Weaker global economic growth bites twice for Antofagasta. First, it curtailed the rapid rise in copper prices that had fuelled the sharp post-pandemic rally in the FTSE 100 miner’s shares; now inflation threatens to eat into cashflows by pushing up the costs of expansion.
The budget for a mooted project to increase production at Antofagasta’s Centinela mine has risen to $3.7 billion, from an expected $2.7 billion. A decision on the project to increase production by 170,000 tonnes a year is not due until next year. If it goes ahead, it would eat into the company’s medium-term cashflows, according to analysts at RBC Capital.
Meanwhile, costs for the first phase of a plan to increase the capacity of Los Pelambres, Antofagasta’s largest mine, by 60,000 tonnes are almost entirely locked in as the project nears completion. Yet a second phase, which could increase production by 35,000 tonnes a year, would not be completed until 2025. Analysts at Peel Hunt reckon the potential overshoot at Centinela could cause the budget for that second phase at Los Pelambres to rise to between $630 million and $680 million, rather than the $500 million that Antofagasta has pencilled in.
Cost inflation is one of several challenges for Antofagasta, which operates four copper mines in Chile, two of which also produce gold and silver. The combination of a recovery in demand and supply shortages pushed up copper prices to record levels last year, with a predictable impact on profits for Antofagasta. But conditions this year are less easy. A potential downturn in demand for metals such as copper has removed one key lever of support for profits. The average realised copper price fell back by 6.6 per cent during the first six months of the year.
With economic growth shaky across several big economies, including China, investors are cautious about the sector’s earnings prospects this year. The result for Antofagasta? An enterprise value of 5.6 times forward earnings before tax and other charges, towards the lower end of the long-running historical range.
Operational challenges have been more disruptive to Antofagasta’s progress this year. Production fell by just over a quarter to 268,600 tonnes during the first half of the year, as drought and a leak in an underground pipeline at Los Pelambres held back volumes. But the company is banking on production accelerating during the second half and has held a target of 640 tonnes to 660,000 tonnes of copper for the full year, picking up to 700,000 tonnes next year. How? First, the completion of a desalination plant at the end of this year at Los Pelambres should help to tackle the issue of water scarcity; second, digging deeper into the pit at Centinela should result in higher-grade copper concentrates.
Another risk? Potential tax reform on mining royalties, proposed by the Chilean government. The effective tax rate for operators is 40 per cent, which would rise to 50 per cent under the plans, an impact that would be “significant”, according to Iván Arriagada, the chief executive.
If the Centinela project goes ahead, capital expenditure next year would remain at the heightened level of $1.9 billion that has been guided towards for this year. Those analysts at Peel Hunt still reckon there will be enough cash to fund a 91.7 cents-a-share dividend next year, which would leave the shares offering a potential yield of 6.4 per cent at the present price. Miners naturally are at the mercy of commodities prices, but there are more secure-looking dividends available in the sector.
ADVICE Hold
WHY Worth having for the dividend but cost inflation risk means the group deserves a cheaper rating
Spirax-Sarco Engineering
Fatter margins and a steely record of organic revenue growth have awarded Spirax-Sarco Engineering a premium rating from the market, but even the strongest companies can’t escape investors’ angst over a contraction in global economies. A forward earnings multiple of just over 31 looks punchy, but it is a discount to the five-year average and roughly in line with levels of March 2020.
There is reason to think that Spirax, which makes steam controls, pumps and electrical heating systems used by a range of sectors, should prove more resilient than other industrial specialists. Spirax has a record of growing sales at roughly 2.5 times the rate of industrial production, which also declines by a lower proportion when the market is in contraction. Why? The Watson Marlow division, which makes a chunk of sales from the structurally growing biopharma market, and is expected to increase organic sales by a fifth this year.
Selling items that are critical to manufacturing processes and that are bought out of operational, rather than capital, expenditure budgets, which are less likely to be dramatically cut, should help to insulate Spirax’s revenues from a more pronounced slowdown. In 2020, industrial production contracted by between 4 per cent and 5 per cent, while Spirax’s organic revenue declined by 3 per cent. Industrial production is forecast to slow to 3.5 per cent this year, down from the 4.2 per cent growth anticipated in March, which could leave Spirax in growth mode, even if expectations should be tempered.
Cost inflation has been recouped through price rises, but increased investment in sales staff, increasing manufacturing capacity and product launches ate into the adjusted operating margin during the first half of the year. Yet, at 23.8 per cent, that was still ahead of the pre-pandemic level, helped by sales that were 17 per cent higher on an organic basis. Analysts at Peel Hunt have forecast an operating margin of 30 per cent this year, down from an exceptional 45.7 per cent last year, before a rise to 39.2 per cent.
Spirax is more worthy of retaining than peers in the industrial sector.
ADVICE Hold
WHY Profits could prove more resilient amid economic uncertainty