Bulk Buys: Fenix Resources kicks off Australian iron ore victory lap
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Iron ore minor Fenix Resources (ASX: FEX) has burst out of the blocks in the new reporting season, possibly the most anticipated in a decade.
Fenix generated a cool $45.1 million from iron ore sales in the June quarter, nearly tripling its bank balance from $26.7 million to $69 million in only three months.
With prices at monthly average records in May and June, the company’s Iron Ridge Mine near Geraldton sold 281,000t of iron ore at a quite staggering operating margin of $127 per tonne.
Iron Ridge only reached steady state production in March but has a leg-up in current market conditions with an overall resource grade of 63.9%, well above the 62% benchmark and a sought-after product given the long-term decline in grade from the Pilbara majors.
The five shipments it sent to China during the quarter garnered an average price of US$185.20/t free on board, equivalent to US$215.60/t cfr, about an 8% or US$16/t premium over the benchmark 62% fines index.
Around half of the ~300,000t Fenix hauled to port was lump – which is in high demand and generates a significant premium because it does not require sintering, making the process of converting the ore to steel cleaner.
Iron ore prices have proven callously impervious to negative sentiment so far this month, rising US$3.08/t to US$217.85 Monday, according to Fastmarkets.
Driven this week by loosening bank reserve requirements that could send as much as US$206 billion of credit into the Chinese economy, the sustained stubbornness comes even as analysts maintain predictions prices will be forced down over the rest of the year as China enforces cuts to steel production.
Fenix only started production at the 1.25Mtpa Iron Ridge project in December last year when it had just $10.25m in the bank.
Managing director Rob Brierley is already getting questions about the minnow’s dividend policy, with cash on hand representing almost 36% of its $193 million market cap. He told investors on a conference call a dividend policy will be presented before or at its full year result.
“Suffice it to say we have surplus cash on our balance sheet already,” Brierley said.
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Quick reminder, Fenix produces roughly 0.5% as much iron ore as Rio Tinto and BHP at ~6x the unit cost, so it is just a taster of the riches to come.
If you want to get an idea of just how wildly iron ore margins have bounded out of any semblance of normality, check out this chart.
Iron ore spot prices relative to marginal production costs is literally off the charts. pic.twitter.com/Wgqurlewsc
— David Scutt (@Scutty) July 13, 2021
BHP, which, based on high frequency shipping data, exported at near record levels in the June quarter, is many analysts’ pick for the big winner.
Assuming prices remain above the bank’s base case of US$157/t for iron ore, RBC Capital Markets analyst Kaan Peker predicts the Big Australian will be able to slash net debt to below its year end target of $8.9bn and pay out 100 per cent of its earnings at $3.53 per share.
RBC has a $54 price target and outperform rating on BHP. Peker has bumped up BHP’s predicted EBITDA for FY21 by 8% to $38.1bn, higher than consensus estimates of $36.3bn and up from $22.1bn in FY20.
With profits soaring attention is now turning to whether labour costs and long-delayed capital expenditure will eat into future returns.
“It is now received wisdom that BHP and the rest of the sector are in strong financial shape with near-record margins,” Peker said.
“We think the key takeaways from this set of financials, beyond the likely strong cash payouts, might be how much cost and capex pressures could start to erode future profitability.”
It is a sign of the high expectations that renowned banana slippers Rio Tinto are set to post record half-year results and still be, as RBC says “not too special”.
RBC’s predicted EBITDA for Rio has been revised up by 18% from $35.5bn to ~$42bn, but Peker is only expecting Rio to pay slightly more than its traditional 50% payout ($4.18 against a consensus of $4.81 per share) after paying a $6.5 billion full year dividend during the half.
Peker upgraded RBC’s price target for Rio from $120 to $127 per share but has a ‘sector perform’ rating on the stock.
China consumes around 70% of the world’s seaborne iron ore supplies and around four out of every five tonnes sailing from Pilbara ports.
As such it has the capacity to wield a big stick when it comes to iron ore prices. If it shuts off demand, prices will logically suffer.
But the Government walks a tightrope.
Poverty is kryptonite for totalitarian governments, and the Chinese Communist Party has an implied contract with its people to support the growth of its economy.
Premier Xi Jinping boldly claimed to have eradicated “extreme poverty” in the world’s most populous country earlier this year, a claim that requires some qualifications.
While some commentators see China becoming more of a service economy in line with the growth of its middle class and plans to cut emissions to net zero by 2060, in real terms China has been hungrily producing steel and consuming iron ore to support its post-pandemic economic growth plans this year.
Steel production in China was up 13.9% year on year in the first five months of 2021 to 473Mt, an annualised rate of around 1.15Bt.
That would be higher even than the 1.05Mt of crude steel it produced in 2020, a 5.2% rise on 2019 levels despite the pandemic.
Chinese trade data yesterday showed it imported 560.7Mt of iron ore to June 30, up 2.6% on the previous year. At 89.42Mt, June imports were down 12.1% on June 2020 and 0.4% down on May levels. However, imports may also have been heavily impacted by the poor performance of Australia’s iron ore miners.
Clearer signs of Chinese iron ore imports moderating in June trade data. June iron ore imports hit a 13m low of 89.417mt, that's -12%yy and -2.3% on 3myy basis. Seasonally adjusted June was the weakest in 7 months. pic.twitter.com/fmeOFHDHxt
— Robert Rennie (@Robert__Rennie) July 13, 2021
Steel mill margins were up around record highs earlier this year but slid into negative territory in June, while output may also be slashed on the back of directives by the Chinese Government to curb pollution.
As Reuben Adams reports, UBS says steel output cuts and better shipping performance from the majors and Brazil’s Vale could see a correction in the supply-demand nexus that has put a rocket under iron ore prices.
UBS analysts believe an additional 65Mt could hit the market in the second half of the year than in the six months to June 30, with demand potentially falling 10% or 75Mt year or year compared to H2 2020 levels from mill restrictions.
Wood Mackenzie’s Rohan Kendall noted the potential impact of credit tightening in China but said it was unclear whether demand or supply was going to tip the seesaw off balance.
WoodMac has a price target not too far off current levels at US$185/t in the second half.
Iron ore market expert and Magnetite Mines (ASX: MGT) technical director Mark Eames said the fall needed in steel production to suppress prices to levels cited by some analysts would be extraordinary.
“To me the observation would be that most analysts are forecasting a very substantial drop in price, not only from today’s US$200/t plus to the 10 year average of US$110/t in real terms which would already be the price halving,” he said.
“They’re effectively saying the price has got to drop even further than that.
“It’s actually going to be that trading conditions for iron ore in the next few years are going to be worse than they were in the last 10 years.”
In the short term, Eames said government intervention would need to be significant for steel output to slip to 2020 levels over the second half of the year, estimating it will need to reduce steel output by 50Mt on corresponding 2020 levels. That’s a ~20% swing on first half levels.
“I think it’s a real question, is the Chinese Government willing to intervene and actually force a reduction in steel production because there’s no sign that the market by itself is going to bring about that outcome,” he said.
“Obviously we’ve seen a history over the last year or so of China intervening in major markets and it’s certainly got the power to be able to do that if it wants.
“Personally I think the magnitude of the reduction would be quite extraordinary and I think would have deep-seated ramifications for the whole of the Chinese economy.
“For myself I’d be a little bit sceptical, we haven’t seen China taking drastic action with regards to steel production and certainly not at the scale of 100Mt annualised swings. But certainly there’s this rhetoric from the Chinese government and some of its sources saying that’s what they intend so I think it’s going to be very interesting to watch.”
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WoodMac Americas vice chair Ed Crooks has this dire projection for the long-term outlook for thermal coal, despite climbing to decade-long highs this year.
“The revival in demand has been a reminder that the talk about an imminent ‘end of coal’ has been greatly exaggerated,” he said last week.
“Yet while the short-term outlook for coal has improved over the past year, the longer-term outlook has deteriorated sharply. Key markets have set goals for net zero emissions, by 2060 for China and 2050 for Japan, South Korea and Taiwan.”
Crooks predicts that coal demand will continue to climb over the next couple of years before the turn to renewables and gas really takes hold and the “long goodbye” begins.
By 2050, global imports of seaborne coal are projected to be about 600Mt in the WoodMac base case, down 37% on current levels, with Chinese demand by the end of the 2040s quartering to 50Mt.
There may well be opportunities presented though by the volatility this portends.
“It is unquestionably a challenging outlook for producers, and higher-cost operators will be squeezed out of the market,” Crooks said. “But coal’s long goodbye does raise the prospect of possible volatility and periods of high prices returning in the future.”
At Stockhead, we tell it like it is. While Magnetite Mines is a Stockhead advertiser, it did not sponsor this article.