Peter Kerr and W McInnes hiting a home run with an inciteful piece on our dividend windfall. My comments on the way through.

Iron ore fuels $65b dividend windfall

William McInnesandPeter Ker

May 11, 2021 – 7.00pm

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Investors will share in a $65 billion windfall in shareholder returns from the big three iron ore miners, with dividend forecasts for BHP Group, Rio Tinto and Fortescue Metals Group upgraded by analysts after prices soared by more than 20 per cent in a week.

In a sign that the market expects demand and prices to remain strong for some time – and that tax revenue and dividends will continue to be pumped into the rebounding economy – a new generation of small producers is looking to move previously uneconomic mines into production.

Totally agree with this- roll on.

The global benchmark for spot market traded iron ore, S&P Global Platts’ IODEX 62 per cent iron ore index, rose $US16.80 or 7.9 per cent to a record high $US229.55 a tonne on Monday, and is up more than 23 per cent in the past week.

A global push for major infrastructure projects to help in the economic recovery has driven demand for steel, triggering record high steel margins and meaning producers are willing to pay top dollar for raw products such as iron ore.

Very accurate analysis here.

BHP and Rio are on track to return 95¢ of every dollar of profit they make in financial 2021, according to broker Citi, as profitability far outstrips levels reached during the last super cycle. Citi estimates that together with Fortescue, they will pay out a combined $US51 billion in their respective 2021 financial years. Most of that will flow to non-Australian investors.

It is speculated that some of this week’s historic rally is the result of steelmakers hoarding materials in advance of possible restrictions on output in mainland China to comply with environmental obligations.

ANZ senior commodity strategist Daniel Hynes said: “Sentiment has been boosted in recent weeks by strong economic data. The housing and construction sectors have been strong, while steel demand outside of China is also picking up.

“Steel mills are clamouring to secure cargoes of the steel making raw materials and boost output of steel in anticipation of further constraints.”

Again correct- steel mills are acting to preempt any restrictions.

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While the iron ore price is expected to remain high for at least the next few months, prices on the Singapore futures exchange tracking contracts were quick to retreat from their highs on Tuesday, suggesting the market may be stretched at current levels.

ING head of commodities strategy Warren Patterson said: “Most market participants believe the surge was a speculative move. Optimism that central banks will retain supportive policies, and that steel production in China will remain robust despite the ongoing production curbs, continues to prove constructive for the iron ore market.

“In addition, the suspension of economic dialogue between China and Australia has heightened the risks of supply and contributed to the recent surge in iron ore prices, given China’s huge dependency on iron ore imports from Australia.”

The leap in demand has naturally created huge margins for the major iron ore miners, which are enjoying the strongest prices ever.

Huge margins- totally agree.

Iron ore has surged 20 per cent above the 2011 record high over the past fortnight and those riches are dragging Australia’s biggest exporter, Rio, into a net cash position just 13 years after it was crippled with debt on the back of the disastrous $US38 billion Alcan acquisition.

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Shareholder returns from Rio, BHP and Fortescue will be far more generous than in 2011, when the miners had big plans to spend on growth and were carrying much bigger debt loads.

Citi analyst Paul McTaggart said BHP and Rio were likely to have payout ratios of 95 per cent at their full-year results in August and February 2022, respectively.

“They’re going to finish this year with something like $US8 billion of net cash on the balance sheet, so it’s hard to imagine they are not going to have a massive payout ratio, they’ve got too much money,” he said of Rio.

Citi expects the benchmark iron ore price will average $US174 a tonne over the 2021 calendar year. Even more conservative forecasts suggest the price will remain high: HSBC is forecasting iron ore to average $US162 a tonne over 2021, falling to $US135 a tonne in 2022.

Finally, Bell Potter estimates Fortescue is trading on a yield of 10 per cent after upgrading its next payout estimate to $2.57 a share from $2.41.

$2.57 divi is very good. Fantastic.

Projects back online

While the deployment of Chinese stimulus appears to be slowing, Mr McTaggart said the Chinese steel sector would likely be hungry for iron ore for some time yet.

“Historically, steel mills don’t drop production levels until they start to see their profitability come under pressure and meanwhile they will be running at high output levels, which might mean that iron ore stays high maybe for another 12 months,” he said.

High for 12 months- even better!

The surging price has meant a number of high-cost producers and projects are coming back online. Anglo American and Hong Kong’s Cheung Kong became the latest multinationals to flirt with the idea of building a new iron ore province in Australia’s mid-west.

HSBC’s Paul Bloxham. Louie Douvis

Even the small Australian miners that have entered the iron ore market within the past year, such as Fenix Resources and Nathan River Resources, would likely be viable at $US125 a tonne.

The windfall in iron ore prices has driven the Australian dollar to its highest level in more than two months. The Aussie climbed to a high of US78.9¢ on Monday evening, with a slight fall in base metal prices more than offset by the high iron ore price.

But even though the Aussie is being supported by fundamentals, the higher exchange rate won’t be welcomed by the Reserve Bank of Australia, which is keen to see a lower dollar support the economic recovery.

“I think the RBA, like most central banks, would like a lower currency because it would be helpful for their inflation mandate,” said Paul Bloxham, HSBC’s chief economist for Australia, New Zealand and global commodities.

“They’re already taking action which they say is putting pressure on the currency, including quantitative easing, the three-year yield target, a more one-eyed focus on the inflation market, and the currency is impacted by those.”

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But even if disappointed by the rising dollar, the Reserve Bank will have little reason to directly target a lower exchange rate. “They can’t argue it looks overvalued at the moment,” said Mr Bloxham, adding there was a case to be made the Aussie was not as high as it could be.

HSBC is expecting the Australian dollar will climb to US81¢ by the end of the year, its highest level in three years, driven by strong commodity prices.

Commonwealth Bank is also expecting the Australian dollar to climb higher through the second half of the year. “High commodity prices are the main reason we expect the Australian dollar to reach US80¢ by the end of the quarter,” said CBA head of international economics Joseph Capurso.

The stronger iron ore price is aiding in the economic recovery, with billions being added to the federal budget. “There’s a mechanism through which these higher commodity prices are boosting the economy, through tax revenues,” said Mr Bloxham. “There’s a clear positive channel through to domestic incomes at the moment.”

And good for the budget too!