Grange Resources To Benefit From Iron Ore Pellet Premium

This story features GRANGE RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: GRR

By Chris Shaw

From the second half of 2009 the outlook for iron ore prices has improved, to the extent spot iron ore fine prices are now at a 90% premium to 2009 benchmark prices.

Foster Stockbroking notes market analysts are now forecasting a 30-40% increase in lump benchmark prices for Japanese financial year 2010 (some have recently moved to 60% and higher), with price risk to the upside in its view given the strength in spot markets.

Not all iron ore is the same as Foster notes pellets typically trade at a premium to lump and fine ore given a higher iron content. As an example, the stockbroker notes the Tubarao blast furnace of Brazilian group Vale produces pellets at an average grade of 66-68%, against an average grade in the low 60s for fines from Rio Tinto's Hamersley mine.

This premium has been in place for some time, Foster pointing out over the past 17 years the premium for pellets has moved between 4c to 36c per dry metric tonne unit (DMTU). The premium tends to be greater in bull markets for iron ore and weaker during bear markets, so the current stronger market suggests the premium could expand this year.

Patersons Securities agrees, taking the view the historical 50% premium of pellets over fines prices will return in 2010.

The logical beneficiary of stronger pellet prices in Australia is Grange Resources ((GRR)), which is Australia's only producer of pellets via its 100%-owned Savage River mine in Tasmania.

Major customers for the output from Savage River include BlueScope Steel ((BSL)), trading house Stemcor and Shagang, china's largest private steel producer. Shagang is the largest shareholder in Grange with a stake of 45%.

Grange currently produces 2.5 million tonnes annually from the mine, with a view to lifting this to 2.7 million tonnes annually in coming years.

As well as scope for increased production, Grange is seen as attractive as it offers potential for cost improvements, Foster Stockbroking noting costs are likely to move lower at Savage River once current pre-stripping is completed.

The stockbroker estimates current costs of around US$71 per tonne at present, meaning little margin given a benchmark price of around US$78 per tonne. But with costs likely to fall to around US$60 per tonne once the pre-strip is completed margins should improve, especially given the stockbroker assumes the benchmark price could jump 50% to US$117 per tonne in Japanese financial year 2010.

This supports expectations of solid earnings growth for the company, Foster forecasting EBIT (earnings before interest and tax) of $8 million this year, increasing to $127 million in FY11 and $254 million in FY12.

In net profit terms this equates to $69 million in FY11 and $106 million in FY12, which Foster suggests puts the stock on respective earnings multiples of 5.9 times and 3.8 times. One reason earnings could jump so significantly is Grange's leverage to pellet prices. On Petra Capital's estimates, a 10% increase would lift its valuation on the stock by 23%. Petra Capital currently values Grange at $0.61.

Patersons is a little more conservative with its earnings estimates than is Foster Stockbroking, forecasting net profit of $39.8 million in FY11 and $77.7 million in FY12.

Aside from earnings there is exploration upside, Patersons pointing out in the last quarter Grange reported the discovery of additional magnetite lenses of around three million tonnes. These are expected to increase the mine life at Savage River and lower operating costs over the next two to three years.

Further exploration is expected and any success would further extend the mine life, Foster noting a profile for Savage River at present is of a resource of 316 million tonnes and a mine life through 2023.

Grange is not a one project company as it also owns a 70% interest in the Southdown magnetite project in Western Australia. Foster notes Southdown has current resources of 654 million tonnes at 25% Fe, with 388 million tonnes booked as reserves. Patersons values the resource at $0.40 in situ.

First production at Southdown is currently scheduled for 2013, with annual output of 6.6 million tonnes at a cost estimated in 2008 to be around US$55 per tonne. Foster notes Shagang could provide some of the funding needed to develop Southdown in return for a production offtake agreement.

Given the potential offered by Grange, both Foster Stockbroking and Patersons Securities are positive on the stock, rating it as a Buy at current levels. Foster has a price target of $0.43 against a valuation of $0.34, while Patersons has a target of $0.70.

At current levels Grange has a market capitalisation of around $415 million, meaning the stock remains too small to come on the radar screen of many analysts. This is evidenced by the FNArena database showing none of the 10 major brokers and research houses covering the stock.

Shares in Grange today are stronger and as at 1.00pm the stock was up 3c at $0.52, which compares to a range over the past year of $0.235 to $0.855.

 

 

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