Today I am looking at two raw material giants under severe pressure.
Mining colossus disappoints again
Due to the precarious state of commodities markets, I believe that shrewd investors should continue to give energy and mining giant Vedanta Resources (LSE: VED) extremely short shrift.
The London-based business advised today that earnings halved between October and December, to $493.6m, as all of the company’s major divisions suffered heavy blows. Total revenues headed 27% south during the quarter, to $2.44bn.
The zinc division — a market from which Vedanta sources almost half of earnings — saw the bottom line dip 45% during the period. And looking elsewhere the company saw earnings at its aluminium and oil arms slump 84% and 72% correspondingly from the same 2014 period.
Vedanta continues to undergo extensive cost-cutting to mitigate the effect of falling commodity prices, but these measures are clearly no match for the colossal descent in raw material values. And this scenario is unlikely to improve any time soon as oversupply across Vedanta’s key markets worsens.
The City expects Vedanta to have finally swung into losses in 2015 following years of persistent earnings declines, and the bottom line is expected to remain underwater with losses of 8.1 US cents per share in 2016.
And I do not expect earnings to recover in the near future as, despite Vedanta’s attempts to offset falling values by hiking output — aluminium production hit record levels of 234,000 tonnes during the most recent quarter — the impact of such hikes on already-abundant supply levels should keep material prices under pressure in the longer term.
All that glistens is not gold
Likewise, I believe the risks at precious metals producer Fresnillo (LSE: FRES) also remain to the downside.
The Mexican mining specialist’s share price has enjoyed a fresh bump higher in recent days thanks to improving gold and silver values. The former struck three-month highs around $1,125 per ounce as poor US data casts doubt over future rate hikes, a phenomenon which also dragged silver prices higher.
But I believe such rallies are likely to prove short-lived. It is true that precious metals have traditionally been a magnet in times of macroeconomic volatility. But industrial demand for silver is expected to remain weak as the global economy splutters, while the likelihood of renewed dollar strength in the months and years ahead should push prices of both gold and silver to the downside again.
Broker consensus suggests that Fresnillo should enjoy an 81% earnings bounce in 2016 as output explodes, resulting in a mega-high P/E ratio of 30.7 times. I find this forecast hard to fathom given that metals prices are likely to keep on struggling, but even if this proves correct, I believe such a high earnings multiple fails to address the massive risks facing the business in the long-term.