The high-cost, low-price environment has put the squeeze on iron ore miners.
The high-cost, low-price environment has put the squeeze on iron ore miners.
High costs is one issue causing pain for the iron ore industry, but a problem on the other side of the ledger – rising discounts for low-quality ore – is another growing source of concern.
The combination is applying a painful squeeze on the finances of most miners, especially those forced to use expensive transport systems such as road hauling second-grade ore, which means high fuel and trucking costs are magnified by lower prices on the goods being carried.
Three iron ore miners, so far, have been forced to take drastic action to try and ride out the crisis caused by the twin effects of higher costs and lower price.
IMX Resources has mothballed its Cairn Hill mine in South Australia. Pluton Resources has suspended trading in its shares while trying to raise $80 million needed to survive, and Sherwin has collapsed after failing to restructure its debts.
They are not alone, and while most investors are aware of the problem being caused by the very public fall in the price of iron ore, most are in the dark when it comes to seeing the corrosive effect on a company’s profit margins from steel-mill customers enforcing ore-quality discount clauses in sales contracts.
A glimpse of what’s happening can be found in last week’s production report from one of the biggest iron ore miners, Fortescue Metals Group.
While the headlines focused on total shipments hitting a record 124.2 million tonnes during the financial year to June 30, and the fact that this was slightly below target, the more important news was the disclosure of a ‘realised’ price of $US106 a tonne for ore sold.
According to the investment bank UBS, that annual realised price masked a very low realised price for the June quarter of just $US82/t, about $US4/t less than the bank’s analysts had expected.
FMG’s June quarter problem appears to have been a high level of impurities (especially silica) in the first shipments of ore from the new Kings mine. This should not be a problem in the future.
However, what the discount suffered by FMG revealed is that a much wider-than-average gap has opened between the generally quoted price for premium ore assaying 62 per cent iron, and the price received for poorer-quality ore.
Another investment bank, Merrill Lynch, noted last week that, for much of the past two years, the average price discount between 58 per cent ore and 62 per cent ore had been around 2.2 per cent after adjusting for iron content.
“This discount has widened dramatically over the second (June) quarter of 2014 to a high of 13 per cent, and has averaged 6.5 per cent over the quarter,” Merrill Lynch said.
After allowing for the heavier than expected ore-quality discounting, Merrill Lynch has downgraded its profit expectations for FMG and another prominent Pilbara producer, Atlas Iron.
A third big investment bank, JP Morgan, has also raised the ore-quality discounting issue at Atlas, which is scheduled to release its June quarter production report on Thursday July 24.
Like UBS, the analysts at JP Morgan will be looking closely at what it terms the ‘achieved’ price by Atlas during the June quarter, when discounting was at its fiercest.
What’s happening in the iron ore industry is that quality is becoming a more important factor than quantity.
Until now, virtually any miner with access to an ore body could sell anything mined to a hungry Asian steel industry.
That game is over, with steel mills having a greater choice of ore thanks to the rising level of production, particularly from the biggest producers of premium-quality ore, the two giants of the sector, Rio Tinto and BHP Billiton.
For smaller miners with their higher costs, which can generally be explained by a lack of access to heavy-haul railway and efficient port systems, the advent of punishing ore-quality discounts means that most will be facing increased financial pressure.
Target Wesfarmers
WESTERN Australia’s iron ore miners are not alone in feeling a chill wind from investment banks, with a quick survey of the biggest home-grown companies revealing that most are facing the prospect of falling share prices as profits dry up.
According to the consensus views of eight top banks, the shares of the two biggest Perth-based companies, Wesfarmers and Woodside, are overpriced by an average of around 3 per cent.
If a share price fall of 3 per cent was all that analysts could see for the big two, it wouldn’t cause too much pain for investors who are heavily exposed to the local leaders.
But, in the case of Wesfarmers, two big banks are taking a very gloomy view, with Merrill Lynch telling clients that the company is over-priced by 13 per cent and could fall from its recent share price $41.40 to $37.50. For its part, Citibank reckons Wesfarmers is overpriced by 16.9 per cent and heading for a price target over the next 12 months of $35.80.
Woodside comes in for less-critical treatment, with Deutsche Bank’s forecast of a future price fall of 8.1 per cent – from its recent $40.12 to $37.95 – topping the negative views.
Overall, six of WA’s top 10 ASX-listed stocks (Wesfarmers, Woodside, Navitas, Mineral Resources, BWP Trust and Monadelphous) are forecast to suffer share price falls over the next 12 months.
$2.2bn question
WHAT is it the South African managers of Woolworths in that country can see in David Jones that most Australians who have shopped at the department store most of their lives cannot?
That is a very interesting question, because the $2.2 billion paid by Woolworths for DJs implies a belief that new management from a foreign country can do better than the locals, and that the rising tide of internet shopping is not as big a threat to profit margins as some people imagine.
Time will tell whether the South Africans have overpaid for DJs, but given the weak condition of Australian retailing and the continued squeeze on margins, it’s a fair bet that they have.
High seas holidays
AUSTRALIANS and Chinese share an unusual passion in their growing taste for cruise ship holidays.
According to data from the International Cruise Lines Association, the number of Chinese taking a cruise last year increased by 165 per cent, to 530,000 people, with Australia not far behind in terms of percentage growth (up 130 per cent) and ahead (for now) in numbers, at 760,000.
