Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Thematic (Sector/Industry)

Australia Metals and mining / Thematic (Sector/Industry)

Much has been written about China’s Belt and Road Initiative, or BRI--formerly known as the One Belt and One Road Initiative--but we think much of the overwhelmingly positive commentary lacks context and is wide of the mark. Major iron ore miners such as <a href="https://www.smartkarma.com/entities/147" target="_blank" data-smartkarma-citation="entities:147:1">BHP Billiton Limited (BHP AU)</a>, <a href="https://www.smartkarma.com/entities/13" target="_blank" data-smartkarma-citation="entities:13:1">Rio Tinto Ltd (RIO AU)</a>, and <a href="https://www.smartkarma.com/entities/41" target="_blank" data-smartkarma-citation="entities:41:1">Fortescue Metals Group Ltd (FMG AU)</a> all expect BRI to drive further growth in steel demand in China, and in turn support growing demand for iron ore. BHP expects China’s steel demand to continue to grow at about 1% per year until the middle of the next decade. However, we think the likely spend on BRI, and its consequent boost to steel and iron ore demand, is small in context of China’s already heady spending on fixed asset investment. China’s increasing reliance on fixed asset investment to drive economic growth has the unwelcome impact of growing debt, declining productivity and a diminishing pool projects worthy of investment and capable of delivering an acceptable return.Fortescue was an early vocal supporter of BRI, but more recently, BHP has grabbed headlines with a bullish take on its potential to drive China’s steel consumption. Recent commentary from BHP makes BRI sound like a very big deal, saying it’s seven times larger than the Marshall Plan to rebuild post-war Europe and estimates total spending of USD 1.3 trillion. The company says BRI could drive an additional 150 million tonnes of incremental steel demand in 10 years, approximately 15 million tonnes a year.This all sounds material and positive for the miners, however, we think context is important. China’s steel consumption in 2016 was about 713 million tonnes, so if BHP’s estimate of 15 million tonnes of additional steel consumption is correct, it would translate to a one-time increase in China’s steel consumption of about 2%. Versus global steel output, which in 2017 is tracking towards 1.69 billion tonnes given year-to-date growth in output of 4.9%, BHP’s estimate of the impact on steel demand from BRI translates to a once-off 0.9% rise.A possible once-off 0.9% increase in steel demand from BRI is small given our view of the headwinds facing steel demand, namely from a likely material decline in fixed asset investment growth in China as investment projects become increasingly inefficient and bad debt builds as a consequence. With respect to BHP’s Marshall Plan comparison, it’s notable that global steel production in 2017 is about nine times larger than 1950s 189 million tonnes.Contrary to the upbeat commentary from the miners, we think the recent uptick in commodity demand and prices is just a cyclical upturn driven by China’s 2016 stimulus. Long term, structural headwinds remain and China’s steel consumption is likely to decline in the next decade. This, along with further low-cost iron ore supply additions, should drive a flattening of the iron ore cost curve and producer margins.<div class="content-highlight">The major miners remain overvalued with the market too optimistic on future demand growth for mined commodities, particularly for the steel making materials--iron ore and coking coal. China’s economy has reached diminishing returns from increasing fixed asset investment and we think future demand growth for mined commodities is likely to suffer as a result. BHP’s London-listed <a href="https://www.smartkarma.com/entities/21840" target="_blank" data-smartkarma-citation="entities:21840:1">BHP Billiton PLC (BLT LN)</a> stock is the cheapest of the major miners, but still somewhat overvalued, trading at an approximate 20% premium to our fair value estimate. We think BHP, particularly its Plc shares, is less overvalued than its peers given its greater exposure to oil and lesser exposure to iron ore. BHP’s Australian listed BHP Limited shares and Rio Tinto’s London-listed Plc shares trade at close to 40% premiums to our fair value estimates while the higher-cost or more iron ore exposed miners, such as Fortescue, Vale and Anglo American, trade at premiums of at least 60% to our fair value estimates.</div>Analyst: Matthew Hodge

Much has been written about China’s Belt and Road Initiative, or BRI--formerly known as the One Belt and One Road Initiative--but we think much of the overwhelmingly positive commentary lacks context and is wide of the mark. Major iron ore miners such as BHP Billiton Limited (BHP AU), Rio Tinto Ltd (RIO AU), and Fortescue Metals Group Ltd (FMG AU) all expect BRI to drive further growth in steel demand in China, and in turn support growing demand for iron ore. BHP expects China’s steel demand to continue to grow at about 1% per year until the middle of the next decade. However, we think the likely spend on BRI, and its consequent boost to steel and iron ore demand, is small in context of China’s already heady spending on fixed asset investment. China’s increasing reliance on fixed asset investment to drive economic growth has the unwelcome impact of growing debt, declining productivity and a diminishing pool projects worthy of investment and capable of delivering an acceptable return.Fortescue was an early vocal supporter of BRI, but more recently, BHP has grabbed headlines with a bullish take on its potential to drive China’s steel consumption. Recent commentary from BHP makes BRI sound like a very big deal, saying it’s seven times larger than the Marshall Plan to rebuild post-war Europe and estimates total spending of USD 1.3 trillion. The company says BRI could drive an additional 150 million tonnes of incremental steel demand in 10 years, approximately 15 million tonnes a year.This all sounds material and positive for the miners, however, we think context is important. China’s steel consumption in 2016 was about 713 million tonnes, so if BHP’s estimate of 15 million tonnes of additional steel consumption is correct, it would translate to a one-time increase in China’s steel consumption of about 2%. Versus global steel output, which in 2017 is tracking towards 1.69 billion tonnes given year-to-date growth in output of 4.9%, BHP’s estimate of the impact on steel demand from BRI translates to a once-off 0.9% rise.A possible once-off 0.9% increase in steel demand from BRI is small given our view of the headwinds facing steel demand, namely from a likely material decline in fixed asset investment growth in China as investment projects become increasingly inefficient and bad debt builds as a consequence. With respect to BHP’s Marshall Plan comparison, it’s notable that global steel production in 2017 is about nine times larger than 1950s 189 million tonnes.Contrary to the upbeat commentary from the miners, we think the recent uptick in commodity demand and prices is just a cyclical upturn driven by China’s 2016 stimulus. Long term, structural headwinds remain and China’s steel consumption is likely to decline in the next decade. This, along with further low-cost iron ore supply additions, should drive a flattening of the iron ore cost curve and producer margins.The major miners remain overvalued with the market too optimistic on future demand growth for mined commodities, particularly for the steel making materials--iron ore and coking coal. China’s economy has reached diminishing returns from increasing fixed asset investment and we think future demand growth for mined commodities is likely to suffer as a result. BHP’s London-listed BHP Billiton PLC (BLT LN) stock is the cheapest of the major miners, but still somewhat overvalued, trading at an approximate 20% premium to our fair value estimate. We think BHP, particularly its Plc shares, is less overvalued than its peers given its greater exposure to oil and lesser exposure to iron ore. BHP’s Australian listed BHP Limited shares and Rio Tinto’s London-listed Plc shares trade at close to 40% premiums to our fair value estimates while the higher-cost or more iron ore exposed miners, such as Fortescue, Vale and Anglo American, trade at premiums of at least 60% to our fair value estimates.Analyst: Matthew Hodge

China's Belt and Road Initiative Unlikely to Slow Commodity Demand Headwinds