Billionaire David Einhorn's Investor Letter: Short Iron Ore
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Why Einhorn hates the iron ore industry. Billionaire David Einhorn and his hedge fund Greenlight Capital underperformed the broader market in 2012, posting a 2012 total net return of 7.9% (check out the top performing hedge funds). Now Einhorn is gearing up for 2013 and per his 4Q letter to investors, one of his investment ideas continues to be short the iron ore industry.
So will the bet be fruitful? Since inception in 1996, Greenlight has managed to return an annualized 19.4% net of fees, so at least digging into this thesis is worthwhile. So what are the best ways to bet against the iron ore industry?
Einhorn said this in his letter concerning his 'short iron' thesis...
Our bearish thesis on iron ore is new, and we have shorted a number of stocks in the sector. Our view is that after a decade-long bull market, supply is now exceeding demand. On the supply side, the miners have spent billions preparing to expand supply, which is poised to grow about 15% in each of the next couple of years. At the same time, iron ore is used to make steel, and global demand for steel is currently growing at just a couple percent per year.
The major iron ore producers includes BHP Billiton (NYSE: BHP), Vale (NYSE: VALE) and Rio Tinto (NYSE: RIO) are all heavily exposed to the iron industry which is heavily dependent on the broader economy. Other stocks to avoid, assuming you agree with Einhorn, include U.S. Steel (NYSE: X) and Cliff Natural Resources (NYSE: CLF). Worth noting, it was reported that Einhorn was short U.S. Steel 'off and on' in 2012.
These iron ore companies also face a number of other risks related to geopolitical and nationalism concerns, government regulations, natural disasters and currency fluctuations.
BHP Billiton upped its exposure to the iron industry late last year by selling off its diamond business. Vale has guided toward negative production volume growth in 2013, which is in large part due to demand decline in Brazil. Vale also faces significant fluctuations in currency prices and is feeling pressures from depreciation of the Brazilian Real relative to the U.S. dollar.
At the Sohn London Investment Conference, famed short seller Jim Chanos (check out his profile) also targeted Vale as an overvalued stock, calling the company a 'value trap'. He went even further to say that the iron industry itself is overvalued. Chanos argued that Vale is too dependent on China’s demand for iron ore, where demand will likely slow due to construction of their own iron ore plants.
Rio Tinto has been struggling of late, with large write-downs that have strained earnings. The recent write-down includes $14 billion, $3 billion for Coal Mozambique and $10 billion for its aluminum assets.
Two companies with a large short interest already include:
|Short Interest (% of float)|
|Cliff Natural Resources||18.90%|
|Price to Earnings to Growth|
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