Strong Support For Iron Ore Prevails

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As the pandemic cuts a swathe through Brazil, analysts are anticipating strong support for the iron ore price will prevail, and the focus is on China's stimulus expenditure.

-Second half surplus unlikely to be enough to reduce price substantially
-Vale production guidance likely to be a challenge
-Easing restrictions in South Africa and India required to alleviate any tightness
 

By Eva Brocklehurst

Iron ore continues to provoke and excite speculation as industrial activity re-emerges from the pandemic-related shutdowns. Iron ore prices have cut through US$100/t, supported by resilient demand from China and reduced Brazilian exports, amid a lack of alternative marginal supply.

China accounts for around 70% of seaborne demand and its quick recovery from the pandemic has boosted expectations. A return to pre-pandemic output is not considered likely in the short term but a modest recovery could be expected.

UBS notes Chinese steel mills have opted to keep production running, despite an abrupt slowing in downstream demand as a result of restrictions on mobility. Actual forecast heights for steel stocks were never reached and inventory has been in decline since restrictions started to lift, so the broker prefers to focus on the trajectory rather than absolute levels. A "slim" surplus in 2020 is expected and prices should trend lower as long as Brazil is able to increase exports.

Still, Credit Suisse points out China's blast furnaces are at capacity of over 91% and demand is unlikely to lift further. True, South African and Peruvian mines are expected to recover and a move to surplus should mean the iron ore price eases, but robust prices above US$75/t (a US$75-95/t range) are likely for the next 12 months.

Goldman Sachs anticipates 2020 will be much like 2019, with a big first-half deficit in iron ore followed by a second-half surplus. Hence, the broker upgrades iron ore benchmark forecasts to US$86/t for 2020 and US$80/t for 2021 and expects Vale will sell 311mt of iron ore and China's steel production will peak mid year.

Iron ore will move to a surplus in the second half of 2020, despite the outbreak of coronavirus in Vale operations, Credit Suisse asserts, and any serious softening of the iron ore price will need substantially increased supply. Australian shipments are already running strongly so there is little upside from that quarter.

JPMorgan upgrades steel production forecasts in China to growth of 1.2% from a contraction of -1.5% based on better-than-expected April output, which was up 0.2%. There is also an encouraging recovery in demand as port inventory throughout May was drawn down. Hence, marking to market in 2020 and factoring in stronger Chinese demand, 2020 and 2021 forecasts are lifted to US$91/t and US$80/t, respectively.

Brazil

Brazil is the pivot point for supply and in the year to date exports are down -12%. Supply was mixed throughout May and did pick up over the last couple of weeks. Yet, Vale is facing a difficult time lifting its run rate, given heavy rain in the first quarter. JPMorgan suspects this may also relate to indirect impacts from the pandemic, such as longer maintenance periods and difficulties in procuring equipment, envisaging downside risks to Vale's 310-330mt production guidance.

Morgan Stanley does not believe Vale will lower its 2020 production guidance but agrees it could be challenging to deliver because of likely delays in the required approvals to re-start operations, and the impact of the pandemic could be greater than the guidance reflects. Total cases in Brazil have risen 40% week on week and the outbreak in that country remains in the early stages.

Reported cases around the Vale south-eastern system continue to increase while the northern system remains still the most exposed area. Nevertheless, mining is continuing in Brazil and, while absenteeism may take a toll, shipments should start to increase as the wet season ends. Brazilian cargo in transit has already lifted by 600,000t/week.

UBS anticipates a strong recovery in iron ore production from Vale will be required to bring production in line with guidance, and easing restrictions in South Africa and India will also be needed to alleviate any tightness in iron ore supply.

Australia

Goldman Sachs upgrades estimates for the major iron ore stocks, maintaining a Buy rating for both BHP Group ((BHP))and Rio Tinto ((RIO)), forecasting an average free cash flow yield of 7-9% for the two over the next three years. The broker, not one of the seven brokers monitored daily on the FNArena database, maintains a Neutral rating for Fortescue Metals ((FMG)) given its valuation.

All up, JPMorgan is positive about iron ore miners in Australia and also finds more valuation support in BHP and Rio compared with Fortescue. Still, Fortescue provides a higher free cash flow/dividend yield over coming years and a lower enterprise value/EBITDA (operating earnings) multiple. Hence, JPMorgan, also not one of the seven, has an Overweight rating on all three.

The FNArena database has seven Buy ratings for BHP Group while Rio Tinto is more mixed, with three Buy, three Hold and one Sell (Credit Suisse). Fortescue Metals has three Buy ratings, three Hold and one Sell (Citi).

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