Iron is a key resource in the world, going into everything from cars to washing machines to the buildings in which we live and work. There are alternatives, like aluminum, but when it comes to cost, it's hard to beat iron. Here's a quick primer on this strong and reliable metal and a few of the key ways you can get exposure, including giant miners like Vale SA (NYSE:VALE), Rio Tinto plc (NYSE:RIO), and BHP Billiton Limited (NYSE:BHP).
Cheap and strong
The key benefit of iron is its mixture of cost and strength. To put it simply, iron is often the cheapest way to make things structurally sound. That's why iron reinforcement bars are added to cement in roads and building foundations. It's also why car frames are usually made of the material. And why really large structures, like bridges, are made of iron.
Iron is also more resilient than alternatives like aluminum. For example, if a car with an aluminum panel, such as a Tesla, gets a dent, the entire panel will likely need to be replaced. With a steel panel, you would just pop out the dent and move on. Iron faces legitimate headwinds in sectors that are looking to reduce weight (specifically the auto arena, where weight is directly related to energy efficiency), but there's really no way to replace it in every application. Iron still has a bright future.
Iron is actually a broad term. It is an element, but to actually use it requires some work. Like most commodities, miners have to dig up iron containing ore and then refine it, in this case creating pig iron. That, in turn, gets used in blast furnaces to create primary steel. Steel, in its many forms, is the useful material created from iron.
The term "commodity" here is important, though, because supply and demand dictate the price of iron ore and the steel that gets made from it. That's a key fact to keep in mind, since commodity prices can move dramatically and swiftly at times. Those price swings will often translate into equally material moves in the stock prices of companies associated with the material, like miners and steel companies. These companies, then, can control their costs to some degree, but they lack material control over their commodity-driven revenues.
Getting it from the ground
This was a big issue for miners after commodity prices fell into a deep downturn in 2011. Their top and bottom lines were hit pretty hard, leading to asset sales to shore up balance sheets, material capital spending cuts, and steep stock price declines. That headwind started to abate in 2016, though, when iron began to recover along with other commodities.
|Company||Ticker||Market Cap||Dividend Yield|
|Vale SA||NYSE: VALE||$66 billion||3.3%|
|BHP Billiton Limited||NYSE: BHP||$122 billion||3.6%|
|Rio Tinto plc||NYSE: RIO||$99 billion||4.4%|
Despite that rollercoaster ride, this trio is probably the best way to gain exposure to iron ore. They have scale, at least modestly diversified portfolios, and each has proven their ability to retrench during tough times (so they can make it through to the good times). However, Vale is probably the riskiest of the trio.
Vale's primary operations are located in Brazil. Roughly 75% of the company's revenues are derived from selling ferrous metals, which includes iron ore and related products. Asia accounts for roughly 60% of its business, with China alone accounting for around 40%. That's a notable issue since Brazil is basically on the other side of the world. Shipping costs are something to which you'll want to pay close attention.
Overall, Vale is a solid miner. The problem with the company is that it's still facing material legal uncertainty surrounding a mining disaster at the Samarco Mine in Brazil that left a number of local residents dead and material portions of two towns effectively destroyed. This facility is a 50/50 joint venture between Vale and BHP, but most of Vale's operations are in Brazil. That means its assets are more exposed to legal issues. There's been progress on resolving those legal issues, but there's still more work to be done before this disaster's costs are fully known. And even when a solution is found, there's going to a huge bill attached that will likely be a headwind for years into the future. Vale is a little too risky for me, but as it's one of the world's largest iron miners, you have to at least have it on your watchlist.
BHP faces a 50% share of any costs for the Samarco cleanup, of course, but with its main operations in Australia, its assets aren't nearly as exposed, legally speaking. (Samarco is the only asset it has in Brazil.) BHP is looking to resolve part of its issues here by selling its stake to Vale, according to Bloomberg. However, it's not clear that this would change its obligations to clean up the mess or resolve the legal costs associated with the disaster.
Still, BHP is another of the world's largest iron ore producers, and you need to take a close look at it if you are considering an investment in the space. Roughly 75% of BHP's sales are made to Asian buyers, but unlike Vale, BHP has notable operations nearby (largely in Australia), helping to reduce shipping costs. About half of the company's top line is related to its iron business. With material exposure to other products, including metallurgical coal (used to make steel), oil, and copper, BHP offers a more diversified portfolio than Vale even though it still has exposure to the Samarco issue. If you were looking at just these two names, though, I'd err on the side of caution and pick BHP.
Rio Tinto gets about 40% of its revenues from iron ore, and about 70% of its top line is derived from sales to Asia. It has mining operations located around the world, but a notable presence in Australia (which is located near its main customers). Rio also produces aluminum, copper, diamonds, coal, and uranium, among other things. Aluminum, interestingly, makes up about 25% of revenues. Since this is one of the main competitors with iron, it provides an additional level of diversification for Rio and its shareholders. And, notably, of this trio, Rio Tinto is the only one that isn't exposed to the billions of dollars of liabilities associated with Samarco, which is a notable positive in my book. Rio Tinto is a top pick if you're looking for iron exposure but want to hedge your bets a little. That said, it's not exactly cheap today, so waiting for a commodity-driven pullback might be a good idea.
There's one more name I'd look at in this space, but it's not normally thought of as an iron company. ArcelorMittal is one of the largest global players in steel, but it is vertically integrated. That means it has sizable operations in iron ore and coal mining, both of which are key inputs to its steel mills. Clearly, this isn't a pure play, and steel makes up the bulk of the company's business, but owning ArcelorMittal gives you exposure to the entire iron value chain, from digging the ore up to processing it into steel.
It's important that ArcelorMittal is its own main customer. That's notable because China, the main end location for most of the products produced by Rio Tinto, BHP, and Vale, has been working to shutter older and less efficient steel mills. The main driving force of this effort is to help clean up China's high levels of pollution. But as primary steel facilities are shut, it has an impact on the demand for iron ore. ArcelorMittal, a competitor to those mills with steel plants across the globe, should be a net beneficiary from China's efforts -- unlike the three other companies noted above. If you are looking for a pure play, iron miner ArcelorMittal isn't a good choice. However, if you're looking for a diversified way to invest in the iron ore value chain, it might be the best option here.
The stocks of all of the companies mentioned above are tied heavily to commodity prices. That includes ArcelorMittal, where steel prices have a more prominent affect on the top line. Since commodity prices have recovered materially from the lows reached in the first days of 2016, all four of these companies' shares have had a nice run. I wouldn't rush out and buy any of them myself.
That said, if you want direct exposure to iron, you have to look at Vale, BHP, and Rio Tinto. They are three of the largest and most important names in the space. I like Rio Tinto's business mix the most. However, if you are willing to go outside the box just a little, I'd suggest you do a deep dive on ArcelorMittal, which gives you exposure to iron and steel but helps protect you a little from the huge influence China has in the iron ore market.