Mining Companies Need To Ramp Up Cash Payouts -BlackRock

The comments by Evy Hambro, manager of BlackRock Inc.'s (BLK) $35 billion natural resources funds, signal a growing impatience in the market at the underperformance of mining company shares relative to other sectors, and concern that miners could be tempted into a value-destructive deal as a way to lower their cash pile.

"The excess prices they are getting are clearly surplus to their requirements," he said in a recent interview with Dow Jones Newswires. "They don't need all that additional money and the windfall that they're getting from today's markets should be shared with investors."

BHP Billiton Ltd. (BHP), the world's biggest miner by market capitalisation, last week completed a $10 billion share buy-back plan, prompting analysts to speculate that more returns on the same scale are likely to be announced in annual results due next month. Vale, the world's second-biggest miner by market value, announced a separate $3 billion program last week.

A BHP spokeswoman declined to comment on the speculation.

Paul Galloway, a mining analyst at Sanford Bernstein in London who advises several other major mining funds, argues that companies still owe a debt to investors who bailed them out during the financial crisis.

"Shareholders put their hands in their pockets to refinance balance sheets. Managements believe they've been paid back by a rising share price but I'm not sure investors see it that way," said Galloway.

Prices of the heavy commodities that account for the majority of major miners' profits at present are at near-record levels. Front-month TSI iron-ore futures on the Comex exchange were quoted at $170.19 a metric ton Tuesday, 10% below their all-time peak in February but well above historic levels. Newcastle thermal coal, the Asian benchmark product, was quoted at $121.85/ton on the Intercontinental Exchange, around twice its typical level before late 2007, while recent steelmaking coal settlements are up around 50% on the year at around $315/ton.

In their most recent results for the year ending December 2010, Vale reported US$17.3 billion and Rio Tinto US$14 billion in net profits, while Xstrata PLC (XTA.LN) and Anglo American reported earnings of US$5.2 billion and US$5 billion respectively. BHP, whose financial year ended last Friday, reported US$10.5 billion profits in its first half alone.

But investors are skeptical about miners' ability to invest their profits wisely, accounting for much of the relative underperformance seen by the sector in recent months, Hambro argued.

Over the past year, the S&P/TSX Global Mining Index has fallen 5.24%, despite a 3.71% rise in the S&P GSCI Commodities Index and a 5.1% rise in the broader-based S&P Global 1200 Index.

Shares in diversified mining companies trade on a multiple of just 8.2 times their expected 2011 earnings and are priced at a 12% discount to the value of their expected future cash flows, according to BMO Capital Markets.

"Generalist investors are saying: 'It's all very well these companies earning loads of money but if they're going to sit on it and reinvest it badly why should I invest in them?'," says Hambro.

Ratings agencies at present see little threat from more aggressive payouts. Standard & Poor's in April upgraded Rio Tinto's debt to a single-A rating for the first time since its debt-fueled $38.1 billion takeover of Canada's Alcan Inc. in 2007.

"As long as the companies maintain the discipline of only distributing surplus cash flows then I don't expect a ratings impact" from cash payouts, says Peter Archbold, a mining analyst at Fitch Ratings in London.

But Galloway says that managements remain scarred by the financial crisis, when companies saw cash running short as materials prices plunged--a fear underlined by the recent wobble in commodities markets.

"There's a huge amount of corporate conservatism led by finance directors who don't want to go through that experience again," said Galloway. "But they're in a very different cash position now to where they were in September 2008."

Copyright © 2011 Dow Jones Newswires

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