Reality check for big three iron ore miners as commodity price comes down to earth
If you thought dividends were good at the big miners – you should see them now after the China rout of recent weeks
The pundits were right – for once. The laws of market gravity were always going to catch up with the price of iron ore, which in a matter of weeks has tumbled more than 50 per cent from its nosebleed territory of $US220 a tonne.
Still, no one quite predicted the extent of the rout, which stems from the sickly Chinese construction sector coupled with Beijing’s steely determination (excuse the pun) to taper the nation’s steel output supposedly for the sake of the long-suffering environment.
According to Goldman Sachs, global crude steel output is already 7 per cent below its May 2021 peak, while Chinese production is 20 per cent off its April zenith.
As always in a market meltdown, the (guessing) game is about when the commodity becomes oversold, as it inevitably does.
On the negative side, there doesn’t seem to be much to support the iron ore price in the short term.
Veteran broker Richard Morrow describes iron ore as “ridiculous” at $US220 a tonne and “ludicrous” at $US100 a tonne.
Ludicrously low? High, actually: the Pilbara producers are digging the stuff out at an average “all in” cost of $40 a tonne ($US29) so even $US100/tonne represents a stonking – and unsustainable – margin.
Are the Big Three now decent value? Broker Evans & Partners tentatively mounts the case for the affirmative, at least in the case of BHP and Rio. Assuming a negative iron ore pricing scenario of $US100/tonne in the current 2021-22 year and $US75/tonne in 2023-25, the firm extrapolates 23 per cent returns for BHP holders and 27 per cent for Rio investors over the next 12 months.
This estimate factors in forecast dividends, with BHP yielding well over 5 per cent and Rio close to 8 per cent. “We continue to believe that both BHP’s and Rio’s iron ore operations are fantastic businesses that produce strong returns,” the firm opines. “But we do think that risks are now more balanced relative to the past 18 months of positive momentum.”
While BHP and Rio are diversified – notably with copper exposures – their Pilbara operations remain responsible for the fat dividend cheques.
The red dust accounted for 70 per cent of BHP’s underlying earnings in the 2020-21 year, while for Rio it was more like 77 per cent.
The proposed merger of Woodside Petroleum with BHP’s oil and gas assets muddies the picture somewhat.
BHP is also the world’s biggest producer of coking coal, which this week hit record levels in direct contrast to the fortunes of its steelmaking cousin, iron ore.
Rio also owns 45 per cent of the giant Simandou iron ore project in Guinea, so stands to benefit if the complex and oft-delayed venture gets into production after recent political unrest.
And Fortescue? As the pure-play exponent the Pilbara upstart is most susceptible to further deteriorating conditions, especially given its produce is lower grade.
But everything has a price.
On Credit Suisse numbers Rio Tinto looks the cheapest of the big three, trading at a multiple of five times expected current-year earnings and a yield of 14 per cent.
BHP and Fortescue trade on multiples of 7.4 and 7.8 times respectively, with yields of 6 per cent and 11 per cent.
This is based on the spot price of circa $US100 a tonne but what happens from here is pretty much guesswork – at least for those not privy to the inner policy workings of the Middle Kingdom.
Predictably, the iron ore sell-off has punished the valuations of our big three producers and automatically enhanced the dividend yields.
Since the iron ore price began tumbling in late July, Rio Tinto and BHP shares have fallen by up to 30 per cent.
Among the spectacular pullbacks is the pure-play Fortescue has been routed to the tune of 40 per cent, slashing more than $10bn from the value of founder Andrew Forrest’s 36 per cent shareholding.
But don’t send care parcels – he’ll be OK.
On the positive side, Beijing is not about to quarantine China’s vast Wuhan-based steel mills altogether: the official dictate is to maintain the current year’s steel production at last year’s levels (having grown a surprising 11 per cent in the June half).
For the foreseeable future, the Pilbara remains the best and nearest source of reliable supply for China, which accounts for more than 90 per cent of the seaborne iron ore trade.
On an annualised basis Australia accounts for 686 million tonnes of seaborne supply, with Brazil (mainly Vale) supplying a further 357 million tonnes.
If it’s any help – and we suspect not – federal Treasury pencils in a $US55 a tonne price (free on board) by March next year.
Tim Boreham edits The New Criterion.
tim@independentresearch.
com.au
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