What a year 2014 has been for Iron Ore miners. The heroes of the Australian economic boom times are now licking their wounds, and even teetering on the edge of profitability leading into 2015.
Just think back to the beginning of 2014 where Iron Ore was trading at $130 plus. All major iron ore miners were enjoying juicy profit margins on their production costs and even federal government policy was targeting how to extract extra dollars to fix the national deficits. Now 12 months on, we see Iron Ore testing the boundaries of US$70 / tonne, some 46.5% lower.
So what has happened and most importantly, how are we going to invest in this space in 2015?
Here is a chart of Iron Ore from 1st Jan to late November.
Interestingly the economics of supply and demand would normally dictate that lower prices, would lead miners toward lower production in an effort to reduce supply and cause prices to move higher again. However we have not seen such moves at all.
Instead heavy weights BHP, RIO and FMG, are actually maintaining production levels and have even announced no plans to reduce those levels in the foreseeable future. Shouldn’t this lead to lower prices… yes most likely it will. In fact most institutional analysts have been quickly revising their estimates sharply lower, chasing if you will the quick slide in Iron ore.
We have seen new price targets for 2015 and 2016 Iron Ore prices as low as US$65. Not that these analysts have been too accurate with the estimates for this year, but such revisions show this is not a short-term affair.
Another interesting factor…
Another interesting factor to consider is whether these big price declines are being seen as an opportunity for the bigger and lower cost iron ore miners to take greater market share. As various higher cost miners are seeing Iron Ore prices slipping below their production costs, they could face the possibly of having to close their doors.
In recent media commentaries, we have even seen BHP and RIO being likened to Saudi Arabia and OPEC, using their control on supply as a tool to keep prices down and increasing the pressure on the higher cost producers.
Looking at the below breakdown, with Iron Order at the low end of $70, this make business very difficult for two thirds of the major Iron Ore miners. Clearly RIO and BHP’s margins are being squeezed by the price decline, but they are at least still clearing a profit. Even FMG is falling short with Iron Ore at $70. This has impacted FMG’s share price greatly due to the fact that over the last few years, their strong growth in production output was thanks to leveraging off borrowed funds. They have been making the move towards repay and lowering this debt, but until this is done, there is extra risk for FMG and hence investors have fled.
Just recently, we have seen China make moves to stimulate their economy via interest rate decreases. While this should help to starve off further economic declines, we are unlike to see China resuming its peak strength in double digit growth for some time, if ever again.
But that’s not the whole story… what about India?
2015 will be a very interesting time to watch signs of growth in India as an expansion surge there could mop up the dwindling Chinese demand for Iron Ore. We have seen inflation in India decreasing, albeit still around 5.5%, but this allows India to start engaging in some more aggressive growth strategies. If we see such signs, then expect BHP and RIO to ramp up production further, and for prices to start slowly drifting higher.
For 2015 we expect Iron Ore to stay below $75. However there is a hidden opportunity here.
That is, both BHP and RIO, are expected to become more and more attractive to investors the longer Iron Ore prices remain depressed. Furthermore, with potential for takeovers and acquisitions in the industry, investors are expected to start paying a premium for these market leaders. As such, despite a depressed outlook for the commodity price, we expect BHP and RIO to return to early 2014 prices as their shares become increasingly popular with investors.
For BHP that puts our targets at $37 – $39 and for RIO, that puts targets at $64 and $66. It will be a slow grind for both these players next year, but if you’re going to have exposure, you’re going to want to have it in BHP or RIO.
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