Iron ore miners are the new cash machines

Investors are scrambling to grab their share of the potential cash flow and dividend bonanza from soaring iron ore prices.

Robert GuySenior Writer

Dec 7, 2020 – 5.20pm

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Fortescue Metals Group chief executive Elizabeth Gaines could be forgiven for entertaining a hint of schadenfreude as she fronts the iron ore miner’s investor day on Wednesday.

The rip in the iron ore price to a hefty $US145 a tonne thanks to a production downgrade by Brazil’s Vale is a welcome gift given Fortescue is scheduled to produce the first ore from its $US1.27 billion ($1.71 billion) Eliwana mine this month.

Her Pilbara rivals won’t lament Vale’s misfortunes either, as BHP pushes to deliver first ore from its $US2.9 billion investment in the South Flank mine next year and Rio Tinto eyes first ore from its $US2.6 billion Koodaideri mine in early 2022.

Iron ore prices have boomed on demand from China's steel mills. Bloomberg

The three miners have bet big licks of shareholder dollars replenishing their asset bases to feed the maw of China’s growth machine, a well-calculated wager given the latest economic data from the world’s largest commodities buyer.

China’s year-on-year export growth of 21 per cent in November obliterated expectations for 12 per cent growth, a surge that reflects the strength of the rebound in manufacturing as the global economy reopens and Beijing revs up growth through fiscal and monetary stimulus.

RELATED QUOTES

FMGFortescue Metals Group

$21.390 3.78%

1 year1 day

Dec 19Jun 20Dec 207.00014.00021.000

Updated: Dec 7, 2020 – 9.19pm. Data is 20 mins delayed.

View FMG related articles

BHPBHP Billiton

$42.390 2.14%

Dec 19Jun 20Dec 2025.00035.00045.000

RIORio Tinto

$115.98 2.46%

Dec 19Jun 20Dec 2076.0095.00114.00

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While import growth fell shy of consensus expectations – imports climbed 4.5 per cent compared with forecasts for 7 per cent – the 10.9 per cent increase in year-to-date iron ore imports showcased the boost from China’s infrastructure-led recovery.

A word of caution though. Iron ore imports fell for a second straight month to 98.2 million tonnes – a still hefty number compared to 85.9 million tonnes in March.

Over the next few months, Chinese steel mill margins may determine their willingness to keep buying. Meanwhile, supply will depend on the vagaries of the wet season in Australia’s north-west.

Cash runs free

The ongoing demand is a blessing for Australia at a time when it’s in the diplomatic deep-freeze with its largest trading “partner”, one that’s proved to be ruthless in its willingness to target wine, barley, beef and coal as part of a campaign, unsuccessful so far, to bring Canberra to heel.

Treasurer Josh Frydenberg probably can’t believe his luck that iron ore is trading the best part of $US80 a tonne above the $US55 a tonne (before freight costs) that’s he’s got pencilled into his budget forecasts.

The cost to ship a tonne of iron ore from Western Australia to the Chinese port of Qingdao is around $US7 a tonne, according to shipbroker Simpson Spence Young.

The surge in the shares of iron ore miners testifies to the cash flow boost that awaits them as they run their mines, rail and ports at full throttle to satisfy the demand of China’s steel mills that have produced in excess of 1 billion tonnes of steel this year.

Macquarie estimates the big three are trading on free cash flow yields in the mid-teen per cent based on spot prices.

Thus, the strong share prices. Fortescue closed at a record high and Rio Tinto ended Monday’s session at its highest since May 2008. BHP enjoyed its best close since May 2011.

The current iron ore price offers plenty of leeway over the capital intensity – or cost per tonne of new capacity – of the three miner’s big projects.

The capital intensity of Fortescue’s Eliwana project was $US42 a tonne, while BHP is set to deliver 80 million tonnes from South Flank at a capital intensity of $US45 a tonne. Rio Tinto is paying around $US60 a tonne for its future production from Koodaideri.

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The commodity and currency price sensitivities included in BHP’s full-year results presentation highlight the potential earnings boost from robust iron ore prices.

Back in August, the miner estimated that every $US1 a tonne change in the iron ore price would produce at $US233 million impact on earnings before interest, tax, depreciation and amortisation.

Combined with a forecast $US4 a tonne of sustaining capex in its Western Australian iron ore operations, it’s little wonder that investors are rushing into BHP given the potential cash bonanza it will enjoy.

It’s the same story for Rio Tinto and Fortescue as income hungry investors scramble to get their share of a potential cash flow windfall even amid the most strained relations with China in decades.