By David Berman
How bad can things get for base metals miners?
Stocks like Rio Tinto PLC (NYSE:RIO), Alpha Natural Resources Inc. (ANR) and Teck Resources Ltd. (TCK) have been pummeled in recent action, with year-to-date losses now between 36% and 66%. The declines come amid signs of slowing global economic growth and the impact that would have on demand for things like copper, coking coal, zinc and nickel.
The big question, though, is how much further can these stocks fall if economic conditions continue to deteriorate. Greg Barnes, an analyst at TD Newcrest, looked at various valuation measures during the depths of the last financial crisis and recession to get a look at the worst-case scenario and found that, should that worst-case be repeated, stocks could fall another 34%. The good news? They probably won’t.
Right now, the average price-to-net-asset-value for Canadian base metals stocks is 0.6. But during the previous crisis, that multiple fell to an average of just 0.3 to 0.4-times. And for companies in financial distress, such as Teck and Lundin Mining Corp., the multiple fell to a mere 0.1 to 0.2 times. (Recall that Teck shares fell to a low of $3.42 in 2009, down from 93% in less than a year.) Verdict: Stocks have the potential to fall more.
When Mr. Barnes looked at enterprise value to earnings before interest, taxes, depreciation and amortization (EBITDA), he found that stocks currently trade at 3.15-times on average. During the last crisis, they fell to an average of 1.53-times. Verdict: The same – stocks can fall a lot more.
However, he did note that balance sheets are in much better shape this time around, which should provide some support to stocks. He explains:
“Teck Resources and Lundin Mining were battling fears of bankruptcy, and First Quantum’s net cash balance at the end of third quarter in 2008 was just $32-million (U.S.). As of the second quarter in 2011, base metal balance sheets are in a much stronger position. While Teck Resources has a negative net cash position of approximately $3.4 billion, the company has only $1 billion of debt maturities between now and 2016. The improvement in balance sheets over the past three years should lend some support to share prices and prevent P/NAV multiple dropping as low as it did during 2008/09.”
As well, there is always the upside potential to think about here. If authorities can get a grip on the European debt crisis by mid-to-late October and a brighter economic outlook coincides with a rebound in commodity demand – hey, it could happen – it would correspond with the strongest season of the year for commodity prices.
“This possibility hovers in the back of our minds and keeps us from getting too negative on the sector,” Mr. Barnes said in his note. Right now, he has a price target of $66 (Canadian) on Teck Resources, implying an upside of 110% from the stock’s closing price on Thursday.