update, page-7

The recent drop in CAP shares caused me to double check my reasons for holding CAP and I’m happy to say that I will continue to hold CAP. Here’s my analysis for those that may be interested.

The recent drop in iron ore has many iron ore producers a little worried. A good article in The Australian on 31 August 2012 clearly highlights how at current prices, the ebit margin for many producers is negative. http://www.theaustralian.com.au/business/markets/iron-ore-price-squeeze-more-dire-for-miners-than-thought/story-e6frg91x-1226462535319

Everything comes back to supply and demand. While demand from China may have dropped (possibly exaggerated if they are decreasing inventories) the drop in price will mean many producers will be unable to supply previous volumes profitably. You can only produce at a loss for so long before you need to stop. As mines close/reduce volumes, supply decreases and prices will return to sustainable levels. I have regularly heard that many Chinese mines are unprofitable at prices below US$110 or US$120. As supply and demand will dictate the long term price, the key is the cost of production.

So what is CAP’s cost of production and how does that compare.

Per slide 8 of presentation on 1 May 2012, estimated costs landed in China are US$63 – US$68. Recent announcements indicate that the costs may be expected this to decrease due to crushing options, but lets stick with the US$63-US$68.

Slide 8 of the presentation on 21-23 May has a great graph of the costs of iron production world wide and where CAP sits and remember that at 69% CAP would get a premium price so the position would be even better. Per The Australian article, given the lower grades in the Pibara at USS93/t for 62%Fe Rio and BHP get about US$77, being US$16 less than the 62% benchmark price that is regularly reported. As I understand it, CAP’s 69% would get a premium of about US$15/t.

Therefore, CAP would get a price premium of approximately US$30 over BHP and Rio. If that price premium is deducted from CAP’s cost in China of US$63-US$68 that gives a cost of US$33-US$38 which is very comparable to BHP’s ebit margin of US$34/t and RIO’s US$40/t. Effectively, CAP’s ebit margin would be similar to that of BHP and Rio which are often considered the lowest cost producers in the world.

The PFS uses a life of mine price of US$89 for 69% Fe and A$ to US$ of $0.85 which converts to around AU$105/t. Current price of 62% Fe is mid $80’s so 69% would be around US$100. If commodity prices remain at lower levels then AU$ is likely to drop meaning CAP would still get around the AU$105/t. If iron price comes back up a little and AU$ stays around parity then CAP would still get its AU$105/t. If iron prices come back to US$125 as predicted by UBS per The Australian article above, then there is a very favourable margin for CAP.

Therefore, in my opinion, the fundamentals for CAP remain sound at current prices and great at anything above current prices. As the fundamentals remain, then interest from JV parties will also remain. We just need to be patient and let the liquidator go through the process he is required to and obtain sufficient evidence of the “market value” of BMG’s 40% interest before selling the JV interest. Once the skeletons of the past are behind us, I think the future of CAP will progress at a much better rate.

Happy to hear others thoughts.