Mining Pair Trade Opportunity: Buy BHP Billiton, Sell Antofagasta

• BHP Billiton Limited (ADR) BHP shares have lost 29 percent year-to-date, while Antofagasta plc (ADR) ANFGY shares are down 21 percent in the same period.
• Jefferies’ Christopher LaFemina upgraded the rating on BHP Billiton to Buy, while downgrading the rating on Antofagasta to Hold.
• Companies have responded to low prices by initiating production cuts, which seems to have balanced the iron ore market and may do the same in copper, LaFemina said.

Analyst Christopher LaFemina mentioned that iron ore prices had declined due to supply growth exceeding demand growth. High cost miners have now responded to the lower prices by shutting capacity, bringing the market to a balance with stabilized prices.

A similar trend can be witnessed in the copper market. Glencore and Freeport have announced copper production cuts in response to low prices. LaFemina said that this should “nearly eliminate the expected copper market surplus over the next year,” adding that copper prices would be less volatile in a balanced market.

“A sustainably higher price is still dependent on a demand recovery, which is unlikely in the near-term. However, Chinese fiscal stimulus could help at the margin,” LaFemina wrote.

Jefferies has, however, reduced its long-term copper price forecast from $3.50 per pound to $3.00 per pound, assuming “further capex and opex deflation will lower the incentive price to build new capacity.”

BHP: Reasons to Buy

LaFemina commented that BHP had been upgraded from Hold to Buy in view of the company’s:

1. Dividend yield of 7.7 percent
2. Robust FCF, which is expected to be able to cover its dividend
3. Low cost assets
4. Low operational and geopolitical risk

The price target for BHP has been raised from 1150p to 1,300p.

Antofagasta: Valuation In Focus

Antofagasta had been downgraded from Buy to Hold based on valuation, LaFemina said, while adding that the company still appears “very well positioned for a 2+ year horizon.”

In the report Jefferies noted, “Antofagasta has limited near-term growth, and capex risk is therefore likely to be to the upside. The company also may acquire additional assets following the recent acquisition of a 50% stake in Zaldivar. While now may be an excellent time for a buyer, the risk of a deal is likely to be an overhang on the Anto share price.”

The price target for Antofagasta has been reduced from 725p to 640p.

LaFemina added that BHP and Rio are the “top picks” for investors who “want to sleep well at night,” while Freeport-McMoRan Inc FCX and First Quantum Minerals Limited FM are “more speculative Buys.”