merrill lynch say prices to rise 30pc

Merrill Lynch report on iron ore to 2012. This is not the report on MMX but an industry report dated 27 April 2007.

QUOTE FROM MERRILL LYNCH IRON ORE REPORT:
“Long term iron ore price +30%: tighter market, higher costs
We have re-visited our IRR/Capex industry analysis on new and impending iron
ore projects, and as a result of higher capex, higher opex and tighter iron ore
market outlook, we have increased our long term iron ore price +30% to US$36/t
(63.5% Fe fines). Lump/pellet price % change forecasts are the same as fines.
Higher iron ore price forecast profile: JFY08 – JFY12
In addition to the substantial increase in our long term price, we have elevated the
iron ore price profile for the next 5 years. Due to both stronger global steel
demand outlook, and continued interruptions to supply response in iron ore, we
believe the inflection point in iron ore prices will be JFY2011 at earliest.

Earnings and valuations rise substantially
Our new iron ore price profile is significantly above market consensus, and in our
view the additional cashflow will drive higher valuations on leveraged stocks:
CVRD: NPAT 2008E +3%, 2009E +22%, 2010E +34%. NPV +31%
RIO Tinto: NPAT 2008E +2%, 2009E +16%, 2010E +26%. NPV +22%
BHP Billiton: NPAT FY2009E +5%, FY2010E +12%. NPV +9%
Kumba: NPAT 2008E +8%, 2009E +37%, 2010E +71%. NPV +74%”

Plus 3 initiations: all Buys with upside potential of 40-140%
We also initiate coverage on 3 new iron ore producers. MMX in Brazil (+42% to
PO), and Murchison (+140% to PO) and Mt Gibson (+90% to PO), both listed in
Australia. We expect these 3 companies to deliver significant growth in production
over the next 5 years which should translate to positive shareholder returns.
1. Iron ore stocks: what to own
This industry report analyses the short, medium and long term outlook for the iron
ore market. The major drivers for prices have been identified:
Supply / Demand fundamentals of global iron ore and steel markets to 2012
Iron ore Industry Structure
Expected IRR’s of planned new iron ore production expansions
In addition, we initiate coverage on 3 new iron ore stocks, MMX (Brazil),
Murchison (Australia) and Mt Gibson (Australia). There will be more to come.
The findings of this report have resulted in substantial upgrades to iron ore prices
from JFY08 – JFY12, and also in a 30% upgrade in our long term iron ore price in
2013 to US$36/t (nominal in 2013).
This in turn has resulted in significant upgrades to the earnings forecasts and
NPVs for iron ore leveraged stocks.
We have a BUY on all iron ore leveraged stocks in our coverage universe
except BHP Billiton. BHP Billiton has far less iron ore leverage than its iron ore
comps (<2x leverage of RIO) and in our view will trade in the short-term as a
nickel & copper play. We have some concerns about the level of nickel and
copper prices for the next quarter and would be re-looking at BHP when it trades
within 10% of NPV ($25-27/share).
Financial Comparisons for Iron Ore Stocks
The least expensive stocks vs NPV are Murchison and Mt Gibson. Of the
large caps the cheapest is CVRD.
The cheapest stocks on PER are the UK listings of BHP Billiton and Rio Tinto
on current years earnings, and Kumba and Mt Gibson on Yr+1.
Kumba has the most impressive dividend and FCF yield, yet looks the most
expensive on PCF.
Largest upside to price objective is Murchison followed by Mt Gibson.
2. Increasing Iron Ore Prices:
JFY08-JFY12 & longer term
We have increased our long term iron ore price by 30% to U57c/dmt fines
(US$36/t 63.5% Fe) in 2013 nominal terms, based on incentive price &
industry cost analysis
In our view, the inflection point for iron ore prices has been pushed out
until 2011. Our industry supply/demand analysis by producer and operation
and by regional demand now indicates that the iron ore market will remain in
deficit until at least 2011. Risk remains that supply response could be slower.
We are therefore also increasing our short and medium term iron ore price
forecasts.

Our new iron ore prices are substantially above consensus post 2009
and into long term. It is the extra cashflow that is generated by the gap in
these forecasts that is under-valuing the relevant stocks.
We are forecasting only an +8% price increase in JFY08 despite the market
being in tight deficit, as we believe there will be a “face saving” negotiation
from the Chinese consumers. China knows it is the major region of demand
growth (85% global iron ore demand growth in 2007E) and we believe it will
be important to them to continue to reduce the % increase in contract price.
For this reason we believe the JFY08E price will be < the 9.5%
increment negotiated in JFY07.
India’s role in the iron ore market remains unclear, following the national
government’s imposition of a US$7/tonne (8% of current spot price in China)
tariff to iron ore exports (as of 1 April). India is attempting to restrict iron ore
exports, preserving resources for the benefit of its own steel industry. India
delivers 90Mtpy of ore to China, so any significant cut in deliveries will be
bullish for medium-term prices.
The Indian spot rate is now only a very small premium over current CVRD
delivered ore given the recent ramp-up in freight rates. It is however a
US$25/t (27%) premium to Australian ore CIF China. Australian iron ore
is now >25% cheaper delivered into China than any other iron ore.”

The above is just a small part of the very informative and well researched 56 page paper on the future of iron ore. This is why Merrills have valued mmx at $5 - $13.20 with a high discount factor and conservative assumptions.