A swathe of Australian sectors could be exposed to slowing growth in China as the rising economic powerhouse grapples with power outages, Covid-restrictions, a government crackdown on powerful corporations and troubles in its property sector, analysts say.

Australian miners are particularly vulnerable to a further correction in the iron ore price says Rob Holder, an asset allocation specialist with Crestone says, as Beijing seeks to cool the overheated property market and the debt crisis at China Evergrande Group ripples through the economy.

Holder adds that tariffs on a variety sectors in recent years have hurt local exporters noting coal, wine and some soft commodities as key examples.

“The impacts of the recent efforts to reduce emissions and the ongoing housing market disruption in China would likely be felt most prominently in the commodity space, specifically iron ore,” he says.

“With [iron ore] prices having almost halved in the space of just a few months, lower property demand, resulting from both government action and reduced buyer confidence, now threatens to further reduce demand for Australia’s key export".

What happens in China has a direct impact on companies at home given it is Australia’s biggest export market and the world’s second-biggest economy after the US.

Growth has slowed in China given the authorities’ recent efforts to reduce leverage in the economy, as well as other policy shifts that have introduced considerable uncertainty to the economic outlook, according to the Reserve Bank of Australia (RBA). The pace of growth in China is expected to continue to moderate and a further slowdown in real estate construction activity could hit Australian exports.

The gross domestic product grew 4.9% in the third quarter from a year ago, China National Bureau of Statistics shows missing expectations for a 5.2% expansion according to analysts polled by Reuters.

“An unexpected slowing in China’s economy – arising, for example, from a deeper-than-expected decline in construction activity or from increased uncertainty about economic policy more generally – would reduce demand for iron ore and other commodities,” the RBA warned in its November Statement on Monetary Policy.

“This would result in lower Australian resource export volumes and a decline in commodity prices, impacting Australia’s terms of trade, corporate profits and reducing government revenues from taxation and royalties.

“A slowdown in China or further restrictions on Australian exports would also delay the recovery in other parts of the Australian economy, possibly including the education and tourism sectors."

Morningstar lowers fair value for iron ore, miners

While the big Australian iron ore miners are well-positioned for a downturn in commodity prices given strong balance sheets and cash flows, Mathew Hodge, Morningstar director of equity research, says historically high iron ore prices are unsustainable.

“We cut our iron ore price assumption for 2021 to 2024 inclusive to an average of US$116 per tonne from US$133 previously,” he says.

“Longer-term, we still see rising production from Vale, initially, and later likely from Africa, as well as slowing rates of urbanisation and infrastructure spending in China as headwinds for iron ore.”

The good news for investors is that the big iron ore miners are now less overvalued after falling in recent weeks. BHP represents the best value buy, according to Morningstar.

“The general material sell-off in iron ore miner share prices sees the group of iron ore producers no longer materially overvalued, with the notable exception of still-expensive Fortescue," Hodge says.

"Of the diversified majors, we now think BHP is the cheapest, trading at a 10% discount to our fair value estimate."

Hodge recently lowered his fair value estimates for Fortescue, Rio Tinto, and BHP after incorporating softening in Chinese demand and iron ore prices. For Deterra Royalties, he has lowered his estimate to $3.35 per share.

“While still somewhat expensive, we rate the quality of wide-moat Deterra Royalties highly and the potential for interest rates to rise could offer the opportunity to buy the shares at a reasonable price,” he says.  

UBS too predicts further price falls for iron ore but says it's too soon to get exposure to the miners.

“With commodity prices falling and costs rising (for energy, labour, consumables), the sector faces negative earnings momentum, consensus earnings downgrades and lower cash returns with first half 2021 the high watermark for earnings, free cash flow (FCF) and dividends for most miners,” the investment bank said in a recent research note.

“Whilst the recent pullback may have unearthed long-term value in certain stocks, in our view, it is too early to buy the miners. We remain underweight the mining sector with predominantly 'Sell' or 'Neutral' ratings across UBS global mining coverage.

"Fundamentals for iron ore are challenging and we see further price downside."

However, other commodities are tipped to do better than iron ore. UBS's "preferred commodities" are thermal coal, nickel and lithium.  

“Our 'preferred' commodities are likely to be more resilient, that is, go down less and stay elevated for longer than expected….thermal coal prices are likely to positively surprise in 2022. Nickel and lithium will be supported by strong electric vehicle-related demand medium-term," UBS says.

Agriculture, education and tourism exposed

Apart from the hit to Australian commodity exports from the China slowdown, the other area likely to be hit is agricultural goods, says Diana Mousina, senior economist with AMP Capital.

“Agricultural goods exports to China are worth nearly 3 per cent of total Australian exports and around a fifth of agricultural goods, so it is a significant portion of Australia’s trade sector,” she says.

“Most likely, these goods would be diverted to other countries, which has been the case with lower exports to China in 2021 due to the growth slowdown in China and the trade tensions with Australia, but it would still create a short-term disruption for the agricultural industry.”

Crestone’s Rob Holder adds that sectors such as education and tourism, which traditionally have been key beneficiaries of Chinese demand, are also likely to be hurt by a slowdown in economic growth, which will reduce demand for some services Australia sells to China, such as tourism and education.

“Reduced demand from a key market would be challenging at a time when many operators are struggling following two years of extreme Covid-19 related restrictions,” he says.