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Equities Research Quantitative Strategy
Issued by Wilson HTM Ltd ABN 68 010 529 665 - Australian Financial Services Licence No 238375, a participant of ASX Group and should be read in conjunction with the disclosures and disclaimer in this report. Important disclosures regarding companies that are subject of this report and an explanation of recommendations can be found at the end of this document.
ACTION & RECOMMENDATION
We got an update today from the Bureau of Resources and Energy Economics (BREE) on the state of mining projects and in our view the data paints a bleaker picture than BREEs interpretation. In particular we note that our analysis of greenfield / brownfield projects, projects by major vs junior miners and floating liquified natural gas (LNG) projects suggest of a fall in capex of 1 to 1.5% of GDP for each of the next three years. Further we note even a house building boom would not be enough to offset that fall the Australian economy needs traditional industrial sectors to increase capex which will need a much lower dollar and lower interest rates.
Damien Klassen
[email protected] Tel. +61 2 8247 3101
In this report we present a range of scenarios depending on the assumptions about which types of projects go ahead. The most bullish
scenarios suggest capex will continue to increase as a % of GDP, the
most bearish look like subtracting 1.5 to 2% per annum from GDP.
Over the last 3 years mining capex has added about 1 to 1.5% to GDP growth per year. Over the next 3 years on our base case mining capex
is likely to subtract 1 to 1.5%% from GDP growth.
Going forward there are likely to be a large number of projects deferred given: commodity prices have peaked; many major resource
companies have new CEOs with a focus on shareholder returns rather
than growth; junior resource companies are struggling to get finance.
While floating LNG projects will add to headline capex, most of the spend will be offshore and so after netting off imports the actual
Australian capex will be much lower as much as 1% of GDP by 2016.
A house building boom is unlikely to make back more than 1% of the 3-4% decline in capex as a % of GDP. The rest would require spending
in other economic sectors to pick up which is unlikely in our view
without a substantially lower Australian dollar and / or interest rates.
FIGURE 1: MINING CAPEX AS A % OF GDP
Key assumptions used
% of Floating LNG projects
imported 85%
Base Case:
% projects in feasibility going ahead before 2016
80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -20%
- Junior Miner -50%
- No Feasibility Study -50%
Mega Projects going ahead before 2016: Browse, Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal,
Roy Hill, Galilee Coal, Carmichael Coal.
Source: Wilson HTM, BREE
22 May 2013
QUANTITATIVE STRATEGY
Choose Your Own Adventure: Capex Cliff Edition
Capex in our view
will fall almost as
fast as it rose.
We note a growing difference if
we adjust floating LNG projects for
the proportion imported
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 2
The BREE data (http://www.bree.gov.au/) gives a detailed breakdown of around 380
resource projects including classification, project owners, capex estimates and timing
estimates.
In the first part of this report (below) we use the BREE data to run a number of
scenarios estimating mining capex as a proportion of GDP and present these
scenarios. In the second part of this document (see page 9) we look at the prospects
for housing to pick up and replace the capex from mining which seems to be the RBAs base case.
Capex Scenarios
For each scenario we show our assumptions to the right of the graph.
% of Floating LNG projects imported: This shows our assumption on how much of
a floating LNG projects capex will be imported. Our understanding of the way floating LNG projects will be accounted for by the Australian Bureau of Statistics is best
illustrated by an example. Assume a 4 year project that will spend $4b per annum in
Malaysia and $1b in Australia. Each year the full $5b would appear in mining capex
and there would be an offseting $4b in imports. Therefore mining capex figures are
likely to overstate the effect on the Australian economy for LNG projects.
Now, this is true also of existing mining projects but for existing projects the split
between Australian capex and imported capex is generally heavily skewed toward
Australian capex whereas for floating LNG the skew is the other way around. Our
assumption is that somewhere between 80 and 90% of a floating LNGs capex is imported, which would mean that including all of an LNGs capex would be overstating its effect by between 5 and 10 times.
This means that the headline capex will be skewed by floating LNG imports and so we provide two estimates in each graph one showing the headline capex and one showing the capex net of floating LNG imports.
Ideally we would adjust both forecasts and historical capex estimates to net out
imports for all projects, but the data is not available. It is worth noting though that the
mining peak we see now in Australian Bureau of Statistics is probably overstated by
at least 0.5% due to the effect of imports.
Base Case: % of projects in feasibility going ahead before 2016: This shows our
assumption of the proportion of the dollar value of projects which have a feasibility
study completed that go ahead before 2016. i.e. if there are $10b of projects and we
have a 80% then we assume that $8b of projects go ahead before 2016.
Discounts to Base Case: These are discounts to the base case numbers above that
we apply depending on the projects characteristics. We apply discounts to greenfield projects (i.e. brand new projects are considered less likely than expansions of existing
projects); to projects based on the size of the company (i.e. smaller companies are
less likely to go ahead with a project) and pre-feasibility projects (i.e. projects without
a feasibility study yet are less likely to go ahead before 2016).
Other assumptions (not shown): For all scenarios we use an assumption of 4%
nominal GDP growth for comparability in reality the more bullish scenarios would see greater GDP growth and the more bearish would see less. We assume all
projects which are at the committed stage go ahead. We make assumptions as to the
average construction length depending upon the project type, generally 2 years for
most projects and 4 years for LNG projects. While there are unlikely to be new
projects not currently on the BREE list that start construction in 2013 or 2014 (due to
the long lead time for financing, environments approvals, feasibility studies etc), there
will likely be projects in 2015 or 2016 that we havent yet heard of. We assume an additional 2.5% increase in 2015 and 5% in 2016 to account for these projects in all
scenarios.
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 3
Mega Projects going ahead: Due to their size, we make specific assumptions about
13 of the largest projects: Browse LNG, Arrow LNG Plant (trains 1 and 2), Dudgeon
Point, Sunrise Gas project, Scarborough FLNG, Gorgon (train 4), Alpha Coal Project,
Roy Hill, China First Coal project (Galilee Coal Project), West Pilbara, Carmichael
Coal Project (mine and rail), Wandoan opencut (phase 1), Olympic Dam project. For
these projects we simply switch on or off rather than applying discount factors.
FIGURE 2: SUPER BULL
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 100%
Cost blowout on all projects +20%
Discounts to Base Case:
- Greenfield Projects 0%
- Mid Tier Miner 0%
- Junior Miner 0%
- No Feasibility Study 0%
Mega Projects going ahead before
2016: All.
FIGURE 3: EXTENDED BOOM
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility going ahead before 2016
90%
Cost blowout on all projects +20%
Discounts to Base Case:
- Greenfield Projects 0%
- Mid Tier Miner 0%
- Junior Miner 0%
- No Feasibility Study -25%
Mega Projects going ahead before 2016: Browse, Arrow (T1+2),
Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal, Roy Hill, Galilee Coal, Carmichael Coal.
The (grossly unrealistic) assumption that
all projects go ahead would result in
another leg up to the mining boom
Next we add a little more realism we pull out the major publicly delayed projects like Olympic Dam, Wandoan
etc, assume 90% of feasibility projects go ahead by 2016.
We apply a 25% discount for no feasibility study
The result is an extended boom
with capex around this years
level until 2015
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 4
FIGURE 4: SMOOTH LANDING
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects 0%
- Mid Tier Miner 0%
- Junior Miner 0%
- No Feasibility Study -50%
Mega Projects going ahead before
2016: Browse, Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal, Roy Hill, Galilee Coal,
Carmichael Coal.
FIGURE 5: GREENFIELD / BROWNFIELD ADJUSTMENT
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner 0%
- Junior Miner 0%
- No Feasibility Study -50%
Mega Projects going ahead before
2016: Browse, Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal, Roy Hill, Galilee Coal,
Carmichael Coal.
Next we double those effects, assuming 80% of
feasibility projects go ahead by 2016, apply a 50%
discount for no feasibility study, and assume no Arrow.
Many of these might still go ahead, just not before 2016.
The result is a relatively smooth path
from 2013-2015 with a more
precipitous drop in 2016 (especially on
the LNG adjusted line)
Then we add a 20% discount to
greenfield (i.e. brand new as opposed to
expansion) projects which slightly
steepens the line
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 5
FIGURE 6: BASE CASE
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -20%
- Junior Miner -50%
- No Feasibility Study -50%
Mega Projects going ahead before
2016: Browse, Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal, Roy Hill, Galilee Coal,
Carmichael Coal.
FIGURE 7: LNG BEAR
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility going ahead before 2016
80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -20%
- Junior Miner -50%
- No Feasibility Study -50%
Mega Projects going ahead before 2016: Dudgeon, Alpha Coal, Roy Hill,
Galilee Coal, Carmichael Coal.
Finally to get to our base case we add a 20% discount to projects
by mid-tier miners and a 50% discount to projects by junior miners. As
an example for a junior miner with no feasibility study and a
greenfield project we use 18% of the value of the project.
Assumes base case but no more
LNG approvals (committed
projects still go ahead)
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 6
FIGURE 8: COAL BEAR
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -20%
- Junior Miner -50%
- No Feasibility Study -50%
Mega Projects going ahead before
2016: Browse, Sunrise, Scarborough, Gorgon (T4), Roy Hilll.
FIGURE 9: FUNDING SQUEEZE BEAR
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility going ahead before 2016
80%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -50%
- Junior Miner -90%
- No Feasibility Study -50%
Mega Projects going ahead before 2016: Browse, Dudgeon, Sunrise,
Scarborough, Gorgon (T4), Alpha Coal, Galilee Coal, Carmichael Coal.
Assumes base case but no more Coal
approvals (committed projects still go
ahead)
Assumes base case but a 50%
discount to mid-tier and 90%
discount for junior projects. No Roy
Hill.
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 7
FIGURE 10: DELAYED PROJECT BEAR
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility
going ahead before 2016 60%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -20%
- Junior Miner -50%
- No Feasibility Study -50%
Mega Projects going ahead before
2016: Browse, Dudgeon, Sunrise, Scarborough, Gorgon (T4), Alpha Coal, Roy Hill, Galilee Coal,
Carmichael Coal.
FIGURE 11: SUPER BEAR
Source: Wilson HTM, BREE
Key assumptions used
% of Floating LNG projects imported
85%
Base Case:
% projects in feasibility going ahead before 2016
60%
Cost blowout on all projects +10%
Discounts to Base Case:
- Greenfield Projects -20%
- Mid Tier Miner -50%
- Junior Miner -90%
- No Feasibility Study -50%
Mega Projects going ahead before 2016: None.
CONCLUSION
Our assessment of mining capex is:
from 1987 to 2005 mining capex varied between 1 and 2% of GDP, with an average of about 1.5% of GDP.
Since 2009 mining capex increased from below 3% to over 6.5% of GDP, adding about 1.5% to GDP growth per year for the last 3 years.
While 2013 is not likely to see major declines, we expect to see declines in
Then we look at the case when only 60% of
projects in feasibility make it to market by
2016.
Finally we add all of the above bear cases
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 8
capex of about 1 to 1.5% of GDP from 2014-2016.
Going forward there are likely to be a large number of projects that are deferred:
o Commodity prices have largely peaked. While there is scope for costs to
reduce, we believe this will be a longer term story especially while the Australian dollar remains high. Net effect is planned mining projects are
generally likely to be less profitable than thought 12 months ago.
o major resource companies have largely all had new CEOs installed, with
a mandate for shareholder returns rather than growth
o junior resource companies are struggling to get finance
There are scenarios where mining capex stays high, the key assumptions being a number of LNG projects and whether they will be floating or on-shore.
o In our analysis we assume that Browse , Sunrise and Scarborough all go
ahead but are floating LNG rather than fixed and that Arrow LNG trains 1
and 2 are deferred / merged with other projects.
o If all are deferred then mining capex will fall faster and would be looking
like declining to 2.7% of GDP by 2016
The net result is that the mining capex cliff represents a real risk to growth. Even if mining capex falls to double its longer term history, it will still detract over 3-4%
from GDP over the next few years.
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 9
Can Housing Takeover?
A frequent theme in RBA documents is that the housing construction market will
take over from the mining capex boom. In the following charts we explore this theme and conclude that while housing certainly has the scope to ease the transition,
housing does not have the scope to achieve this on its own (even taking into account
that housing has a higher multiplier effect on the rest of the economy) and can
probably at best only make up around 1% (as a % of GDP) of the 3-4% shortfall that
falling mining capex will create.
FIGURE 12: HOUSING APPROVALS PER 1,000 PEOPLE
FIGURE 13: HOUSING INTEREST / DISPOSABLE INCOME
Source: ABS, RBA
Housing approvals look depressed
compared to the last 40 years
The bullish argument says that
this could easily increase back
to the 8-9 range i.e. 50% higher (including population
growth) than current levels
Falling interest rates
have led to improved
affordability
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 10
FIGURE 14: HOUSING APPROVALS PER 1,000 PEOPLE 1980-2000
FIGURE 15: HOUSING DEBT TO DISPOSABLE INCOME
FIGURE 16: VALUE OF NEW HOME APPROVALS + ALTERATIONS
Source: The Hague: Ministry of the Interior and Kingdom Relations, FRED Economic Data, ABS, RBA
A more extreme example would see
levels halve and still be consistent
with the UK, Italy from 1980-2000
If Australia declined to the likes of
Germany, Austria, France then maybe the
current level (of just under 7 starts per
1,000) is already above average?
The bearish argument says higher population
growth countries like Australia and the US
have long had housing approvals that were
well above most other developed countries
so an increase in housing starts will depend
on immigration policies (given low birth rates)
And you will need a magnifying
glass if you want to find signs of
deleveraging in Australia which means little scope for extra debt
and is another reason why building
approvals are unlikely to reach the
highs of previous cycles
While looking at the interest
paid shows affordability
improving, this is a function
of low interest rates
debt levels increased 5-6x
over the last 20 years
Which suggests to me that with
lower population growth and high
debt burdens that new home
building will probably struggle to add
1% to GDP growth
4% of GDP seems to be the top of
the cycle for new home building
8 April 2012
Economic Strategy
Tactical Asset Allocation
Equities Research Quantitative Strategy 11
CONCLUSION
The net effect is that the end of the mining capex boom will likely deduct 3-4% from
Australian GDP over the next three years. Without a pickup in other areas this would
likely mean a recession. There are five main areas that can pick up:
Residential building, but appears unlikely to be able to pick up more than
1% (and maybe closer to 0.5%) of GDP. Appears to need even lower interest
rates, maybe some changes in development restrictions.
Government spending: The most logical source given low interest rates,
but given the fixation on government debt in the last few election campaigns
at both state and federal levels, public capex would appear to be unlikely to
add much (if any) to fill the gap.
Household consumption: Households are still quite leveraged and do not
appear willing to take on more debt, consumption appears unlikely to grow
much faster than the rate of household income growth.
Non Mining Capex: Current capex levels and plans are negative. To get this
part of the economy moving a much lower Australian dollar and / or interest
rates are needed.
Net Exports: Mining exports will help, however increased volumes are being
offset by lower commodity prices. To get this part of the economy moving a
much lower Australian dollar is needed.
The key factor we are watching is the Australian dollar at the US80c level other sectors will be affected, but without exchange rate relief it is hard to see where the
growth can come from.
Date
Economic Strategy
Tactical Asset Allocation
Equities Research Economic Strategy - Tactical Asset Allocation 12
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