Resource News

Rising wages, falling resource prices and other challenges are gripping the country’s resource sector. But there are still opportunities to profit, says one investment expert.

Australian mining companies have faced significant headwinds lately. In addition to the strong Australian dollar (which makes the country’s exports more expensive) and a decline in prices for iron ore and other resources, explorers and producers have been facing sharply higher operating costs.

According to a September report commissioned by the Minerals Council of Australia, capital expenses are rising faster in Australia than in many other parts of the world. For example, the report states that the cost of building an iron ore project in the country is about 30 percent higher than the global average. The cost of thermal coal mines is even higher, at 66 percent above the average.

Figures like those are raising questions about the country’s global competitiveness, particularly as mining companies scale back their current operations and put off future projects. Australian resource firms have cut 10,000 jobs in the last couple of months in an attempt to reduce their overhead by around $2 billion, according to a recent report from R2Mining and CostMine.

“Truck drivers cost $75,000 a year in the US but $125,000 in the Pilbara [iron ore mining region],” BHP Billiton (NYSE:BHP,ASX:BHP,LSE:BLT) executive Alberto Calderon said in a recent article in The Australian.

Mining companies operating in the country are also subject to the minerals resource rent tax (MRRT), which came into effect on July 1, 2012. The MRRT applies to profits from new and existing iron ore and coal projects at an effective rate of 22.5 percent. The government also brought in a carbon tax on July 1 under which about 300 companies are charged AU$23 per metric ton of emissions.

Shares of major Australian miners are still holding up

So where does that leave investors? Despite these challenges, Australian resource stocks have held up relatively well compared to the competition, according to the data available.

Over the past 12 months, the S&P/ASX 300 Metals & Mining Index, which consists of some of the country’s largest mining stocks, has declined 15 percent. To put that in context, the iShares S&P/TSX Capped Materials Index Fund (TSX:XMA), which tracks the movements of the biggest mining stocks on the Toronto Stock Exchange, has fallen about 18 percent in that time. The TSX Venture Exchange, which is dominated by junior miners, is off about 23 percent.

Meanwhile, shares of BHP Billiton are down just 3.7 percent, while another Aussie major, Rio Tinto (NYSE:RIO,LSE:RIO,ASX:RIO), has declined just under 1 percent.

US investment expert: Australian majors are well positioned to handle setbacks

Those two majors continue to look attractive to Roger Conrad, editor of the Australian Edge newsletter. The publication spotlights investment opportunities for US investors in the land down under.

“I’m still very bullish on Australian majors like BHP and Rio Tinto,” said Conrad in a December 7 phone interview. “They’re much better value than they were five years ago. They’re holding more cash, they’re more diversified and they’re better able to handle shocks and setbacks.”

Conrad feels these strengths put majors in a better position than the country’s junior mining firms, which he believes will have more trouble dealing with rising costs. He also points to the majors’ dividends as another plus for investors: right now, BHP shares yield 3.1 percent annually while Rio Tinto has a 3.2 percent yield.

A long-term approach is the key

On the whole, Conrad still sees Australia as an attractive place to invest — but investors need to take the long view.

“I think if you look at a map, you’ll see where Australia’s future lies,” he said. “I think a lot of investors see the country as a proxy for China because it produces so many of the resources that China needs, such as iron ore and metallurgical coal. That connection has had its ups and downs for Australia — I’d say more ups than downs.”

Conrad sees signs that China’s resource demand is starting to pick up again after the country’s recent slowdown, but again he cautioned that patience is key. “These mining companies have to think long term,” he said. “These are huge projects with massive capital expenses. The problem is that we as investors tend to think in the short term.”

“Australia still has lots of resources to be developed,” he added. “It’s also a politically stable, first-world economy, so there is less resource nationalism to worry about than in some more risky countries. Its companies also have a lot of expertise that they can bring to nearby developing markets.”

LNG projects have strong potential

Another potential growth area? The country’s large liquefied natural gas (LNG) projects. These massive facilities convert natural gas to liquid form for shipment to Asian markets. Many, such as Chevron’s (NYSE:CVX) massive Gorgon facility, have also experienced cost overruns, but Conrad feels Australia’s LNG business has a bright future.

“There is tremendous demand for LNG in Asia and prices are around $17 per million British thermal unit,” he said. “And believe it or not, energy is a steadier source of revenue than mining over time.”

 

Securities Disclosure: I, Chad Fraser, hold no positions in any of the companies mentioned in this article.

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