The FT has a little note explaining the sensitivity of miners to iron ore rice movements:
Every time iron ore prices move by one dollar a tonne, it means another $120m on – or off – this year’s post-tax net profit at BHP Billiton, the world’s third-largest producer of the metal. Last year at Rio Tinto, the second largest, $120m of earnings also rode on, or off, each $1 move.
UBS also takes a shot at breakevens:
- RIO: $US43 per tonne
- BHP: $US45 per tonne
- FMG: $US72 per tonne
- AGO: $US82 per tonne
- BCI: $US70 per tonne
- GBG: $US91 per tonne
Some see a break even for FMG above $80.
Meanwhile, we can turn to iron ore tragic and regular MB reader “Researchtime” for detail:
Mining costs – what a wonderful subject. I will try simplify what is actually quite a diabolical subject – one that management loves to mislead investors on. Obviously I am going to make some serious generalisations here and miss some areas – so to those self-proclaimed experts out there – don’t be too hard one me…
Just before I begin, The Motley Fool suggested that they have “already paid off the majority of debt due before 2019, there is much lower risk of a default” – That is a shocking statement with no basis in fact – no they haven’t… the company’s net debt position at 31st Dec. was US$8.6bn, even taking into account the US$2.9bn cash on hand. From memory, FMG peak debt was around US$12bn – so they still have a long way to go, with FY14 capex forecast at around US$2bn. They have publically stated that they want to get down to a 40% gearing (currently at 59%), but personally I think if prices continue to fall, that gearing ratio will have to fall as well.
C1 costs actually mean very little when you look at a company. They are used for published cost curves, typically representing direct operating costs only. If you have been lucky to go through a mining bust, it’s the critical reference point that management use to justify keeping a certain operation going – or not. The logic behind that is all the capex, which includes plant, stripping, etc. up to that point is already considered a sunk cost, so depreciation and other attributable costs have no effect on whether you continue produce. Incidentally, as forewarning, this is why there will continue to be substantial iron supply hitting the market long after the price for most producers becomes an “economic loss” (as opposed to an operating loss). Part of this also relates to the fact that closing an operation involves a lot of on going costs, such as plant, port and rail maintenance, redundancies, and even things such as pumping, etc.
Why is this important? Because if you look at FMG’s C1 costs for 2QFY14 were US$33/t (wmt), which if maintained (and as a little inside – they cannot in the long-term, for a variety of reasons) is not far off what BHPB and RIO are producing at, collectively. Importantly, this C1 cost could notionally be improved upon a depreciating AUD. It’s not a linear relationship of course, because fuel and equipment contracts are typically negotiated in USD. Notionally, revenue also increases as the AUD falls – although its important to remember that FMG gets approximately a 7.5% discount to Rio spec benchmark prices; which is incidentally, substantially less that for smaller companies such as AGO, which receive a 11% discount for their fines product– up to 32% discount for their “Value Fines” product. But at current prices – why not…
Taking into account that FMG are still in the midst of ramping up, current costs should improve into the future. If you look at FMG’s recent H1 numbers, revenue was US$5.9bn, COG’s US$3bn, equating to a revenue number approximately $108/t a tonne (implying a lower discount ~13% than the one mentioned above – will have to look into that) and a cost per tonne of around $56/t, substantially higher than the reported 1HFY14 C1 cost of US$33/t – which everyone loves to quote. Even so – that gives an EBIT margin (~48%) of around US$52/t. Which is good stuff.
But I note also that the net depreciation charge was only $19m (see Note 6), which is frankly unbelievable given that book value of plant assets is approx.. US$18bn (see Note 8) and growing. You may ask, how does this affect our economic break-even point? Good question. Assuming that current C1 costs are already at their base level, and a 20 year straight line method, depreciation per tonne of production at 155Mtpa is around >US$5.8-7/t. If we add in maintenance capex as well (est. 3% book value – should use 5%) adds another US$3.48-4.50/t. This implies, ceteris paribus, that the economic break-even point for FMG is approximately >US$65-66/t. This seems about right, as FMG is actually a very low cost producer, ranked 3rd on a global cost basis (using the Metalytics cost curve).
Just one last point, if I may – it is important to understand that production economies of scale only exist at a particular mine site. Yes you can glean a number of other efficiencies via shipping and rail if a number of smaller deposits are clustered together. Over the past decade we have had a number of major UK based mining conglomerates created with what I would term second tier assets – which works fine when times are good. However, I believe that in a very short period of time we are about to see a mining crash second to none in recent memory, maybe with the exception of 1929. When you compare production cost curves, always remember that they contain a plethora of different deposits, with completely different cost structures. For instance, one of the most expensive BHP iron ore operations is Mt Newman (well it was once), which produces a good product that is often blended with Mara Mamba ores from Area C. As an aside, a lot may have been said of Kloppers in hi
s time as BHP’s CEO. But I think his greatest legacy is yet to come – that he did not commit to any stupid acquisitions and run up too much debt…
