14/09/2015 - 14:46

Profit margins squeeze the top end

14/09/2015 - 14:46


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The commodity price crash is drawing in some big-name, high-cost producers.

TOUGH GAME: FMG comes in fifth of the world’s big iron ore miners in terms of its breakeven price – estimated at $US38/t.

The commodity price crash is drawing in some big-name, high-cost producers.

Tonnes just don’t do it any more. The new game in mining is dollars, with Gina Rinehart a few weeks away from pushing Andrew Forrest further down the pecking order in Western Australia’s iron ore mining business.

While the details remain to be confirmed, it seems likely that Mrs Rinehart’s Roy Hill mine will operate at a meaningfully lower cost than those of Mr Forrest’s Fortescue Metals Group, which means she will post higher profits on a per-tonne basis.

A similar battle to be the low-cost leader is being fought at the top end of the mining game as Ivan Glasenberg, another resource sector champion with strong connections to WA, confronts his future as a high-cost operator forced to adjust to the new era of low commodity prices.

Mr Glasenberg is the biggest private shareholder in Glencore, the world’s leading commodity trader, which is hurriedly restructuring its financial affairs in an effort to retire debt and retain an investment-grade credit rating essential for the funding of its trading business.

The slippage of Messrs Forrest and Glasenberg on an earnings test also reveals how rankings on the Australian list of billionaires is being adjusted, with both men likely to fall out of the top 10. This will Mrs Rinehart as the leader, followed by big names in packaging (Anthony Pratt), gambling (James Packer) and property (Frank Lowy and Harry Triguboff).

Losing altitude on a list of billionaires might not seem important, but it is a measure of how the business world is changing, as industries that once produced the strongest profits are returning to ground level.

Growth for growth’s sake is being replaced by measures such as earnings per share and costs per tonne, with profit margins the key test – as it should always be in any business.

The now-faded resources boom led to false measurements of success, such as tonnes mined or shipped, with management leaving earnings to take care of themselves, which is never smart.

In the game of Rinehart versus Forrest, everything changes when the former’s Roy Hill mine reaches its nameplate capacity of 55 million tonnes a year, exactly one-third the size of FMG’s 165mt output.

However, there are three measurements that draw Mrs Rinehart and Mr Forrest closer together.

Firstly, Mrs Rinehart owns 70 per cent of Roy Hill, which means she is entitled to 38.5mt of ore from the mine. Mr Forrest owns approximately one third of FMG, which means he is notionally entitled to 55mt of the company’s output.

Next comes the test of profits per tonne, which can be estimated using an updated breakeven price analysis from the investment bank, UBS. It reckons Roy Hill’s breakeven iron ore price will be $US33/t, whereas FMG’s breakeven price is $38/t – inferring a $US5/t advantage for Roy Hill.

Thirdly, Roy Hill is not Mrs Rinehart’s only iron ore allocation. She owns half of the Hope Downs mine, which means she is entitled to a further 22.5mt, taking her personal share of low-cost ore to 60.5mt million tonnes a year (with royalty income on top).

Sticking with Roy Hill versus FMG in this iron ore drag race (because Hope Downs is operated by Rio Tinto), it can be calculated that, at the latest price for high-grade iron ore of around $US57/t, the gross profit margin for Mrs Rinehart from Roy Hill is $US24/t versus Mr Forrest’s $US19/t.

In very rough dollar terms, that means Mrs Rinehart’s share of Roy Hill’s annual gross profit at current iron ore prices is about $US924 million, while Mr Forrest’s notional share of FMG’s profit is $1.05 billion – with tax, interest and other changes eating into those numbers and perhaps turning a profit into a loss.

UBS did not track profit shares, but did construct a global pecking order for the biggest iron ore miners, and that’s when the rise of Mrs Rinehart becomes quite interesting; because the $US33/t breakeven price for Roy Hill ranks the mine third behind Rio Tinto at $US29/t and BHP Billiton at $US28/t – with BHP Billiton in front for the first time.

Vale, the big Brazilian iron ore miner, is in fourth spot on the UBS league ladder at $US37/t, and FMG is fifth at its estimated $US38/t.

Billionaires such as Mrs Rinehart and Mr Forrest invariably claim that they are not interested in lists of who’s richest; and perhaps that’s right, because what’s a billion dollars here or there, when you are so far up the ladder?

But the game changes when you start to slip down the ladder, either on a personal wealth test or a cost-comparative test, which is what’s happening to Messrs Forrest and Glasenberg as their high-costs business interests start to melt in the heat of the commodity crash.

Watch Indonesia

COMPANIES and rich investors are not alone in feeling the pressure of lower commodity prices; countries are also being hurt, and Indonesia is the country closest to Australia that could be moving towards a crisis.

So far, the emerging economies receiving the closest attention because of falling commodity prices are the oil exporters such as Venezuela, Nigeria and Libya, with Russia also on the danger list.

Indonesia, which used to be a big oil exporter, is more reliant on other raw materials such as palm oil, rubber, coal, bauxite and nickel ore.

Three of those top exports (coal, bauxite and nickel ore) have been hit hard by a combination of lower prices and a self-imposed export ban on unprocessed materials in the hope that investors would build new added-value projects.

Fresh investment has been slow to arrive, leading to a 20 per cent fall in foreign trade, with the result that Indonesia is looking at ways to restart the export of unprocessed ore, especially nickel, which will hurt the WA nickel industry.

However there is also growing concern that the Indonesian currency is primed for a big fall, as it did in 1997, triggering a political crisis, which invariably affects relations with Australia.

Don’t bet on China

AN alternative way of measuring the problems in China is to look at the collapse in one of that country’s national sports – gambling.

In Macau, revenue from the tables in its casinos has fallen by a whopping 35 per cent over the past year, as a crackdown on conspicuous consumption takes its toll of the country’s elite.


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