Market may be underestimating iron ore boom

Things could hardly be better for BHP and its shareholders (reports The Australian Financial Review).
23rd April 2021
Resources Rising Stars

Things could hardly be better for BHP and its shareholders (reports The Australian Financial Review).

With just 2½-months to go in the financial year, the mining giant’s March quarter production numbers released on Wednesday suggest it is on the cusp of beating its own iron ore export target for shipments in the full year of 286 million tonnes.

Better yet, the strong performance – arguably stronger than that of Rio Tinto, which dug into iron ore stockpiles during the March quarter – comes amid a demand boom that has sent iron ore prices to record levels in Australian dollar terms, and near all-time highs in US dollar terms.

The iron ore price jumped more than 4 per cent to $US189.61 overnight amid surging demand and ongoing concerns about supply from Brazil.

With prices at this level, it’s no surprise observers are recalling the heady days of the mining boom. But BHP and its fellow giants Rio Tinto and Fortescue Metals Group are very different companies. And this is a different type of price boom, too.

A decade ago, Australian mining was still rushing to ramp up to meet surging demand from China – BHP shipped just 134 million tonnes of ore in 2011, the year iron ore prices hit $US190 a tonne – and its unit costs per tonne were hovering around $US40 a tonne.

On Wednesday, with its huge iron ore machine now fully built out and running close to top speed, BHP reaffirmed cost guidance for between $US13 a tonne and $US14 a tonne.

Prices are great, but it’s the margins that the Global Australian is enjoying right now that are truly historic.

The nature of this price boom is different, too.

While demand is again being led by China’s desire to stimulate its economy after the pandemic with construction and infrastructure spending, the US - and to a lesser extent Europe - are embarking on infrastructure spending sprees in a way they weren’t in the heady days of 2011 and 2012.

A consumption boom, particularly inside China’s now much more mature economy, is also adding to demand.

There are other subtle differences about this price boom. The carbon emissions created by steel making were only a vague concern 10 years ago, but are now at the forefront of the minds of miners and steel makers.

It’s notable that in his brief comments on the March quarter numbers, BHP chief executive Mike Henry dedicated almost as many words to the company’s efforts on decarbonisation in the quarter as he did to operations.

This focus on making cleaner steel is leading mills to increase demand for higher quality ore, which plays into the strengths of BHP and Rio.

The other big difference this time around is the issues Brazilian iron ore giant Vale is having in ramping up production after a period of supply disruptions.

Monday brought yet another set of underwhelming production numbers from Brazil, giving the iron ore spot price another little kick along.

The iron ore price continues to confound analysts who have been predicting prices would soften thanks to weaker Chinese demand and stronger Brazilian supply for what seems like the best part of two years.

And to be clear, they’re staying firm on these predictions.

Goldman Sachs said on Tuesday it sees iron ore at $US137 a tonne by the end of June, implying a 27 per cent fall in the next 10 weeks. UBS sees the iron ore price ending the year at $US100 a tonne (which suggests a 47 per cent fall) before dropping to $US75 a tonne by the end of 2023.

The longer-term view may well prove to be right – Vale will get on top of its problems and the post-pandemic stimulus surge will fade.

But what causes a savage fall in the iron ore price before the end of the year is more difficult to see. The view inside Rio and BHP is that conditions in China remain strong.

While iron ore inventories have increased in recent weeks, Chinese steel production rose 19 per cent year-on-year in March, steel mill margins remain surprisingly strong despite the high iron ore price - which points to white-hot demand - and mills are still favouring higher quality ore.

One investor, Tribeca Global Natural Resources portfolio manager Ben Cleary, was brave enough to put a $US200-a-tonne price on the table this week. While BHP and Rio insiders aren’t in the business of making price predictions, they remain upbeat about what they’re seeing on the ground in China.

Mining’s a game played in decades, of course, but the short term will matter for investors and the returns they might see in August. As Macquarie points out, at spot prices, BHP’s earnings for the 12 months to June 30 are more than 30 per cent ahead of market consensus.

If iron ore prices can continue to defy analyst predictions, then the dividends that BHP delivers might be even better than the market expects.

 

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