Mining: Sun still shining on iron ore
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 17 February 2021, 12:00 PM
- Sectors Covered:
- Mining, Energy
- Iron ore markets remain supported by a combination of demand/supply factors, with
consensus remaining in catch-up mode with steady upgrade expectations.
- Stimulus has effectively buoyed China’s economy post COVID-19 fallout, but
should ease during 2021 as domestic consumption picks up.
- Vale has been purposefully conservative with its 2021 shipments guidance, leaving
the door open for additional supply vs expectations.
- The chasm between spot and consensus iron ore prices is fuelling a sustained
upgrade cycle.
- We have upgraded our iron ore forecasts for the next three years.
- While trading near our revised targets, we see robust earnings and dividends as
increasingly important in the current global climate.
Earnings power not going anywhere in a hurry
Supply and demand factors continue to support iron ore, although these conditions are
likely to moderate over the year.
China has supported its economy post COVID-19 through
stimulating fixed asset investment (FAI) (an old favourite in terms of growth lever).
This has
proven effective, but as 2021 progresses and the recovery advances, we expect the pace
of FAI stimulation to back off and give way to improving domestic consumption.
Further
pressure from reduced liquidity and limited steel mill profitability, combined with
government plans for a leaner (and smaller) steel industry, could also contribute to a
flattening of steel production following record output in 2020 of 1,053mt (+5.2%).
Supply supportive but could also slow
Meanwhile, bullish supply factors also contributing to iron ore market tightness, namely the
inability of Brazilian major Vale SA to return to full production, could remain in place during
2021.
Although we do expect Vale’s 2021 guidance of 310-335mt may be conservative
given the low end is already in line with the level of production Vale exited 2020.
When it
set the low 2021 guidance, Vale did comment that it was being purposefully conservative
with guidance given significant risks from wet weather and government restrictions.
Ultimately, net of the above factors, we see spot iron ore prices as likely to remain at robust
levels during 2021, albeit likely peaking in the first half.
Another upgrade to iron ore
Given the magnitude of current spot market strength, iron ore remains supported by a solid
upgrade cycle.
Given the ongoing strength, we have upgraded as follows: 1Q21 US$143/t
(was US$115/t), 2Q21 US$131/t (was US$110/t), 3Q21 US$114/t (was US$100/t), 4Q21
US$108/t (was US$90/t), 1Q22 US$103/t (was US$90/t), 2Q22 US$99/t (was US$85/t),
3Q22 US$95/t (was US$80/t), 4Q22 US$92/t (was US$80/t).
Robust spot fundamentals have a place in the portfolio
The global fallout from COVID-19 has seen diminished earnings power across several key
sectors.
This has led investors to look ahead and make assumptions about the possible
pace and trajectory of earnings recovery for these sectors, pushing market implied
valuations higher.
Against this backdrop, we view the importance of having exposure to
companies that currently have robust peak-cycle earnings has heightened, and supplying
a nice portfolio complement.
This earnings strength also translates into attractive dividend
profiles across our big miners (BHP 6.5%, RIO 8.8% and FMG 13% over the next year).
All of the above factors combine to see us maintain a preference for the superior
diversification of BHP, with strong base metal prices and recovering energy and coal prices
providing a potentially nice balance against peaking iron ore.
Investment view
All three large iron ore miners are trading close to or just above our target prices on a Total
Stock Return basis, but we believe there are plenty of reasons to hold a position in each.
We maintain Hold ratings on all three miners.
We view BHP Group (ASX:BHP) as offering an attractive
combination of superior diversification, mix of peaking and recovering commodities, and
solid underlying fundamentals.
Rio Tinto (ASX:RIO) meanwhile is better suited to those investors seeking
a larger iron ore exposure from a low risk franchise.
Fortescue Metals Group (ASX:FMG) meanwhile is supported by a
13% yield and exceptional earnings momentum, better suited to more active investors
capable of tolerating higher levels of risk and volatility.
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Disclaimer: Analyst may own shares. The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.