It's always seemed to be a matter of when, not if, the iron pricing rally would stall since it began more than a year ago. When even the executives of the mining companies themselves were doubtful about whether it could trump the fundamentals of the industry, it became a matter of just waiting for the drop to come.
While it went on far longer than most anyone expected, as the outlook for demand from China remained elevated, that moment seems to have finally arrived. After peaking at nearly $95 per dry ton in late February, the price of iron ore at China's port of Qiangdo has dropped 10% so far, and futures for September delivery lost 15% in one day and now sit 20% below last month's high.
Naturally the iron ore miners are also feeling the blow, but just because their share prices have fallen doesn't mean there aren't still quality names in the space. We'll take a look at Vale (NYSE:VALE), Cliffs Natural Resources (NYSE:CLF), and Mesabi Trust (NYSE:MSB) to see what sets them apart.
Vale is the world's biggest producer of iron ore and pellets, and earlier this year began operations at its massive, $14 billion S11D project in at Carajas in the Brazilian Amazon that will add an additional 90 million tonnes to its capacity. Vale expects the mine to help it achieve production of between 400 million and 450 million tonnes per year by 2020. More importantly, the project could help drive Vale's industry-leading low costs even lower than they already are, perhaps even below $10 per tonne.
That should help its bottom line regardless of whether the price of iron ore falls back to the $65 per ton level, where many analysts anticipate it will settle. It will be profitable regardless, though one of the other risks Vale faces is the economic instability in Brazil, where its mines are concentrated. The Brazilian real has been volatile, and having been devalued in 2015, it gained 17% last year against the U.S. dollar. The currency depreciation, though, reduced its costs and expenses by $399 million in 2016 while also giving it non-cash gains of $4.2 billion on earnings before taxes.
Vale's preeminent position in the industry, plus having the lowest costs, the biggest mines, and an improving debt profile -- it realized $3.8 billion worth of non-core asset sales last year that went to help pay off some of its outstanding debt -- keeps it at the top of the list.
Cliffs Natural Resources
Vale might be the biggest miner, but if there was one company that profited most from the pricing rally, it was Cliffs Natural Resources, which soared more than 430% last year. Yet it wasn't just because prices rose that Cliffs advanced, since the rising tide should have lifted everyone (it did, just nowhere near as much as at Cliffs). Rather, it had to do with the improvements the miner made to its own operations that helped it beat just about everyone inside its industry and out.
A good portion of it had to do with shedding the last of its coal operations the year before, which had served as a drag on its business. There was also a new supply deal to supply ArcelorMittal with iron ore pellets for 10 years. The agreement set the minimum level at 7 million long tons, which was higher than the combined minimum levels of agreements it had that were expiring this past December and January.
But investors shouldn't count on triple-digit gains again this year, and its stock is flat so far in 2017 (yet down 31% from the highs it hit last month). Still, even with lower iron ore pricing, Cliffs Natural Resources doesn't have the same bankruptcy fears surrounding it that once haunted it and the miner should be a bigger, better, more profitable company going forward.
Mesabi Trust is what's known as a royalty trust and is a bit of a twofer, as the lessee/operator of its mining interests in the Mesabi Iron Range of Minnesota is Northshore Mining, a subsidiary of Cliffs Natural Resources. Mesabi's biggest stake is the Peters Lease.
Royalty trusts derive their value from the volume and price of the commodity produced in the future based on the current proved reserves where it receives royalties. Dividends are the major reason investors seek out investments in trusts, compensating you for the relative degree of risk involved in them. They are also designed to pay out all their cash flows as dividends every quarter.
Mesabi, which is generally seen as less risky than others, pays an annual dividend of $0.64 per share that currently yields 4.3%. The inherent risks in these trusts is they come with an expiration date, meaning you can get burned buying in too late or staying too long.
For Mesabi, the lease will cease to exist 21 years after the death of the last of the 25 people named in the Peters Lease. Since several of them are only in their 50s, it presumably has many years left to operate. Even its smaller Cloquette Lease doesn't terminate until 2040.
Because of the unique investment the royalty trust provides, the dividends it pays, and its long expected life, Mesabi Trust is an interesting play on the iron ore industry.