Analysts consider that the boom in mining stock prices seen this year will slow down due to rising costs pressures and steady, rather than increasing, metals prices.
Author: Eric Onstad
Posted: Wednesday , 19 Sep 2007

JOHANNESBURG (Reuters) - A slowdown in earnings growth at mining firms is likely to accelerate amid rising costs and flat or weaker metals prices that threaten the industry's hefty margins.
Demand from burgeoning economies in China and India may still underpin the sector in coming years, but the easy money generated during blistering rallies in metals prices is coming to an end, some analysts and fund managers warn.
While mining shares are still outperforming the broad market, some are wary of earnings prospects and have already shed key mining stocks.
"It's what I call a 'dance close to the door'. If you haven't already made some plans, you should be making some plans to reduce in my opinion," said Liston Meintjes, chief investment officer at Metropolitan Asset Managers in Cape Town.
Metropolitan divested some of its mining holdings earlier this year and Meintjes said he was worried about slowing profit growth amid worries that rising supplies from new mines will pressure metals prices.
A global commodities boom fuelled by Asian demand has lifted the bulk of mining stocks in recent years, providing rich rewards to investors in the sector.
The UK-focused FT350 mining index <.FTNMX1770>, which includes most of the world's biggest diversified mining groups, has nearly tripled over the past three years, compared with a 40 percent gain in the benchmark FTSE 100 index <.FTSE>.
So far this year, the mining index is up 36 percent versus a 3.3 percent rise for the FTSE.
Some warning signs have already appeared.
Last month, Rio Tinto Ltd/Plc posted a 6 percent fall in first-half profit, missing forecasts due to higher costs and taxes.
JPMorgan analysts said at the time that a 3.4 percentage point drop in the EBITDA margin marked the first time in three years that profitability had fallen, while costs rose over four times the rate of inflation.
While healthy profits at other major mining groups have reassured some investors, overall earnings growth among the three biggest UK-listed mining groups have shown a sharp decline, according to Reuters calculations.
Collective year-on-year operating profit growth for the three -- BHP Billiton , Anglo American and Rio Tinto -- slid to 11.6 percent in the six months to the end of June versus 36.6 percent in the prior six months.
Valuations in the sector are not yet pricey but could become stretched if earnings growth slows.
"The PEs (price-to- earnings ratios) don't look all that bad, the dividend yields don't look all that bad, but it's the sustainability of the 'E', which would in my opinion make them perhaps not immediately attractive investments," said Simon Hudson-Peacock, head of equities at Cadiz African Harvest Asset Management in Johannesburg.
The FT350 mining index is trading on a multiple of 11.8 times this year's forecast earnings, a slight discount to the 12.1 times multiple for the FTSE 100, according to Reuters data. Rio trades on 12.7 times, BHP Billiton on 11.4 times and Xstrata on 9.3 times.

"I don't think there's necessarily going to be a short-term impact on the revenue line, but I do see declining margins which will make them less attractive as investment opportunities," Hudson-Peacock said.
The sector's net profit margin nearly tripled to 27 percent last year from 10 percent three years earlier, according to a study of the 40 world's biggest mining firms by accountants PricewaterhouseCoopers.
But margins could be squeezed as the global commodities boom creates shortages in mining supplies and skilled labour.
BPH Billiton, the world's largest mining group, calmed many investors last month when second-half results rose largely in line with expectations and annual costs, excluding non-cash costs, rose only 3.6 percent. Deutsche Bank Securities upgraded the firm to "buy" from "hold", but cautioned that its cost control was not as rosy as it seemed.
"We also challenge the cost performance and suggest BHP Billion's costs have been little better than others, with some divisions show some 'eye-popping' outcomes over the past two years on the face of it," a research note said.
A levelling off or decline in base metal prices after blistering rallies in recent years may also pressure profits. "Most commodity prices remain materially above long-term price expectations," said analyst Simon Toyne at Numis Securities.
Metal prices have been volatile, with copper having soared fourfold over the past four years while nickel made the same fourfold jump in only 18 months when it hit a record of $51,800 per tonne in early May. Nickel, however, has since shed nearly half of those gains.
Toyne said while demand growth remains at current levels, the sector was attractive, but noted: "Although prices appear relatively stable, it does require a high level of demand growth going forward to stay at those levels, therefore any sort of risk to that could amount to really significant earnings downgrades."