Who Will Benefit From Low Iron Ore Prices?

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Iron ore prices reached new yearly lows after an unexpected drop in February Chinese exports.  China is a key source of demand for iron ore, as the country leads in the production of steel. That's why any news pointing to the slowdown in economic activity in the country puts pressure on materials prices. As prices drift lower and lower, some producers will have to quit business. This will benefit those who are able to withstand the pressure, as they will gain market share and take advantage of rising prices.

Overdependence on iron ore revenue could be a weakness
As the iron ore market continues to be oversupplied, miners must be able to tolerate a period of prolonged downside in prices. Companies like Cliffs Natural Resources (NYSE: CLF  ) , which produces iron ore and met coal, experience the biggest pressure. Cliffs Natural Resources totally depends on demand from steel producers, as both iron ore and met coal are used to produce steel.

The company's stock has been a laggard this year, down 31%. Cash costs for Cliffs Natural Resources' Canadian operations remain elevated, at $110.03 per ton in the fourth quarter, which led to negative sales margins. If the company is not be able to achieve additional cost cuts, it will experience significant problems during the period of low prices.

Vale (NYSE: VALE  ) is a much bigger company than Cliffs Natural Resources, but it has recently focused its business on the iron ore production. Vale received 74.5% of its fourth quarter revenue from its ferrous minerals segment. However, Vale's costs are lower than Cliffs Natural Resources', and the company showed decent performance in the fourth quarter.

Financial strength is the key
The situation looks better for diversified miners like BHP Billiton (NYSE: BHP  ) and Rio Tinto (NYSE: RIO  ) , as their businesses are spread among multiple segments. What's more, BHP Billiton's and Rio Tinto's iron ore mines are situated in Australia, which positively affects their costs due to the weakness of the Australian dollar. Cliffs Natural Resources also has mines in Australia, but their production constitutes just 26.3% of total company sales.

No wonder both BHP Billiton and Rio Tinto outperformed Vale and Cliffs Natural Resources this year (although their shares are still down 3% and 5% respectively). These miners possess strong balance sheets that will help them withstand difficulties that arise as a result of low iron ore prices. However, BHP Billiton decided to sell its West African iron ore assets in order to focus on its core Australian operations. This move looks like a focus on more cost-efficient operations rather than a disbelief in the future of iron ore business.

Bottom line
The iron ore slump is likely to be prolonged due to oversupply and the uncertainty about Chinese growth. Given this fact, Cliffs Natural Resources is in the most vulnerable position, as it heavily depends on iron ore business and has relatively high costs. Bigger miners like BHP Billiton and Rio Tinto could be winners at the end of the game as they have enough resources to wait until weaker players leave the market. Vale's profitability will be hurt because of the low price environment, but the company should be able to withstand the headwinds.

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Read/Post Comments (2) | Recommend This Article (0)

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 March 12, 2014, at 12:56 PM, SisyphusRocks wrote:

    I don't understand commentary that equates Cliffs' iron ore business to spot price iron ore exposure. Cliffs has about 70% of their iron ore sales in long-term supply contracts, which only have slight variability for iron ore spot pricing. They have a lot of sensitivity in their Canadian operations, because those are higher price and sell on the world market, but it's hardly the whole company's revenue picture.

    Companies that sell much more into the China iron ore spot market like Vale have more direct exposure to iron ore variability, even if their very low costs per ton assure they will be profitable (perhaps unlike Cliffs in its Canadian mines).

  • Report this Comment On April 20, 2014, at 10:18 AM, Demirfiyat wrote:

    Iron prices go down more?

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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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