Iron-Ore Profit Mojo Rivals Hermes, Dior Even After Price Plungeby
Biggest suppliers are cutting mine costs to preserve margins
Rio says its Australia pits remain `most attractive business'
At the peak of the iron-ore boom, the world’s biggest producers were spinning out profit margins the envy of luxury goods makers such as Christian Dior SE and Hermes International SCA. What’s surprising is how much money some are still making, even after prices plunged.
Iron ore has tumbled more than two-thirds from a 2011 peak, squeezing owners of higher-cost mines. But some of the biggest producers continue to boast hefty margins. Earnings before some expenses at BHP Billiton Ltd. were 50 percent of revenue in the year ended June 30, more than for industries like health-care services and software.
By boosting capacity and exploiting labor-saving technology including driver-less trains and automated drills, the top suppliers have cut costs by an average of 40 percent since the second half of 2012, according to CLSA Ltd. Wide margins are helping BHP and Rio Tinto Group to bankroll about $10 billion in full-year dividend payments to shareholders in the depths of a rout in raw materials that sent commodity prices to a 16-year low.
“The idea that iron-ore was at its peak and that Rio and BHP had lost their mojo has probably proven to have been presumptuous,” said Tim Schroeders, a portfolio manager who helps oversee about $1 billion in equities at Pengana Capital Ltd. in Melbourne, including holdings in the two companies.
Rio’s earnings before tax, interest, amortization and depreciation -- or Ebitda -- were 44 percent in 2011, when iron ore prices peaked at $191.70 a dry metric ton. In the first half of 2015, Rio’s margin was 41.5 percent, according to data compiled by Bloomberg.
That’s more than some of the biggest names in luxury fashion and cosmetics, including Christian Dior, with a 24 percent Ebitda margin in the first half, and a 23 margin for LVMH Moet Hennessy Louis Vuitton SE-- which produces Moet & Chandon Champagne. Hermes, the maker of Birkin bags that can fetch$9,400 to $68,000 for a version in crocodile skin, had a 36 percent margin.
Iron-ore “margins are still very, very good,” despite being down from “absurd” levels four years ago, when they outperformed even the gross margins of luxury goods makers, said John Hempton, chief investment officer of Bronte Capital Ltd., a Sydney-based hedge fund. “That is the joy of being the low-cost producer in a mineral.”
Rio’s iron-ore unit “is one of the most attractive businesses in the world,” Andrew Harding, the division’s chief executive officer, told investors in Sydney on Sept. 3.
The London-based company reported an average margin of 54 percent on iron ore in the first six months of 2015, and Chief Executive Officer Sam Walsh said Aug. 6 that its open-pit mines in Australia have averaged 62 percent over the past 14 years. At BHP, iron-ore margins that the company reported at 59 percent in the year ended June 30 “remain outstanding,” Chief Financial Officer Peter Beaven said last month.
The average Ebitda margin for companies in the Standard & Poor’s 500 Index, excluding banks, was 21 percent in the fourth quarter of 2014, according to data compiled by Bloomberg. Real estate topped 24 industry groups at 56 percent, the data show.
BHP had $31 billion of total debt as of June 30, or 1.42 times bigger than Ebitda, according to data compiled by Bloomberg. Ebitda will be 47 percent company wide in the year to June 30, 2016, according to the average of analyst forecasts compiled by Bloomberg. Rio, with $25 billion of total borrowings, will have a margin of 35 percent in 2015, according to the forecasts.
Cash flow from low-cost operations in Western Australia’s iron-rich Pilbara region is helping to shelter BHP and Rio from the price collapse, according to Citigroup Inc. Brazil’s Vale SA, the biggest exporter, is trying to boost margins by replacing sales of lower-quality ore with premium products from newer mines. Brazil has higher costs than Australian competitors and is three times farther away from China, the top buyer.
“Margin is more important than volume,” Peter Poppinga, Vale’s executive director for ferrous minerals, said on a July 30 conference call. The company had an Ebitda margin of 30 percent in the three months to June 30.
Benchmark iron-ore prices have plunged about 70 percent from their peak in February 2011 as low-cost output rose and demand growth slowed in China. About 230 million metric tons of new supply is scheduled to be added in the next two years, sustaining a supply glut through 2017, according to Bloomberg Intelligence.
Should prices tumble further, suppliers such as BHP and Rio may have limited capacity to cut production costs more than they already have, said Chris Drew, an analyst in Sydney for RBC Capital Markets. Iron ore may fall to $45 by the end of the year, according to Capital Economics Ltd. Ore with 62 percent content delivered to Qingdao was at $55.30 a dry ton on Wednesday, according to Metal Bulletin Ltd.
As smaller and costlier suppliers are forced to exit, the low-cost producers can claim an even greater share of the 1.7 billion-ton global market. At least 120 million tons of production will be shuttered this year, Rio forecasts.
Cost cuts by the biggest supplier have “been simply astonishing,” said Phil Ruthven, Melbourne-based founder and director of IBISWorld, a business research provider. “I can only praise them for how quickly they’ve responded to the challenge of falling prices.”