The Australian reported that record production of Australia's key exports is not enough to stop an expected earnings downgrade across the mining sector, with softening commodity prices tipped to hit forthcoming profit results

Major diversified miners BHP Billiton and Rio Tinto led the sector with strong results from their West Australian Pilbara mines, but both said that price pressures in other divisions could weigh on profits this financial year.

Rio announced in its quarterly report earlier this month that weak demand in the aluminium sector had affected its operations, forcing it to cut 462,000 tonnes a year of annual production capacity.

Rio downgraded its October 2011 guidance of a break even in the second half to a small underlying loss for the assets it mostly acquired in the ill fated USD 39 billion cash takeover of Alcan in 2007.

Meanwhile, BHP flagged headwinds in the miner's coking coal, aluminium and nickel businesses. The world's largest miner said rolling strikes at its Queensland mines had contributed to a 9% drop in coking coal production from the previous quarter, along with the effects from the previous summer's floods and operational issues.

Mr Tim Schroeders of Pengana Capital said while the earnings pain might not be evident in next month's earnings results, the impact of softening commodity prices was likely to be felt later in the year. He said that "Profit season should be OK, but looking for the next 12 months it is going to be difficult for these companies to grow in terms of profits. For something like iron ore, 4% volume growth is not going to mitigate a 30% price fall. There are more negative pressures than positives for the next 12 months, it's going to be very difficult for these companies to grow their profits."

Mr Schroeders added that there were unlikely to be any upgrades after the reporting season. Iron ore, which is used to produce steel, is again the major highlight of the quarterly reporting season, with most producers reporting record results and continued strong demand.

Junior Atlas Iron was the only one to slightly lower guidance, saying that adverse weather from Cyclone Heidi had affected operations, forcing the miner to miss its production target. Changes in the iron ore price led the big miners to allow some customers to pay spot market prices as opposed to quarterly contracts, leading to a drop in the price.

Mr Schroeders said that "There are probably discounts for less grade and less quality ores that are starting to impact the companies. That will lead to earnings revisions downwards for the sector and those companies with an exclusive Chinese customer basis."

According to Mr Schroeders, the price of metallurgical coal is also expected to be downgraded quite savagely as mines return to full production as operations recover from the adverse effects of the Queensland floods.

Downgrades in bulk commodities could lead to renewed pressure on mining stocks, which have enjoyed a short rally this month, with Rio Tinto up about 16% and BHP 10%.

Mr Schroeders said that "You don't need a lot in terms of making people nervous and it doesn't take much in terms of sentiment change and people start selling these stocks because they are off to a flying start for the year and they probably want to lock in some gains."

But Deutsche Bank strategist Mr Tim Baker remains confident about resource stocks, and the investment bank is comfortable being overweight in resources. He added that "Commodity prices have corrected substantially relative to the slowing in global growth, taking resource stocks with them. In the last cycle, commodities and resource stocks bottomed as Chinese growth did not after. With inflation pressures in China quickly easing, we see scope for policy easing."

He said that while the resources price-earnings ratio was well below average levels, it probably reflected anticipation of earnings downgrades given where commodity prices were. He added that "Resource sector earnings growth is expected to be strong, though this is predicated on a pick-up in commodity prices from here."

At the smaller end of Australia's resources sector, Deutsche Bank analyst Mr Levi Spry said there were no significant surprises in the quarterly reports but a couple did disappoint. He added that "There were weather impacts on some operations but some miners had already downgraded estimates before Christmas to temper expectations. We had some negative surprises, namely, Alacer Gold and Mirabela Nickel. Mirabela had a slower than expected ramp up and they reduced guidance, and Alacer outlined more capital expenditure and its growth profile is a little further out than expected."

Mr Spry said the positives were St Barbara and Western Areas, while OZ Minerals, PanAust and Newcrest Mining were in line with guidance because they downgraded estimates before Christmas. He added that "We will see some stocks downgraded after the quarterlies and lower profits are now expected."

Commodity demand is expected to continue to grow but analysts are widely tipping it will be at a slower rate than witnessed previously.

Mr Schroeders said that "For some of these commodities they have, in the short term, benefited from supply disruption. You are getting demand being influenced disproportionately by destocking and restocking, which can be misinterpreted as stronger consumption, and we're not really going to know the picture for a couple of quarters looking back."

(Sourced from www.theaustralian.com.au)