Key Variables: Why Pressure on Iron Ore Prices Could Persist
(Continued from Prior Part)
China’s CFR 62% iron ore prices
China’s CFR (or cost and freight) 62% (iron content) iron ore prices—the benchmark—are down by 11.6% year-to-date. While a strong supply side and weaker demand growth scenario had pushed iron ore prices to a ten-year low in early April, disruption in shipments resulting in tighter stocks at ports led to improvement in prices since then.
Investors may want to know which iron ore players are doing better than others and why. We’ll answer that question now.
The YTD performance of iron ore companies
The above chart shows the year-to-date (or YTD) performance of iron ore as well as major iron ore stocks. BHP Billiton (BHP) (BLT) is doing the best among all the iron ore companies, rising 3.6% YTD. Rio Tinto (RIO) fell just 3.4%, and Vale SA (VALE) fell 18.9%.
The pure plays and mid-caps like Fortescue Metals Group (FSUGY) and Cliffs Natural Resources (CLF) were down 22.9% and 30.9%, respectively.
Companies’ performance
BHP Billiton and Rio Tinto have reduced their per-unit costs significantly over 2014 and 1Q15. This is helping them remain profitable, even under the depressed iron ore price environment. BHP’s stock was battered in the second half of 2014 due to falling crude oil prices as well. Stabilization in crude oil prices has also helped BHP’s stock price.
On the other hand, Vale still has a long way to go with the S11D project. This project will lower the overall production cost for the company. However, Vale needs funding to complete it. Its cash flow requirement, along with the greater distance to Asia compared with BHP and RIO, is the primary reason for its relative underperformance.
For pure plays and smaller players like FMG and CLF, the margin cushion left is too low at the current levels, making them much more sensitive to iron ore prices. CLF has a company-specific issue of high debt, which is leading to a fall in its stock price.
Exchanges-traded funds (or ETFs), such as the SPDR S&P Metals and Mining ETF (XME), are good ways of getting exposure to this sector without picking individual companies. CLF forms 4.2% of XME’s holdings.
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