09 June 2020 by jbchevrel
RIO 5y CDS peaked at 150bp in March. BHP 5y CDS peaked at 140bp. Now these are back to 60bp and 53bp. These had started the COVID crisis (2/21) at 35bp and 32bp. They retraced c80% of the initial widening. RIO products include iron ore, aluminum, copper, diamonds, gold, industrial minerals (borates, titanium dioxide and salt), and thermal and metallurgical coal. BHP does some uranium and petroleum on top of the main ones (iron ore, metallurgical coal, copper). This retracement is broadly in line with the retracement of the itraxx Australia index (75% area). At the end of 2019 both had seizable cash balances reported. RIO had c$11b cash on balance sheet. BHP had c$16b. RIO net income recently ranged from -$1b (2015) to +$14b (2018) and BHP -$6b/+$8b. Both now benefit from the iron ore price rally. BHP and RIO do not seem so exposed to COVID disruptions now because Australia's handling of the virus propagation looks like it has been quite effective. So far. Not much to do with Brazil’s. Reversely, Vale SA has suspended its operations at the Itabira iron ore complex due to the ongoing COVID outbreak in Brazil. That factor has helped sending ore prices higher, adding to an existing rebound. DCE iron ore futures have rebounded c+50% since March lows. The Vale Itabira iron ore complex accounts for c10% of Vale SA production and produces 2.7 mt of iron ore every month, under normal circumstances. The big question there is whether Vale will make up for this output loss later on this year. The fact that their guidance is unchanged at 310-330 mt argues in that sense, but the sharp appreciation of iron ore futures argues oppositely. Vale will have to ramp-up drastically to achieve full-year guidance. It needs to ship 180 mt in H2, which is huge. Iron ore prices are also benefiting from a still healthy Chinese steel production. Chinese steel production had printed in positive territory: up ~+3% YTD as of April end. In parallel, iron ore inventories at the Chinese ports had declined by 110 mt (-21 YTD) as of May end. The recent tensions between China and Australia will not impact RIO and BHP much so long as 1/ it’s mostly verbal 2/ regarding the ‘Students & Tourism’ bucket of Australia exports toward China. Imposing duties on Aussie raw materials is seen as counter-productive for China. Longer term, the main risk on RIO and BHP is a slower-than-expected recovery in raw-material-intensive sectors and countries. At the second order, adverse FX effects (AUD vs EM FX) may weigh on profitability.