On 12 June the spot price for China bound iron ore dropped to $93.50. Some analysts are suggesting another drop on 13 June as iron ore futures in China fell to record lows. They were right. As of 13 June the price dropped to a 21 month low – $US91.50. As a result the already rampant speculation about the future of junior iron ore miners ratcheted up another notch.
The problem for the juniors is not just the declining price, but the lower grade ore many produce and the higher cost of production. The spot price investors track daily is for higher grade ore with FE (chemical symbol for iron) content between 60 and 65%, quoted at 62%. Ore with lower grade content is categorised at 58% fe, and it fetches a lower price. According to some estimates there is now a 15% price difference between iron ore with 62% fe content and 58% content.
So it is reasonable to assume some juniors are selling ore at lower prices than what investors see in daily tracking. Then there is the troubling issue of production costs. Gold miners are moving toward a uniform cost reporting system, AISC or All In Sustaining Costs, that reflect ancillary costs needed to produce gold such as administration and capital expenditures. Iron ore miners do not have such a system, causing analysts to dig into company financial statements to calculate a more accurate cost.
Many analysts and experts expect the current price of $US91.50 to fall, with $US80 not far off. The price dipped below $100 a tonne on 19 May, reaching a low point of $91.80 on 30 May. With a $80 price tag, Mt Gibson Iron (MGX); Fortescue Metals (FMG); and BC Iron (BCI) would remain marginally profitable, according to UBS, assuming the cost estimates are correct. Only Rio Tinto (RIO) and BHP Billiton (BHP) have costs low enough to survive the drop with some degree of safety. However, it is questionable whether investors would remain onboard. A one month price performance chart for BHP and RIO shows the reaction of market participants to the most recent iron ore price declines. Here is the chart.
For two of the highest cost producers in the UBS chart, Grange Resources (GRR) and Atlas Iron (AGO), the decline has been more drastic. Here is the chart.
The most immediate concern for the juniors is whether or not the price of iron ore will stabilise, as some predict, or continue to fall. As an alternative to sorting through the dizzying area of analyst and expert forecasts, let us look at the history of iron ore price movements over the last five years. Here is a chart showing the volatile movement.
Note that we have been there before, when the price dropped below US$90 in September 2012. At that time the fall was attributed to slowing steel production in China and destocking of iron ore. China was then and is now the largest importer of iron ore, but predicting demand in China is difficult. Here is a quote from an insider in the Chinese steel industry, Wang Guoqing the deputy director at the Lange Steel Information Research Center:
• “The golden age for imported iron ore in the Chinese market has gone, and will never come back,” going on to predict that imported iron ore prices will fall to $70 a ton next year, if steel demand continues to be weak.
What seems to be most relevant here is not the source of the quote, but the date it first appeared – 30 August 2012.
What is puzzling about the current situation compared to 2012 is the level of demand. Back then experts were cautioning of the impending oversupply of iron ore as the industry’s massive mining expansions began to produce. The supply is coming online, driving down the price, but at the same time Australian iron ore producers are shipping at record levels. The strategy is obvious. Greater sales volume at low cost of production can offset falling prices. This appears to be working, as without demand for iron ore at current prices the producers would not be shipping at record levels. China Customs reports that iron ore imports for the first five months of 2014 are up 19% from the previous corresponding period.
The surprising Australian GDP reported recently provided more evidence the strategy is working. Analysts at UBS had a 0.7% estimate while Citi had cut its forecast from 0.9% to 0.6%. The actual number was 1.1%, which was the fastest pace in two years. Annual GDP growth rose to 3.5%. After an endless stream of negative predictions for the mining industry, the biggest surprise of all may have been that mining made up about 80% of the growth, with those massive iron ore exports contributing to an 8.6% expansion in the overall mining sector for the March quarter.
There has been much talk of slowing demand for steel production and thus iron ore in China, but in reality it may be that what is slowing is the rate of growth. In August 2013 analysts at JPMorgan issued an investor note with revised steel production forecasts. Here is the chart.
JPMorgan recently reduced its forecasts for the price of iron ore but as yet the company does not appear to have lowered the steel production forecasts. The concern for all iron ore miners is the point at which the growing supply of iron ore exceeds demand growth.
There is little question that continued declines in the price of iron ore puts high production cost junior miners at risk. However, the same pricing pressures put the Chinese domestic iron ore sector at risk. China’s National Development and Reform Commission recently stated that the production cost for Chinese iron ore miners ranged from $75 to $145 a tonne in 2013. In addition, the lower grade domestic iron ore is environmentally not as desirable as higher grades; adding another issue that could result in shutdowns of Chinese miners. High cost producers in China and Australia shutting down should mean increased market share for the lower cost, higher grade major producers. Some speculate driving some of the juniors out of business is part of the volume ramp-up strategy of the big players.
While there is much about which junior miners and their investors should be concerned, the issue of their survival is still in doubt as some have attractive prospects underway. The following table shows some valuation, growth, and balance sheet measures for all of the nine stocks that appeared in the UBS Breakeven Analysis Chart.
11/06 – 12/06 % Change
2 Yr. Earnings Estimate
Mt Gibson Iron
Even the boldest of contrarian investors might pause after looking at the share price drops following the decline in the price of iron ore on 12 June. Investor sentiment towards iron ore miners since the price of iron ore began to fall has been overwhelmingly negative. Here is the share price percentage drop of each of the stocks over the last three months, as of mid-day on 13 June:
• Grange Resources down 40%
• Gindalbie Metals down 12%
• Atlas Iron down 38%
• Arrium down 42%
• Mt Gibson down 20%
• BC Iron down 36%
• Fortescue Metals down 18%
• BHP Billiton down 3%
• Rio Tinto down 9%
Despite this, Gindalbie Metals is the only stock with an analyst consensus Sell recommendation. Arrium has a Hold recommendation, and the remaining seven are rated Overweight. Note that Arrium has the second highest gearing percentage and the lowest two year estimated earnings growth forecast. In truth, interpreting forward measures and analyst opinion for this sector is tircky, as estimates and recommendations are based on assumptions about the future of the price of iron ore.
Investors who count themselves among the brave and bold could have a few options here. Note that in the 11- 12 – 13 June bloodbath, the diversified miners suffered least. BHP is making major efforts to capitalise on its oil and gas holdings in addition to expanding into potash with a major project in Canada. RIO is far less diversified, still generating around 90% of its revenue from iron ore, according to some analyst estimates. However, RIO is reportedly looking into getting its own potash project in Canada.
The remaining stocks are all pure plays. While Fortescue has attractive looking valuations with a P/E of 3.93 and a P/EG of 0.11 to go along with an earnings growth forecast approaching 35%, the company is leveraged to a degree most investors would find alarming. In addition, FMG’s production costs of around $72 per tonne leave it vulnerable to a worst case scenario for the price of iron ore.
Grange Resources (GRR) has low gearing and solid valuations and growth estimates. The company owns and operates the Savage River iron ore mining and pellet production operation in Tasmania. The ore is a lower grade magnetite that is processed into high grade pellet form for sale. The company also owns 70% of the Southdown Magnetite Project in Western Australia which is under development. Although the pellet producing process increases production costs, the ore grade can exceed 69% purity.
In its March Quarterly report, company management stated it had adopted a strategy of selling its premium quality product for “value rather than volume” in the face of challenging market conditions.
Ginalbie Metals (GBG) may be out of favor with analysts, but it has a powerful JV partner in Chinese steel producer, AnSteel. Gindalbie’s flagship project is the Karara magnetite operation. Ansteel believes enough in the substantial reserves of the project and its long life to increase its holdings in GBG to over 52% in March of 2014. In another sign of support, Ansteel arranged financing through the China Merchants Bank to fully complete the Karara project, which began shipping in late 2013. Investors liked what they heard, as GBG was the only stock from the UBS chart to have a positive month. Here is the chart.
Atlas Iron (AGO) is the remaining stock with impressive numbers. The company’s current price to tangible book ratio is 0.39, which is considerably less than the sector P/B of 0.66. The company has four operating mines and a major expansion underway in Horizon I, II, and III. Capital expenditures are expected to wind down in FY 2014, which should lower AGO’s production costs and accounts for the impressive two year earnings growth forecast. The company reported record shipments and eight analysts have a Buy recommendation on the stock.
In another sign there is life left in the iron ore mining sector, on 21 March Gina Rhinehart signed an impressive financing deal to complete the Roy Hill iron ore mine in the Pilbara. The project is 70% by Rinehart’s Hancock Prospecting, with an hefty list of partners including South Korea’s Posco, Japanese steelmaker Marubeni Corporation, and Taiwan’s China Steel Corporation.
The partners have already poured $3 billion into Roy Hill and the newly acquired $US 7.2 billion comes from 19 commercial banks from Australia, Japan, Korea, Europe, Singapore, and China. When fully operational, Roy Hill is expected to ship 55 million tonnes, making it the fourth largest producer in the country.
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