FEATURE: A stubbornly high dollar, falling prices and high operating costs are combining to exert real pressure on smaller players in the iron ore sector.
High costs and low prices are squeezing the profits of those operating in Western Australia’s most important industry – iron ore mining – with the inevitable result that the big miners are getting bigger and small are struggling to survive.
Bold expansion plans that once dominated the sector are being quietly shelved, with ‘growth by merger’ becoming the preferred option as a way of achieving essential economies in a business that has become far more competitive than a few years ago.
The recent deal between BC Iron and Iron Ore Holdings is an example of how mid-sized miners will try to leverage their way up to a size able to attract the attention of bankers, investors and iron ore buyers who can get most of what they want from the giants of the industry – Rio Tinto, BHP Billiton, Fortescue Metals Group and, from next year, Gina Rinehart.
Evidence of the tougher conditions in iron ore can be found across the industry, as the effects of a 30 per cent fall in the average benchmark price (from more than $US130 a tonne little more than a year ago to a recent price of around $US93/t) eat into profits.
The situation is not being helped, as it has in previous periods of lower prices, by an offsetting decline in the value of the Australian dollar; an event, which if it occurs, could boost diminishing optimism among iron ore miners.
Compounding the price pressure is the problem of heavy discounting being applied to lower grades of ore by Asian steel mills, which are demanding higher quality material to maximise their profits and minimise the environmental pollution around their steel-making plants.
Atlas Iron, one of the mid-tier success stories acknowledged the quality problem when it announced that it was significantly reducing the production of its secondary product known as ‘value fines’, and boosting production of its higher-grade standard fines, a switch that means Atlas is effectively ‘high-grading’ its ore bodies, which could shorten their lives.
The net result of the change is that Atlas will continue growing with a targeted output in the current financial year of up to 12.8 million tonnes of ore at an all-in cost per tonne of between $US64 and $US69, a number that rises after accounting provisions.
Atlas is not alone in feeling the squeeze, with even the biggest miners being forced to work harder.
Rio Tinto recently impressed investors with its half-year production report, which included a 10 per cent increase in iron ore output. Less well noticed was that the higher output only resulted in a 6 per cent increase in pre-tax profits.
Across the industry there are signs of stress as the boom years for iron ore are replaced by a period of tight cost controls and, in some cases, heavy financial losses.
The increasingly fragile position of Gindalbie Metals is a worry not only to shareholders in the company but to the WA government, which had hoped it would be a trail-blazer in the business of value-added iron ore processing.
However, rather than succeed in upgrading a low-grade ore called magnetite, Gindalbie has struggled to master the process and has been forced book heavy losses against its part-owned Karara project, with control of the venture passing to Gindalbie’s Chinese partner, Ansteel.
Sino Iron, another magnetite processing project, does not reveal its full financial results, but is likely to also be struggling under the pressure of the lower price and high ore-processing costs.
The profit squeeze on iron ore miners is being reflected on the stock market, with most producers being heavily sold-off over the past 12 months as rising levels of iron ore production overpower slower demand growth in major markets, especially China.
Atlas, for example, has underperformed the broader stock market by 32 per cent over the past 12 months as its share price has fallen by 43 per cent from a peak last year of $1.24 to recent sales at 70 cents, meaning the stock has plunged by more than 80 per cent from the $4.20 it was trading at three years ago.
Once valued at close to $1 billion, Gindalbie is now valued at $70 million with a share price that has plunged by 96 per cent, from $1.40 three years ago to recent trades at 4.7 cents.
The big miners, with their cost advantage from economies of scale and highly efficient rail and port services, will not make life easier for small rivals as they fight each other for market share.
Rio Tinto chief executive Sam Walsh delivered a warning to rival miners in early August when he said that he would not slow expansion plans, or cost-cutting drives, at WA’s biggest integrated iron ore business.
“Now is not a time for one of the best iron ore producers in the world to take a step back,” Mr Walsh said.
“Now is a time for others to really feel the consequence of the price against their operating costs and (for them) to make decisions.”
Decoded, Mr Walsh was delivering a blunt warning along the lines of ‘if you can’t take the heat, get out of the kitchen’.