The bearish earnings multiples on BHP and Rio, which were always a commodity price play rather than an operational assessment, are beginning to look prescient given the prospect of slowing growth in China. Merrill is looking at the implications for the majors, suggesting that BHP is taking the more bearish position. This is perhaps the mosre realistic assessment, but of course the issue is always that economic trends can change a lot faster than project timelines. And while it is possible that demand in China will fall of a cliff, it is unlikely. The Chinese leadership has a huge interest in maintaining growth, and it has more economic options than most governments. According to Merrill:
BHP is looking to re-evaluate capex plans, citing amongst other things a “flattening of demand for iron ore, to drop to single digits” but added that the iron ore price was not expected to fall dramatically and forecasted a price floor of ~US$120/t. Is this breaking news, NO. The growth rate for Chinese iron ore consumption has been expected to moderate to single digits from 2012 onwards for a number of years now – 2012-2019 CAGR ~6% vs 2003-2011 of 19%. China steel production capacity is expected to reach ~1100Mt by 2025 vs 700Mt today.
Rio remains confident on iron ore demand despite the slowing of China’s growth compared to previous years. Growth in China’s steel demand has a long way left to run after a 40% expansion over the last 5yrs, with India and others expected to follow suit. Global iron ore supply additions are expected to be at least 100Mtpa for China alone. With Rio spending billions of dollars to push its production capacity to 283Mt by 2013 and potentially to 353Mt by 2015 – this certainly confirms confidence in the iron ore demand equation.
FMG continues to power forward with its “stretch” expectations of achieving the 155Mtpa expansion by FY14. Company estimates are predicting a potential FY14 EBITDA of US$9.2bn a whopping US$3bn above market consensus of US$6.2bn. Infrastructure capital intensity at 155Mtpa expansion is $84 per tonne. Progress at Nyidinghu is tracking well – first exploration was August 2010 and 2bn tonnes announced September 2011. Elsewhere, the Solomon project is on track.
Merrill also notes that Anglo is “sniffing around” for iron ore assets. Macquarie likes Fortescue after it has raised some well priced debt:
Fortescue Metals Group – Maximum yield. FMG has secured US$2bn of senior unsecured debt funding for its expansion to 155mtpa and the acquisition of mining fleet. The current raising is at 6% for 5-year debt and 6.875% for 10-year debt and is priced significantly lower then previous debt raisings. The US$2bn raised should see FMG through its expansion provided there is no material capex increase or ramp-up delay, even if iron ore prices dip to US$130/dmt and stay there. We believe the next price move for iron ore is likely to be to the upside, driven by increasing Chinese demand and lack of new seaborne supply.
It’s true that iron ore price weakness as nothing new. But not quite in the way it’s being portrayed. Most of the commodity analyst community is only now catching up to the correction of the ore price that transpired six months ago, largely because they saw it then as temporary. That they are circling the wagons around an ongoing bullish iron ore story now that BHP has come clean is not necessarily encouraging. Truth is, if the iron story deteriorates further, the brokers will probably be the last to say so. Market pricing of the mining majors has been a far better indicator of future prospects.