Mt Gibson Our key pick for leverage to higher iron ore...

Mt Gibson Our key pick for leverage to higher iron ore prices;
Buy MGX PT $2.30 (Price: $1.65; Diluted Market Cap $1.8b).
With spot iron ore prices hovering ~90% higher than last years contract prices, it is looking more likely that JFY10 contract prices will settle significantly higher than the 30-40% increase on JFY09 prices that the market appears to be factoring in.
Iron ore prices US$/t
Source: Bloomberg, ABARE, FSB research
We are also of the view that with a growing spot iron ore market, spot prices will have greater influence on settling contract prices with traditional customers. Historically, the iron ore spot market has been only a small proportion of internationally traded iron ore as BHP, RIO and Vale all settled term contracts for the bulk of their production. Therefore, references to spot prices when negotiating contract prices had limited merit.
However, we believe Chinas decision last year to purchase the majority of its iron ore on spot terms dramatically increased the prevalence, liquidity and therefore, relevance of the spot market. It is estimated the spot market now accounts for more than half the seaborne traded iron ore versus less than 10% ten years ago.
The increasing relevance of China in seaborne traded iron ore is best demonstrated in the graph displayed below which shows the spectacular increase in Australias iron ore exports to China versus Australias more traditional markets of Japan and South Korea.
The trend in Chinas voracious iron ore appetite is continuing with Chinese iron ore imports increasing 42% in 2009 to 628mt. This accounts for ~70% of the total estimated seaborne traded iron ore in 2009 of 900mt.
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Iron ore spot prices -cif China
FOB Pilbara contract + US$20
Value of Australian iron ore exports 1998-89 vs 2008-09
Source: ABARE
Mt Gibson (MGX) is our key pick for investors to obtain leverage to higher iron ore
prices. MGX sold 3.4mt of iron ore in 1HFY10 from its Tallering Peak and Koolan Island
operations and recently announced a 1HFY10 NPAT of $39.4m based on sales revenues
of $242m, which equates to $71.70/t.
However, if JFY10 contract prices are settled 60% higher than JFY09 prices, we estimate
MGX revenues and earnings to increase to $859m and $267m in FY11, which equates to
a P/E of 6.6x based on the current share price. We have not assumed any sales from
Extension Hill in FY11 in this analysis.
MGX Key Financials A$m
FY ending June 30
2010e 2011e 2012e
Assumptions
Hamersley fines price USc/d mtu 111.55 155.20 155.20
AUD/USD
0.86 0.85 0.85
Iron ore sales kt 6,912 7,800 9,300
Financials
Revenue A$ m 569.8 858.7 1026.8
EBITDA A$m 412.5 624.7 747.8
NPAT A$m 100.9 267.2 320.1
P/E x 17.6 6.6 5.5
EV/EBITDA x 3.6 1.7 1.4
Source: FSB research
Our one-year forward DCF based valuation of MGX is $2.27/share based on the
assumptions shown in the table above and a long term fines price ofUSc93/dmtu. If we
apply a P/E multiple of 10x to FY11 earnings, we arrive at a share price of $2.48/share.
Also worth noting is MGXs announcement on 12 January 2010 to recommence the
Extension Hill project which is expected to add ~3mtpa to production by FY12 and cost
$80m to complete. With net cash of $118m as at 31 December 2009, the company is in a
healthy position to finish the project without needing to tap capital markets.
Given MGXs steady production profile, clear growth path and pure exposure to iron
ore, we view MGX as the best exposure to higher iron ore prices in JFY10 and beyond.
We have derived a price target of $2.30/share based on our one-year forward DCF
based valuation.
Recommendation. BUY MGX, (Price: $1.65; PT $2.30/share, Diluted Mkt Cap. $1.8b)
Recently released Talking Points are now available on our website:http://www.fostock.com.au/talkingpoint.htm