Should You Be Worried If You Own Shares of These Iron Ore Producers?

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At first glance, fresh news from China doesn't look great for iron ore producers like Cliffs Natural Resources (NYSE: CLF  ) , Vale (NYSE: VALE  ) , Rio Tinto (NYSE: RIO  ) and BHP Billiton (NYSE: BHP  ) . The country, which is the main driving force for iron ore demand, slowed down its growth to 7.7% in the fourth quarter of 2013. What's more, China's steel output dropped for the third consecutive month in December. Is it time to get worried if you are a shareholder of these companies?

Cliffs and Vale are more sensitive to price changes
As Cliffs produces both iron ore and met coal, the company is totally dependent on the demand for steel. However, Cliffs' U.S. and Canadian production is mostly supplied to domestic customers. Only iron ore that is produced in Australia is supplied to Asian customers.

Vale has been selling non-core assets and focusing its business on iron ore production. As a result, its ferrous minerals segment brought 73.4% of revenue in the third quarter, up from 69% in the second quarter. Vale's main customers are in China, Japan, and Brazil, so the situation with iron ore prices in China is extremely important for the company.

Vale's CEO Murillo Ferreira has recently commented that the decline in iron ore prices in China is temporary and prices should rebound. However, if China's steel output continues to decline, Mr. Ferreira's forecast will not turn into reality.

Iron ore production will continue to grow
Big miners are growing their iron ore production, and this supply needs constantly rising demand. Otherwise, the prices will fall further. BHP Billiton has recently reported its fourth quarter production numbers. They showed that while iron ore production was flat compared to the third quarter, it rose as much as 16% compared to the fourth quarter of 2012.

Rio Tinto's fourth quarter production update showed a similar trend. Rio Tinto grew its production by 3% consecutively and by 6% compared to the fourth quarter of 2012. What's more, Rio Tinto expects that the Pilbara mine production capacity will increase by more than 60 million tons of iron ore between 2014 and 2017. Again, this means more iron ore will be at the market and this iron ore will need customers.

However, both Rio Tinto and BHP Billiton are less vulnerable to the situation with iron ore prices in China as they are well-diversified miners.

What to watch for?
China is the key. The country will probably aim for a 7.5% growth in 2014. Even if this or a similar growth target is met, it doesn't necessarily imply the same rate of growth for steel output. Lower steel output will certainly lead to lower iron ore prices. In this case, Vale's strategy of shifting its focus to iron ore production will become dubious.

Another risk is that Chinese economy could become less steel-intensive as the country shifts its focus from export-oriented industries to those that satisfy domestic demand. Together with the fact that iron ore production will continue to grow this will put additional pressure on prices.

In these circumstances, BHP Billiton and Rio Tinto look to be safer investments than Vale and Cliffs.

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Read/Post Comments (2) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 23, 2014, at 2:41 PM, allrightallready wrote:

    Vladimir: What advice should I follow?

    Your advice today or the insight that you gave on VALE on November 12, 2013.

    I "guess" POSSIBLE, MAYBE, PERHAPS steel production dropoff in China was not a possibility last November.

    Are you shilling for traders?

  • Report this Comment On January 26, 2014, at 8:53 PM, BrianSanders wrote:

    Disagree entirely. Sentiment is very poor for these companies. VALE is actually the most attractive out of the group. I could back it with numerous facts but i'll give the overview points:

    forward p/e

    price to book

    expansion projects

    cyclical company

    after digesting will see there is a HUGE margin of safety - the lower this goes, the cheaper and more attractive it is.

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Vladimir Zernov

Vladimir Zernov believes that fundamental analysis works best with energy and materials stocks and covers them on Motley Fool.

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