Who Will Benefit From Low Iron Ore Prices?

Big miners could be the surprising winners from slumping iron ore prices after weaker players leave the market.

Mar 12, 2014 at 9:30AM

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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Vladimir Zernov has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale Ads. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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