Anglo to be hit more by iron ore deals than Rio

Reuters | Mon, 01 Jun 2009 14:36
[miningmx.com] -- A sharp fall in prices of high grade inputs for steelmaking is set to deepen the underperformance of Anglo American relative to a red-hot mining sector and notably archrival Rio Tinto this year.

Under initial benchmark prices agreed last week, top quality iron ores slumped more than the most widely used grade, prompting some analysts to pencil in earnings cuts for Anglo American and upgrades for Rio Tinto and Brazil's Vale.

Rio, the world's No. 2 iron ore producer, agreed with Japanese and Korean steelmakers to cut the annual price of standard "fines" ore by 33 percent, but top quality lump iron ore by 44.5 percent.

Anglo and rivals have yet to finalise their own settlements, but the first iron ore benchmark agreement sets the tone for price deals throughout the industry.

"Although AAL has lower iron ore exposure than RIO, it has greater exposure to lump... resulting in the potential for slightly larger earnings downgrades," Citigroup said in a research note.

Lump iron ore accounts for more than two-thirds of production at Anglo, the world's fourth biggest iron ore producer and majority owner of South Africa's Kumba Iron Ore, it added.

Anglo, which produces most of its iron ore in South Africa but is developing mines in Brazil, declined to comment.

South African exposure

Rio shares have doubled this year, leading a surge in mining stocks. Anglo, by contrast, has risen just 21 percent, underperforming a 54 percent rise in the DJ STOXX European Basic Resources index.

Anglo is also due to be worst hit of the major miners by stronger currencies in metals-producing nations. South Africa accounted for 55 percent of Anglo's 2008 operating profit.

Bank of America Merrill Lynch said last week it made "significant" cuts in earnings per share estimates for Kumba due to the Rio settlement and the stronger South African currency.

Quality iron ore products make up a smaller portion of total output at No. 1 producer Vale, Rio and No. 3 BHP, accounting for 12 percent, 29 percent and 31 percent respectively, according to Citigroup.

Prices for high quality lump and pellet iron ore are volatile. They are more in demand when steel prices are high since they need no initial processing as opposed to fines, but they are shunned when prices are weak and mills are seeking to contain costs.

"Remarkable outcome": advantage Rio

The one-third price cut for standard iron ore was better than many analysts expected and is still the second highest price ever achieved. Prices had quadrupled during the four years until 2008, largely driven by China's hunger for materials to build infrastructure. "This is... a remarkable outcome given today's macro-economic environment," said Goldman Sachs JB Were in a note, boosting its 2009 EPS forecast for Rio by 9.2 percent.

"Assuming that the benchmark is accepted across all contracts, our earnings estimates would increase 4.8 percent for Rio Tinto and 4.2 percent for BHP," Deutsche Bank analyst Rob Clifford said. Vale could see a 20 percent upgrade, a Deutsche colleague wrote in a note.

Although Rio's settlements this week have provided a yardstick for other deals, it has failed to get on board the biggest iron ore consumer, China, which wanted deeper price reductions and has baulked at agreeing to those rates.

China is likely to eventually cave in and agree to the benchmark deal set by Rio Tinto so it can secure future supply, said analyst Jim Lennon at Macquarie Research.

Beijing could threaten to move its business onto the spot market, but that would be risky. "The Chinese buyers run the risk in this scenario of losing tonnage and also end up paying a higher price," Lennon said.

Smaller producers

The impact of Rio's benchmark deals on smaller iron ore producers will vary.

Ukraine's Ferrexpo, like Anglo, is set to be hurt by the weakness in prices for high-quality iron ore. The output of the London-listed group is 100 percent pellets, whose price moves in line with lump material.

"Traditionally lump and pellets (prices) are relatively similar, so if this is the benchmark we would expect something similar for pellets," said Gavin Mackay, head of corporate communications.

"The pellet premium was at a record level last year -- 86 cents per iron unit -- and the average over the last seven or eight years was between 25 and 30 cents."

Kazakh mining group ENRC, the world's sixth biggest iron ore exporter by volume, produces equal amounts of pellets and iron ore concentrate.

The firm's biggest customer is Russian steelmaker MMK, which accounted for 64 percent of sales revenue last year, with the contract price set by world benchmarks.

Rio's benchmark deals will have scant impact on Sesa Goa, the iron ore unit of Indian mining group Vedanta, since it has moved in recent years to selling nearly all of its output on the spot market, analysts said.