Iron Ore Supply Growth Slowing, Great News For These 2
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Iron Ore Supply Growth to Slow, but by How Much, and How Soon?
TMF readers may have seen previous posts of mine about iron ore and coking coal. Recently, the Big 3 producers -- Vale, (NYSE: VALE), BHP, (NYSE: BHP) and Rio Tinto, (NYSE: RIO) -- have announced significant cutbacks in 2013 capital expenditure plans. This is from Bloomberg News on September 10th:
Vale, the worst performer among major mining companies this quarter, is poised to reduce investments to the lowest in three years as prices for iron ore slump on slowing Chinese demand. "The biggest producer of the steel-making ingredient will approve a 2013 budget of $16.8 billion, 22 percent less than this year's $21.4 billion....
While it may be too soon to read too much into the implications here, there are some important takeaways. In an industry like iron ore where the top 4 producers control more than 70% of the seaborne market, cutbacks by the Big 3 make a huge difference. If the Big 3 are cutting, what does that suggest about the prospects for emerging, unfunded, iron ore players in Brazil, Australia, Africa and eastern Canada? Foolish readers should understand that when a major postpones a project, that project can't be revived quickly.
Delays in Mega-Projects Will Not be Short Delays...
BHP is postponing capital allocation decisions on all major projects across all commodity segments. These project delays will amount to much longer than 6-9 months; they could push back first production for 12-24 months. Why? Because resources devoted to the stalled projects get re-deployed, long-lead time orders may be canceled, and certain permitting, legal, environmental and regulatory steps may be delayed. With iron ore prices down almost more than 50% from last year's high, there's a decent chance that the Majors will pursue other projects in their giant portfolios.
Oil & gas and copper are 2 examples of commodities that have held up far better than iron ore despite China's woes. BHP and Rio produce a number of industrial commodities besides iron ore. In fact, iron ore is only the third largest segment for BHP. BHP is printing money in its oil and gas business and has the biggest and best premium hard coking coal franchise in the world.
Winners Will Be Small & Mid-Sized Producers Already in Production with Reasonable Costs
There will be winners as well as losers. The losers will be emerging producers that are not yet in production and especially those that have large unfunded capital requirements this year or next. The winners are players like Cliffs Natural Resources, (NYSE: CLF) that are not big enough to negatively impact global prices by raising production. Cliffs is a mid-sized globally diversified producer with projects in eastern Canada, the U.S. and Asia. By increasing production, Cliffs will be able to reduce per tonne costs while the majors experience margin compression. Don't shed a tear for the majors; they're still tremendously profitable with all-in costs in the $40's to $50's per share.
Fortescue Metals Group. Fortescue is also a mid-sized producer, but it's growing and will become the 4th largest producer after Vale, BHP and Rio next year. However, Fortescue has too much debt. Unless iron ore prices rebound comfortably above $120 per metric tonne, the stock is too risky. If funding continues to be an overhang, Fortescue may have to raise highly dilutive equity at an unfavorable price. In addition to Cliffs, I like a mid-sized producer with operations in Africa: London Mining, (LSE: LOND).
London Mining Is Well Positioned
While London Mining is an emerging producer, unlike peers it's already in production. Among global emerging producers, only those currently in production AND those with reasonable costs should be considered. There are a bunch of African iron ore projects dreamed up when iron ore prices were $140-$180 per tonne. These projects are really struggling right now. Like Cliffs, London Mining can increase production to its heart's content without weighing on iron ore pricing. London Mining's stock has sold off hard with the rest of the sector, but is over-sold in my opinion.
Once the initial ramp-up to 5 million tonnes is completed, London Mining claims its costs will be $45-$50 per tonne. If the company can achieve that level on just 5 million tonnes, that would be spectacular. Even at a $55 to $60 per tonne costs, London Mining trades at a cheap valuation. Importantly, growth can be partially funded with internally generated cash flow and debt. The bigger picture is growth to 10-20 million tonnes and the possible take out by a major.
I like Cliffs, but it has rallied quite a bit in the past week. I would wait to buy CLF in the $36-$37 zip code. For London Mining, I'm a buyer at current levels.
MockingJay2011 owns shares of Vale and London Mining.. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.