JPMorgan has kicked-off the sell-side iron ore downgrades that, in my view, will flow all year:
We are updating models to factor in lower YTD iron ore prices, with our revised profile implying a modest recovery in Q3 as better seasonal demand offsets expected supply additions. Despite reduced earnings forecasts for 2014, the FCF improvement theme remains intact for the iron ore majors. We continue to believe BHP & RIO will be in a position to initiate capital returns over the next 12 months, while FMG should be well placed to increase dividends significantly once net debt reduces. We remain buyers of RIO and FMG and maintain our Overweight recommendation. While BHP is Neutral rated, first mover advantage on capital management is likely to support the share price near term.
- 2014 iron ore price forecast cut 6%: Our Global Team has lowered 2014 forecast iron ore prices by 6% from US$125/t to US$118/t, while our medium and long term view remains unchanged. The revision mainly reflects lower forecast steel production growth in China for 2014, which is
- now +3.5% vs +5.0% previously (from a base of 775Mt in 2013). The key issues, which have impacted the year so far, include weak sentiment, pollution controls, tightening credit conditions and high inventories at Chinese ports. For full details refer to “Trimming 2014 iron ore price forecasts by 6% on lower demand assumptions”.
- Mark-to-market Q1 and updated FX: We also take this opportunity to mark-to-market Q1 commodity prices and update our FX forecasts to reflect the latest J.P. Morgan house view. The adjustments are generally modest, with the most significant change being a 4.7/8.9% weaker C$ assumption in 2014/15, which mainly benefits RIO’s Canadian Aluminium operations.
- Miners continue to face headwinds but valuations looks compelling. We acknowledge there are several headwinds the large miners face including: 1) recent volatility in commodity prices has potentially created heightened uncertainty around potential cash flow, 2) significant supply additions in iron ore near term require curtailment of high cost Chinese supply to balance the market, 3) recent China data has been underwhelming. However, we continue to believe these issues are well known and largely priced in. Further, with FMG and RIO trading on very attractive metrics, along with the capital returns thematic likely to play out (see our note), we maintain our Overweight recommendation.
A text book case of catching the falling knife.
