Morning Report\ RIO’s US$4.2b capital commitment for iron ore demonstrates long-term value in the sector - Positive momentum for FMG, AGO. Today’s Top Picks
RIO’s US$4.2b capital commitment for iron ore demonstrates long-term value in the sector - Positive momentum for FMG, AGO. RIO commits US$4.2b to expand iron ore operations. Despite recent talk of project deferments or slowed capital spending, RIO’s announcement to commit US$3.7b for expansion of the Pilbara operations to 353Mtpa (US$6.2b 100% basis) and US$501m for infrastructure development at Simandou (Guinea) demonstrates the med-long term macro fundamentals for iron ore remain favourable vs. the short-term uncertainties priced into iron ore equities with the ASX producers (RIO, BHP, FMG, AGO) bearing the scars of share price declines between 20-40% during May and June. Long-term Chinese steel growth remains robust. While a lot has been spoken about China’s steel mills running well below capacity, crude steel production is still expected to grow from ~600Mt in 2010 to ~1bt through 2030 as urbanisation will shift demand growth from construction to industrial/domestic use. Iron ore pricing remains stable with consensus pricing at ~US$135-145/t for 2012-14. With the marginal cost of Chinese low-grade production reported at ~US$130/t we feel consensus pricing for iron ore over the near-term will provide healthy margins to existing producers and those with manageable capital growth objectives. Despite some parts of the media talking down demand, reports from Port Headland Port authority show May 2012 was a record month for iron ore exports, meanwhile Indian exports appear to be falling. Supply from major projects requiring infrastructure capital likely to slow. The sector has witnessed the delay in large scale projects announced for 2012/13 completion due delays in funding/approvals/macro factors with the next wave now likely to be 2015/16 at best. Given the contraction in equity and debt capital markets and required lead time on key items (dumpers/rail cars/ports). We retain a preference for existing producers funding expansion through manageable balance sheet capacity (RIO,FMG) or those with smaller scale low capital intensity growth profiles (AGO). Fortescue Metals (FMG.ASX, Mkt Cap $15b, Trading Buy $5.50/sh) – Management team with impressive growth achieved to date with 55Mtpa delivered and rapid growth plans funded to 155Mtpa by June 2013 remains on track despite some analysts discounting this timeframe. The development of the 2Bt discovery at Nyidinghu 35km from an expanded Chichester Hub will deliver further growth at a reduced rate of capital. Upside risk in delivering the 155Mt target remains the approval for the fifth birth at Port Headland, hence many brokers discounting the 2013 target to 140Mt. FMG is trading on 10x FY13 PE with broker PT consensus at $6.85/sh. Atlas Iron (AGO.ASX, Mkt Cap $1.8b, Trading Buy $2.50/sh) - With strong cash flow and cash reserves (~A$360, as at 31/3/12) from Horizon 1 available to fund growth to 12Mtpa 2H 2013, the low capital intensity model successfully employed by AGO through trucking operations remains profitable with cash margins of ~$80-90/t. While the funding requirement to deliver Horizon 2 at 31.5Mtpa estimated at ~$6.5b (100%) appears out of reach in the current market environment, we could see AGO quickly re-rate through an announcement of a port sharing/co-development deal with Hancock Prospecting or 3rd party access to rail (again Hancock) or the introduction of a equity partner at the project level. Furthermore, given the strong package of existing cash flows, resource inventory and port capacity, a corporate deal on AGO might also surprise on the upside given the market’s heavy de-rating of the stock price. AGO is trading on a 15x FY13 PE with broker PT consensus at $3.44/sh.
