Is Iron Ore Price Slump Sending Mining Sector Stocks to the Bottom?

Many ASX mining shares have recently tumbled to low levels at the back of the slump in iron ore futures. The slip from the high level of around US$100 per tonne earlier this year to a level as low as US$68 has shaken up the mining industry. Some forecasters have even signaled the drop to go to US $46 by 2021 at the back of surplus supplies from Australia and Brazil, while others find support from prices undergoing a mere correction.
 
China's manufacturing sector growth also decelerated faster than expected in April 2017, the National Bureau of Statistics' official Purchasing Managers' Index (PMI) fell to a six-month low of 51.2 in April from March's near five-year high of 51.8. The demand witnessed a slump with the biggest decline in the input price sub-index, which fell to 51.8, its slowest expansion since June last year, from 59.3 in March. China's economy grew at a faster-than-expected rate in the first quarter, boosted by higher government infrastructure spending and the nation's gravity-defying property boom, which in turn led to positive investor sentiment on the Chinese infrastructure sector and increased stockpiling by steel producers who bought high grade iron ore leading to a massive buildup in inventories. The price of iron ore had hit USD94/tonne in February 2017, compared to the average of USD58/tonne in 2016. Further, Iron ore inventories in China rose to an all-time high of 132.45 million tonnes in March 2017. However, recent sharp declines in iron ore and onshore steel prices point to some of the pressures the country's manufacturers are facing. Chinese steel and iron ore futures tumbled to multi-month lows in March as market sentiment turned bearish on demand outlook with growing worries about an excess supply of steel in past few days. Steel and iron ore futures in China fell 1% on May 01, 2017, as the two commodities retreated on persistent worries over weak demand in the world's top steel consumer.
 
In the past few quarters, mining equities have performed well; but recently felt the brunt of the commodity price volatility. However, the long-term scenario for low cost producers is still expected to be positive, at the back of their increasing efficiencies and productivity gains as cost reductions and efficiency improvements are expected to drive strong balance sheets, and improved cash flows. The point still to keep in mind is that if Chinese steel exports slow down due to increasing protectionism and anti-dumping duties by major trade partners, steel production may be impacted and this will eventually impact iron ore demand and the price. Australia and Brazil are typically the lowest-cost iron ore producers and exports from these destinations has been on the rise given the present scenario.Rising exports from these countries and low-cost supplies don’t augur well for iron ore prices. Let us now look at the key iron ore miners of Australia and their performance as impacted by the latest iron ore volatility.

BHP Billiton Ltd

BHP Details
Revision to production guidance:Over the past four years’, BHP Billiton Ltd (ASX: BHP) company delivered US$11 billion of productivity gains which in turn led to improvement in margins. In FY16, company generated productivity gains of US$437 million and expected strong momentum to continue during FY 17 with US$1.8 billion of gains. Further, these productivity gains contributed to free cash flow of US$3.4 billion and the sustained strength of the company’s balance sheet. As per earlier updates, productivity initiatives were expected to result in production growth of 5% in copper, 4% in iron ore and 3% in metallurgical coal in FY2017, while further gains were expected over the short to medium term by cost reductions, using latent capacity and investing in capital efficient projects. Owing to some adverse conditions, the group recently slashed production guidance for copper, iron ore and coking coal for the 2017 financial year (for instance, guidance for copper production has been cut down by as much as 18% to between 1.33m tonnes and 1.36m tonnes following a 44-day strike at its Escondida mine in Chile).
 

Production Highlights (Source: Company Reports)
 
On the other hand, BHP reported record production at Western Australia Iron Ore and five Queensland Coal Mines for nine-months ended March 31, 2017. BHP stock has declined 13% in the last three months as on April 28, 2017. We maintain a “Buy” recommendation on the stock at the current price of $ 23.88
 

BHP Daily Chart (Source: Thomson Reuters) 

Rio Tinto Ltd

RIO Details
Improving production performance:Rio Tinto Ltd (ASX: RIO) had witnessed challenging weather conditions at its West Australian and Queensland operations, but was able to post a solid production in the first quarter of 2017. Pilbara iron ore shipments were of the order of 76.7 million tonnes in the first quarter (100 per cent basis). Even, mined copper production was 29% higher than the first quarter of 2016. The group had earlier reported a revenue de-growth at 12.9% CAGR over FY11-15 due to significant impact of reduced commodity prices globally and deterioration in key metal-intensive sectors in China. However, the company delivered strong operating performance; and over the past three years, RIO has significantly reduced costs while reducing capital expenditure, working capital and strengthening its product portfolio. Further, these cost-effective initiatives led to return of over USD13bn of cash to shareholders during the same period. RIO stock has declined 11% in the last three months as on April 28, 2017. Though, there are some sector headwinds owing to commodity price movement, given the company’ robust financials and low cost production, we maintain a “Buy” recommendation on the stock at the current price of $ 59.85
 

RIO Daily Chart (Source: Thomson Reuters) 

Fortescue Metals Group Ltd

FMG Details
Widening of spreads in prices impacting the business:Fortescue Metals Group Ltd (ASX: FMG) reported for 39.6 million tons of iron ore shipments during Q3FY17 at cash production costs (C1) of US$13.06 per wet metric tonne (wmt), which was a 12% improvement over the prior comparable period and 4% higher than the December 2016 figure due to wet weather impacts on production and shipments. During the quarter, Fortescue repaid a further US$1.0 billion of debt, reducing gross debt to US$4.3 billion, inclusive of US$0.7 billion of finance leases with US$1.5 billion cash on hand at 31 March 2017. This debt reduction has lowered gross gearing to 31% with net gearing of 22%. The average realized iron ore price of US$65 per dry metric tonne with a C1 cost of US$13.06/wmt generated strong cash flows. However, the group has lowered its FY17 price realisation guidance owing to widening of spreads in prices. FMG stock has declined 13.6% in the last one month owing to industry head winds and decline in iron ore prices. We give an “Expensive” recommendation on the stock at the current price of $ 5.25
 

FMG Daily Chart (Source: Thomson Reuters) 

BC Iron Ltd

BCI Details
Operating income impacted by increased discounts:During Q3FY17, BC Iron Ltd (ASX: BCI) reported an EBITDA of A$4.1M from Iron Valley, impacted by declining iron ore prices and lower lump premiums. While the headline CFR 62% Fe iron ore price was high during the quarter, BC Iron’s Iron Valley EBITDA was impacted by a decline in the price premium for lump ore and an increase in quality discounts for 58-60% Fe products. In addition, March quarter shipments are largely priced on forecast June 2017 quarter iron ore prices, which are assumed to be lower than actual prices in the March quarter. Based on the current iron ore price outlook and performance till date, BC Iron’s FY17 Iron Valley EBITDA guidance remains unchanged at A$18-25M. During the quarter, BC Iron also earned its first 15% interest in the Carnegie project by contributing its mobile exploration camp facilities and the first $0.5M in expenditure towards a scoping study and related activities. Although the stock has declined by 46% over the last three months as on April 28, 2017, given the challenging environment for iron ore prices, we give a “Hold” recommendation on the stock at the current price of $ 0.13
 

BCI Daily Chart (Source: Thomson Reuters) 

Atlas Iron Ltd

AGO Details
Q3FY17 shipments impacted by weather and Wodgina:For Q3FY17, Atlas Iron Ltd (ASX: AGO) reported net operating cashflow of $22m after inventory build, interest, contractor profit share and realized hedge impact. Company shipments declined to 3.2m wmt at average realized price (inclusive of low?grade Value Fines product and realised hedge impacts) of $62/wmt CFR due to weather impacts and decline at Wodgina. C1 Operating cost stood at $36/wmt while full cash cost stood at $56/wmt CFR. While the company reduced its debt to A$112m, cash on balance sheet stands at A$108m. Further in Q3FY17, company sold its 51% stake in Cisco lithium prospect to Pilbara Minerals for $2.3m and entered MoU to provide logistics services to Pilbara Minerals. Atlas will pay a further $8 million off its debt later this month as well as set aside A$20m to help fund the company’s next mine, Corunna Downs.
 

Q3FY17 Operations Summary (Source: Company Reports)
 
AGO stock has declined by 40.7% over the last one month (as at April 28, 2017) and slipped over 6.3% on May 01, 2017, given the performance and down turn in commodity prices. We give an “Expensive” recommendation on the stock at the current price of $ 0.015
 

AGO Daily Chart (Source: Thomson Reuters)

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