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Mining
Benchmark iron ore prices fell US$3.81 to US$87.27/t overnight according to Fastmarkets MB, as news of further emissions restrictions Handan in China’s Hebei province emerged.
While still supporting strong margins for the biggest iron ore producers, it is a dramatic fall from record price levels seen only in May this year.
Morningstar this week downgraded its iron ore forecasts and taken the knife to valuations for iron ore producers. It expects iron ore prices to average US$116/t from 2021 to 2024, down from its previous forecast of US$133/t.
That is high compared to more bearish forecasters like UBS, Commbank, Westpac, RBC and government forecasters, who all see iron ore trading under US$100/t in the years ahead.
But its “midcycle” forecast of just US$43/t is especially bearish, skating close to decade lows of $US38/t seen in 2015 that characterised Australia’s mining downturn.
“Our midcycle iron ore price acknowledges the lowering of the industry cost curve and forecast drop-off in China’s steel demand as China’s economy transitions from investment-led to consumption-led growth,” Morningstar equities analyst Matthew Hodge said.
As prices have contracted so have the valuations of the ASX’s biggest mining companies, who are all hitched to the iron ore wagon.
At $15.36 Fortescue Metals Group (ASX:FMG) has seen its market value collapse by ~32% over the past six months.
BHP (ASX:BHP) ($36.03) is down ~26% over the same period, while Rio Tinto (ASX:RIO) ($88.61) is off 28.5% and Deterra Royalties (ASX:DRR), which counts a royalty over BHP’s Mining Area C as its main asset is off around 7.5% to $4.03.
Could these share prices sink further. Based on its fair value metrics, Morningstar thinks so.
Morningstar equities analyst Matthew Hodge views Fortescue as the most under pressure of the iron ore companies because its fortunes rely solely on iron ore.
Other majors like BHP and Rio have been able to moderate the losses from their iron ore business with historically high copper and, in BHP’s case, metallurgical coal prices.
For Fortescue, its biggest risk factor comes from the large grade discounts it receives for its ore, which average 57-58%.
The delivery of its 67% iron content Iron Bridge magnetite project, which has seen numerous cost blowouts and remains at least a year away from producing iron concentrate, could mitigate that.
But it would still not get FMG up to the 62% benchmark product grade used as the main index price by Chinese steel making customers. 58% fines were paying US$60.58/t yesterday according to Fastmarkets.
Hodge believes Fortescue remains expensive, despite the sell-off in recent months, estimating its fair value is ~30% lower than its current price at $10.
“The company’s rapid expansion during the boom peaks, driven by (Fortescue chairman Andrew) Forrest’s exuberance, ant the lower-grade iron ore products bake in a permanent cost disadvantage for no-moat Fortescue relative to the lower-cost majors,” Hodge wrote.
“Fortescue’s invested capital base is inflated as a result of investing during a boom and that disadvantage, which dilutes returns, is permanent.”
“High levels of debt funding were a tailwind for returns on equity and earnings per share in the boom.”
It should be noted Fortescue has considerably altered its debt profile since 2013, moving from a US$10 billion net debt position to just US$0.1 billion net debt by 2020.
Although Andrew Forrest has reinvented himself, and in part Fortescue, as a green energy advocate, FMG itself may be the iron ore business most exposed to decarbonisation policies because of its grade discounts.
“Should a carbon price be implemented on the customers’ use of iron ore, Fortescue could be at a competitive disadvantage,” Hodge said.
“Their lower-grade iron ore comes with relatively higher emissions, particularly in the steel-making process.”
However, Hodge says these are not material compared to the major fair value drivers of iron ore price, leverage and capital intensity.
Hodge also reduced his fair value estimates on BHP by 5% from $41 to $39 a share and Rio Tinto by 4% from $93 to $89 a share.
He believes BHP is the cheapest of the major iron ore stocks, trading at a 10% discount to its ‘fair value estimate’.
“The blow from lower iron ore prices for Rio Tinto and BHP is partially offset by stronger near-term copper prices, and for BHp, higher metallurgical coal prices,” Hodge said.
“We expect to see BHP’s proportion of revenue from iron decrease as other BHP mined commodities fetch higher prices.”
“However, even with the downgrade factored in, we expect iron ore to the largest contributor to group EBITDA to fiscal 2026. Hence the decline in iron ore dictates a lower fair value estimate, despite tailwinds from copper and metallurgical coal.”
Hodge said Morningstar expects BHP’s EBITDA to halve by 2026 against its 2021 peak because of its cautious outlook on fixed asset and real estate investment in China, one of the key end markets for steel.
“The current share price offers little margin of safety considering the risk of a persistent downturn in China’s economic activity and investment.”
Morningstar has added an initial valuation of US$5 billion for Rio’s Jadar lithium project, its key diversification asset in the battery metals space, but says its earnings contribution will be modest relative to iron ore.
Internationally, Morningstar has lowered its valuation on Brazil’s Vale by 30% to US$13, while Deterra’s fair value rating has been lowered by 7% to $3.35, but left Anglo American unchanged due to its diversification in consumer focused products like platinum and diamonds.
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