In a note to its investors last month, US investment bank Goldman Sachs advised investors to sell Aussie banks, specifically Westpac Banking Group (WBC), and buy the miners, specifically BHP Billiton (BHP). Mining valuations are at 10-year lows compared to the banks, and Goldman expects BHP to “lead the resources sector higher.” Other investment research firms by and large appear to agree with Goldman.
The following table summarises analyst recommendations to date for the top five iron ore miners on the ASX:
Company (Code) Date of recomen- dations BHP Billition (BHP) Rio Tinto (RIO) Fortescue Metal (FMG) Mt Gibson Iron (MGX) Atlas Iron (AGO) Analyst Firm BA-Merrill Lynch BUY 11 June 2013 BUY (Medium Risk) 16 May 2013 BUY 16 May 2013 UNDER-PERFORM (High Risk) 16 April 2013 BUY (High Risk) 31 May 2013 CIMB Securities NEUTRAL 18 April 2013 OUT- PERFORM 17 May 2013 OUT- PERFORM 19 April 2013 OUT- PERFORM 16 April 2013 OUT- PERFORM
Upgrade from NEUTRAL on 03 May 2013 City NEUTRAL 30 May 2013 BUY 16 May 2013 BUY (High Risk) 19 April 2013 BUY 16 April 2013 NEUTRAL 18 APRIL 2013 Credit Suisse NEUTRAL 04 June 2013 OUT- PERFORM 12 June 2013 OUT- PERFORM 31 May 2013 OUT- PERFORM 16 April 2013 OUT- PERFORM 06 May 2013 Deutsche Bank BUY 04 June 2013 BUY 07 May 2013 HOLD 19 April 2013 BUY 16 April 2013 HOLD 18 April 2013 JP Morgan Chase NEUTRAL 23 May 2013 OVER- WEIGHT 07 May 2013 OVER- WEIGHT 19 April 2013 NEUTRAL 16 April 2013 OVER- WEIGHT 18 April 2013 Macquarie OUTPER- FORM 30 April 2013 OUT- PERFORM 17 April 2013 RESTRICTED 19 April 2013 NEUTRAL 2o February 2013 NEUTRAL 18 April 2013 UBS BUY 07 June 2013 BUY 19 April 2013 NEUTRAL 19 April 2013 NEUTRAL 16 April 2013 BUY 06 June 2013
RIO Tinto is the standout with not a single SELL recommendation. But the price of iron ore is in free fall, currently $110 per tonne, which is a steep drop from February highs in the $150 per tonne range. On 16 May Bloomberg characterised the price of iron ore as “officially in bear territory” when it stood around $125 per tonne. Despite the drop, the iron ore price is still above August/September 2012 levels - which saw the price drop below $100 per tonne. The question is: can iron ore recover its February highs? The iron ore price hinges on Chinese economic growth, and most analysts have downgraded China GDP forecasts, including UBS and Morgan Stanley just recently. Goldman Sachs, JPMorgan, the World Bank, and the IMF forecast growth in the 7.6% to 7.8% range. Mr. Zhang Xiaogang, the CEO of China’s fourth largest steel producer, Ansteel, anticipates prices between $110 to $120 per tonne. A dire warning, he noted that it could take the steel industry in China five to seven years to fully recover from losses incurred to date. Additionally, the chairman of China's biggest steel producer, Bao Steel, predicts that demand growth for iron ore will soon fall below increased supply. The fall is likely due to Chinese steel makers shedding inventory. Macquarie Capital analysts in London expect prices to “recover” to $120 per tonne in the second half of 2013 following another month of falling prices until the Chinese begin rebuilding inventories. The looming problem of oversupply is likely to materialise later this year. During the boom, Australian iron ore miners invested heavily in expanding production capabilities. Recently, projects have been delayed or cancelled but others will begin producing at the end of the year. Rio is expected to produce an additional 45 million tonnes in Q3 of 2014 with Fortescue putting out an additional 40 million tonnes in Q4 and BHP contributing 30 million new tonnes of supply during the first quarter of 2014. Morgan Stanley is predicting 300 million tonnes of oversupply by 2018, based on demand forecasts. Market research firm Metal Expert Consulting has an iron ore forecast summary chart on its website. The company compared its own forecasting model against adjusted forecasts from industry experts and investment analysts (as of mid-April 2013). Here is the chart: What's important here are not individual forecasts, but the trend - and the expectations are for prices to decline. With that in mind, let’s look at some performance indicators and valuation measures for our top iron ore miners. The analysts are bullish. Should we be bullish too? The price/earnings ratios listed in the table are forward looking while the price to book and balance sheet measures are for the most recent quarter. Efficiency measures – profit and operating margins – are on a trailing twelve month basis. Here is our table:
Share Price 52 Wk % Change
5 Yr Expect. P/EG
Total Cash (MRQ)
Mt. Gibson Iron
16.3% Based on share price performance, the two diversified miners in the table, BHP and Rio, have dramatically outperformed the pure iron ore plays, Fortescue, Mt. Gibson, and Atlas. In these uncertain times balance sheet issues are important, and for smaller players like Mt. Gibson (market cap around $490 million) and Atlas Iron (market cap around $690 million) they can be a matter of survival. Capital raises and borrowings become increasingly difficult for smaller players in tough times. The falling AUD could be a significant catalyst for all miners whose expenditures come largely in Australian dollars while revenue comes in US dollars. Predictions for how low the AUD will go vary widely with a few forecasting the USD/AUD at $0.60 and $0.80. Credit Suisse has the lowest forecast of major investment banks, predicting a possible drop to $0.85 within the next twelve months. A weaker dollar means higher profits for all miners, assuming commodity prices do not fall through the floor. In theory, it'd be expected that BHP's broad diversification would make it an analyst favourite. BHP derives around 30% of its revenue from iron ore and 21% from oil and gas operations. Of the four major analysts who like this stock, Macquarie and BA-Merrill Lynch cite improved cash position from asset sales as a big win for BHP. UBS anticipates improved performance from its coking coal operations and Deutsche Bank expects strong growth from its US oil and gas assets. Of the brokers with a NEUTRAL rating, only Credit Suisse expressed concern that “China-related factors” could impact growth. However, the analyst expects conditions in China to improve. BHP’s reputation as a low cost producer is borne out by its healthy profit and operating margins. The valuation measures are not especially appealing when you consider the current P/E of the materials sector is 8.04. Yet the company is the largest diversified resources company on the planet with assets well-positioned to capitalise on Asian growth over time. As of 13 June 2013 the share price is at $32.12, close to its 52 week low of $30.09. It has been a tough month for the ASX, with the XAO All Ordinaries Index dropping 10%. The following price chart shows BHP outperforming the market by a 3% margin: In contrast to BHP, RIO derives around 45% of its revenue from iron ore operations. The company is looking to shed non-core assets in aluminum, coal, copper, and diamonds leaving Rio more dependent on its iron ore operations. Asset sales and an improved balance sheet are among the reasons major analysts are uniformly bullish on Rio. The company expects to raise $US10 billion to pay down debt through the sale of iron ore and diamond mines in Canada as well as coal mines, copper mines, and diamond mines in Australia. Rio has moderately attractive valuation measures and despite its horrific negative profit margin is still on a par with BHP as a low cost producer, with iron ore production costs of $40 per tonne. In February 2013 RIO posted a loss of almost US$3 billion due to write downs in its aluminum and coal operations. It was the first time in its history to show a loss. The company is taking a big gamble continuing its expansion of the Pilbara iron ore mining operations. However, with the prospect of a falling AUD and a production cost of only $40 per tonne, Rio can remain profitable even in the face of the direst forecasts for iron ore at $80. The question, of course, is will declining but still healthy profits be enough for shareholders. Despite analyst opinions, Rio underperformed the ASX XAO in the last miserable month, falling 11% versus 10%. Here is the chart: Fortescue is a pure play and as such presents higher risk than BHP and RIO. In addition, FMG has higher production costs, although reduced from $50 per tonne to around $44 per tonne as of the end of Q1 2013. Of major concern with FMG is the massive amount of debt run up in the wild days of expansion. The company may sell some of its infrastructure assets in port facilities and rail lines to improve its balance sheet. The company faces an additional obstacle with the potential of oversupply conditions. Its iron ore is of a lower grade than rivals BHP and RIO; 57% FE versus 62% FE. Perhaps the best reason to be wary of Fortescue can be found in the comments of CIMB Securities in its 19 April OUTPERERFORM recommendation, stating a “sustained high iron ore price is expected to lead to upgrades in earnings estimates.” The spot price on that date was $138 per tonne and on 11 June 2013 it was at $110.90. Fortescue’s share price is down 30% year over year and 15% over the last month. Here is the one month chart: The smaller pure play producers in the table, Mt. Gibson Iron (MGX) and Atlas Iron (AGO) have attractive valuation measures and strong balance sheets. Note both are trading below book value. MGX has a current book value per share of $1.00 as of 13 June 2013 and a share could be had for a mere $0.45. Similarly, AGO has a book value per share of $1.75 and you could pick up some shares at $0.75 each. In addition, both companies have more cash on hand as of the most recent quarter than total debt. Both companies could be potential takeover targets should market conditions continue to deteriorate. What is troubling from an investing viewpoint – beyond the obvious concerns about the stability of the price of iron ore – is the negative price to earnings growth ratio for both companies. Analyst estimates show EPS (earnings per share) for MGX dropping from $0.159 in 2012 to $0.10 in 2013 and $0.094 in 2014. In addition, Mt. Gibson suffered in the wake of the GFC, and was subsequently assisted by a substantial capital raise. MGX has higher production costs and lower grade ore as well. The two year earnings growth forecast for Atlas shows a rise from a -$0.052 in 2012 to a positive $0.067 in 2013 and $0,099 in 2014. According to data from Thomson/Reuters, the EPS drops again through to 2017. Atlas had solid production growth in the first quarter of 2013, but of a lower grade ore sold at discounted prices. The share price of both companies has fallen dramatically year over year, a trend that continued in the past month. Here is the chart: Based on their recommendations for the major iron ore miners, it appears analysts are less concerned about fluctuations in the price of iron ore, but the same cannot be said for investors. In the first week of June the spot price of iron ore experienced a rally of sorts, rising to $116.90 on 04 June 2013. Look back at the price charts for our five miners and you'll see that share price rose accordingly while the overall market did not. Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au. You should seek professional advice before making any investment decisions.