Iron
ore prices have strengthened as concerns mount regarding supply from
Brazil, where there has been a surge in the number of cases of
coronavirus in the country’s key mining region.
This
is a further aggravation for Brazil’s Vale, the world’s largest iron ore
miner, which has been plagued with output problems since the fatal
tailings dam disaster in early 2019 that provoked the closure of several
mines.
Meanwhile, steel production has been resilient in China, supporting iron
ore prices, and there are high expectations that there will be further
stimulus for infrastructure to boost demand. So, does this scenario
herald an opportunity for Australia’s iron ore miners, which have
sustained better-than-expected production over the wet season amid
strong shipments?
Not
necessarily. ANZ analysts suggest the recent rally in iron ore is
stretched and there is the likelihood of downside risks developing in
the market, despite the prospect of up to 80mt of supply being at risk.
Global
steel demand is expected to fall sharply, as there is only so much heavy
lifting China can do for the market and, once the pandemic has passed,
the market will face rising exports from both Brazil and Australia.
Vale
was never expected to return to full capacity until 2021, the analysts
point out, and while Brazil’s iron ore industry has been largely spared
as activities were considered essential, in recent days there is been a
sudden spike in coronavirus cases in the state of Para, where around 29%
of the country’s iron ore is produced.
Morgan
Stanley also notes the northern mining and port system in Brazil remains
the most exposed to the pandemic and the expected recovery in Brazilian
shipments subsequent to the usual seasonal disruptions is yet to
eventuate.
Current annualized shipments are 200-250mt, well below Vale’s production
guidance of 310-330mt. Morgan Stanley expects a largely balanced market
over 2020, noting, with stimulus from China anticipated, sentiment has
turned significantly positive on iron ore despite poor steel production
elsewhere.
China Stimulus
Yet,
the ANZ analysts suspect steel mills have kept production high in the
hope that demand picks up, and the market will be very disappointed if
no stimulus does not ensue from China’s annual party meeting.
The
other major steel producer, Japan, is therefore critical, and its
government estimates second quarter steel output will be down -26%, to
the lowest level since 2009. This would leave China is the only active
buyer of iron ore.
Macquarie’s analysts are looking for a large lift in China’s economic
stimulus but believe the party meeting will not be the forum that
delivers a policy shift. Stimulus will likely be rolled out when the
economy reports a “double-dip”, probably late 2020.
Therefore, in the broker’s view, central government policy will not
drive key commodity markets until the 2021 restocking. Still, JPMorgan
points out China is very dependent on the import market for iron ore and
is only 23% self-sufficient.
Macquarie notes the latest China’s steel survey shows a large lift in
sales and orders and even orders in the struggling automotive sector
have stopped deteriorating. Moreover, mills have revealed a normalising
of utilisation rates, and buying demand for iron ore is stronger than
for coking coal.
Another fact. Iron ore inventory on vessels outside of the key iron ore
ports in northern China has dropped by -1mt over the latest week and, as
UBS points out, inventory at the ports overall is down -2mt, which
implies a tight iron ore market.
Australian Iron Ore
Iron
ore prices are the main driver of iron ore stocks and two key risks for
the short term are moderating, including higher iron ore supply from
Brazil and production curtailments outside of China.
UBS
prefers the less leveraged stocks and retains a Buy rating on BHP Group
(BHP).
Macquarie retains a positive view for iron ore miners, assessing leading
indicators such as increasing steel margins and declining port stocks
underpin the outlook. The broker notes those with iron ore exposure have
strong cash flow yields and earnings upgrade momentum for the medium
term.
In the
small stocks, Champion Iron (CIA) and Mount Gibson Iron (MGX) both look
attractive to the broker in terms of cash flow. Mount Gibson has been
the only Australian producer to withdraw guidance, while Mineral
Resources (MIN) has downgraded Koolyanobbing but upgraded Iron Valley.
Both
BHP Group and Rio Tinto (RIO) have reiterated guidance while Fortescue
Metals (FMG) upgraded shipment guidance in the March quarterly report.
Still, Macquarie acknowledges Rio Tinto’s shipments have been volatile
and the smaller Australian ports have sustained weaker shipments, while
the major miners are operating close to capacity.
Morgans believes Fortescue Metals will be the main beneficiary of the
strong conditions, as a mass-scale low-grade producer, even in the
downside scenario of broader trade and geopolitical instability and
upgrades to Hold from Reduce.
The
broker assesses China will support Fortescue Metals, even with trade
tensions between China and Australia, given its market position as a
decentralising force against the dominance of Rio Tinto, Vale and BHP
Group.
Macquarie points out 63% of China’s iron ore imports come from Australia
and there are few viable alternatives.
Morgan
Stanley assesses Fortescue Metals and Rio Tinto valuations imply the
lowest iron ore price at around US$80/t because of their pure exposure.
BHP Group and Mineral Resources, on the other hand, are both “optically”
implying higher prices because of other commodity exposures that are
continuing to be affected by low prices.
Source: Eva Brocklehurst |