Debt investors are betting Australia’s iron-ore producers will survive what Goldman Sachs Group Inc. has described as the dusk of a bull market as they improve balance sheets and cut production costs.
Bond risk for BHP Billiton Ltd. and Rio Tinto Group fell this quarter even as prices of the steelmaking ingredient slumped 11 percent, according to CMA credit-default swap pricing. Contracts for Rio, which last year got 87 percent of its profit from iron ore, were at 93 basis points on May 9, 12 below this year’s high. Those for BHP dropped to 61 basis points from as high as 71.
“BHP and Rio have been lifting production while also taking out costs,” Ben Byrne, a credit sector specialist at Citigroup Inc. in Sydney, said by phone May 9. “These efforts have offset weaker commodity prices to some degree.”
Goldman wrote in a May 7 report that over-investment in new supply means dusk is settling on the iron-ore bull market from 2004 to 2013, which will force mine closures among high-cost producers. BHP and Rio, the world’s two biggest mining companies, are reining in investment and cutting debt after a decade-long boom in metal prices slowed.
Rio plans to reduce spending on new operations to about $8 billion in 2015, less than half its outlay in 2012. BHP is focusing on the highest-returning projects and plans to spend $16 billion during fiscal 2014 on new projects and exploration, down from $22 billion the previous year.
The austerity drive, which includes slashing operating costs, is set to reduce net debt for both companies. Rio’s may fall 21 percent to $14.2 billion in 2015 compared with this year, RBC Capital Markets forecast this month. BHP’s net debt may fall 45 percent to $13.7 billion in fiscal 2015, RBC said.
The savings drive by the miners means there’s a smaller pool of debt for bond investors to choose from, said Chris Walter, a credit analyst in Sydney at Westpac Banking Corp.
“There’s little to no supply of cash bonds in the near term” from mining companies, Walter said. “Credit investors still need to put their money to work in a low-yield environment, so it’s not surprising we’re seeing further spread tightening” in CDS.
BHP and Rio have both predicted lower iron-ore prices this year after producers in Australia and Brazil spent billions of dollars to expand output. After a balanced export market in 2013 totaling 1.2 billion metric tons, Goldman Sachs forecasts a surplus of about 77 million tons this year, rising to about 145 million tons next year.
U.S. dollar debt issued by Rio returned 1.6 percent this quarter through May 9 while BHP’s gained 1.4 percent, according to a Bank of America Merrill Lynch U.S. Metals, Mining & Steel Index. The gauge advanced 2.4 percent.
Australia’s 10-year bond yield fell to an seven-month low of 3.80 percent last week, before standing at 3.84 percent as of 2:30 p.m. in Sydney. It offered a 1.21 percentage points pick-up over similar-maturity U.S. Treasuries.
The Aussie dollar, the world’s fifth most-traded currency, fetched 93.63 U.S. cents, a 5 percent gain since Dec. 31.
Growth in China, the biggest buyer of iron ore, is slowing after the government reined in a credit boom and toughened regulation to combat pollution. The economy expanded 7.4 percent in the first quarter from a year earlier, matching the weakest pace since 2009. Premier Li Keqiang is targeting growth of 7.5 percent.
Iron ore entered a bear market in March and fell to $102.70 a ton on May 9, the lowest level since September 2012, taking this year’s price drop to 23 percent. The average annual price is forecast to decline each year until at least 2017, according to estimates compiled by Bloomberg.
“If iron ore fell to $80 or $90 a ton in the next couple of years, Rio’s credit metrics could become strained for its current A- and A3 ratings,” said Byrne. “However there is little risk of a credit event given the company’s scale and strong liquidity.”