Iron ore prices are looking pretty dodgy as Houses & Holes has been documenting. JP Morgan has looked at the consequences for the large players and is arguing that Rio is more compelling than BHP and Fortescue needs more funding, which has been the case for some time. Morgan likes Atlas Iron and Grange Resources for iron ore. But with the price signals looking so weak, investing long is starting to look pretty dodgy. There is growing bearishness about China:
Chinese steel demand appears to be falling with China rebar prices down about 15% on the June average. Lower steel prices are placing producer margins under pressure and local steel mills are destocking raw material inventory in an attempt to preserve cash. Mills are taking the opportunity to undertake maintenance during this period of weak demand, but steel production still remains relatively strong, adding to the glut. Chinese steel production for the second 10 days of August was around 704Mtpa, down from a record high of circa 740Mtpa in July 2012. Eventually, mills should begin to re-stock (inventory is reportedly down to about 2 weeks), China’s high cost domestic iron ore mines may begin to cut production, and Chinese policy makers may look to stimulate growth, however these events are likely to take some time to play out. In the meantime, there doesn’t appear to be a catalyst for the iron ore price to bounce back near term.
On estimates of weaker spot prices, JP Morgan is reducing BHP and Rio’s NPV by 10%. Ouch.
BHP looks cheaper on CY14E PE of 14.5x vs RIO at 15.2x. However, RIO would still have almost 50% upside to a revised NPV of A$75ps, while BHP’s NPV would fall to A$36ps, showing only 10% upside. This scenario is supportive of our RIO over BHP call.
Fortescue requires a mere $US2.3 billion by Morgan’s estimates. And with the $A also looking rocky, that US part of the currency estimate might blow out the amount in $A terms. JP Morgan argues that there is an appetite for raising equity (which of course might need some underwriting). One wonders why when there has been so much bearishness around BHP and Rio, much stronger stocks. But that’s broking for you.
Here is the take on the mid cap stocks:
Mount Gibson’s valuation is impacted the greatest by lower short-term spot prices, as the short life of its mines means it extracts most value over the next few years. In the mid-cap sector, we maintain our preference for companies with strong balance sheets, positive cash flow and low development risk and reiterate our Overweight on Grange Resources and Atlas Iron. Gindalbie remains our least preferred given its high financial leverage and potential risks through the commissioning and ramp up of Karara.
The party is starting to look very over. The coal and iron ore mining boom is likely now to be overtaken by what is happening in the LNG sector.