are almost balancing a sharp reduction in demand for raw materials.
The net result is that mining companies, especially WA iron ore and gold producers, are trading strongly, earning handsome profits and paying dividends that make them yield leaders.
Banks, meanwhile, are being forced by governments to cut dividends and focus on supporting business and households (at the expense of shareholders).
Australian joined this worldwide anti-dividend drive earlier this month when the Australian Prudential Regulation Authority (APRA) ‘asked’ banks and insurance companies to reduce or defer dividends.
In the world of business regulation, it would be a brave bank to ignore a request from APRA because it’s the body that makes the rules by which the financial sector operates.
But as the banks become yield-free investments, Australia’s mining companies are steaming along as strong yield generators – with some yields verging on the fabulous when compared with what can be earned in a bank savings account or term deposit.
Examples of the bank versus mining divide can be found in a number of places, including comments from Gaurav Sodhi, an investment analyst with the advisory firm Intelligent Investor.
After noting that a colleague had never recommended a mining stock in his career, Mr Sodhi noted that all industries have their challenges: software and telecommunications companies face rapid technology change, infrastructure and real estate bend to interest rates, and regulators are crucial to healthcare.
“It’s true that miners have no control over the price of their output, yet volume and costs are well understood and competition isn’t likely to come from the garage of a teenager, or anywhere else, overnight,” Mr Sodhi said.
Those comments were carried under the headline: ‘Mining: refuge from the mad?’
An even more compelling case for miners can be found in a research report from investment bank Credit Suisse, which started by noting the bank dividend freeze and then praised the strong balance sheets of the big miners, their ‘defendable’ payout/dividend ratios and, in many cases, a host of earnings drivers moving in the right direction, including lower fuel costs and a low Australian dollar.
Credit Suisse expects WA’s iron ore miners to top the yield league table, with BHP generating a return of 4.4 per cent, Rio Tinto 5.8 per cent and Fortescue Metals Group a startling 11.9 per cent.
Other WA-focused miners on the Credit Suisse list with high yields forecast are South32 at 3 per cent, Iluka Resources at 3.7 per cent and Alumina Limited at 8.9 per cent.
Another investment bank, JP Morgan, said in its latest Australian mining report that free-cash-flow yields were solid and balance sheets largely no stretched at spot (short-term) commodity prices.
UBS warned that mining company dividends could be reduced if COVID-19 restrictions remained in place, citing a decision by one of WA’s top gold stocks, Northern Star Resources, to defer its latest dividend.
But where mining really shines is in comparison with the perennial favourite of institutional and private investors, banks, which are in danger of having their profits and dividends socialised in the COVID-19 fight.
