There’s good reason for Australia’s obsession with iron ore – the world can’t get enough of it. According to Australian Bureau of Statistics data, in 2020, iron ore brought in record annual export revenue of $116 billion, up 20.8% on the $96 billion earned in 2019.
Iron ore is the first commodity to break $100 billion of export revenue in a year. The surge comes on the back of high demand across Asia, with China importing 1.17 billion tonnes of iron ore last year, exceeding its 1.075 billion-tonne record from 2017.
This pace has come off the boil slightly: Australia’s iron ore exports in February dropped to their lowest in a year, as Lunar New Year holidays and cold weather in China crimped demand. But while the February figure was actually the third lowest volume of iron ore exports in the last four years, it still represented a rise of 6% year-on-year, after Tropical Cyclone Damien cut into exports and damaged Western Australian port infrastructure in February 2020.
The iron ore price picture is very favourable for Australia’s producers, with the price riding at nine-year highs above US$170 a tonne – up from US$40 a tonne at the end of 2015, and not far short of the record of US$187.50 of February 2011. It is not supposed to be this high – the main customer, China, is very aggrieved at having to pay these prices – but post-COVID stimulus needed to be applied, and while that was happening, supply was tightened by the continuing problems in Brazil.
Brazil’s iron ore exports have been struggling since the tailings dam collapse in January 2019 at the Brumadinho mine killed 257 people, which led to the country’s iron ore behemoth Vale – the world’s biggest iron ore producer – being ordered to close several mines until they were inspected and cleared to resume operations. (This had followed a previous dam collapse in November 2015, at a mine operated by Samarco, a Vale/BHP joint venture.)
Production in Brazil is still not back to normal, as bad weather and COVID-19 shutdowns and disruptions have added to the Brazilians’ regulatory worries. Brazil is one of the nations worst-hit by COVID-19, with a potential new strain causing additional problems. Vale has been struggling to return to full production and many analysts now do not believe this will happen in 2021.
Meanwhile, demand has recovered much faster than expected – especially in Europe – and that has seen analysts scrambling to lift their price forecasts, with triple-digit prices expected to remain well into 2022 – while slowly coming down from the current elevated levels.
It has been a windfall period for Australian producers, with the market price for their commodity well above what they would have expected. Look at Fortescue’s December 2020 half-year: a net profit of $US4.1 billion, up 66%, after sales rose by 44% to $US9.3 billion. Shareholders will receive a fully franked interim dividend of $1.47 per share, almost double the interim payout a year ago.
While iron ore from north-western Australia is the main (only, at this stage) business for Fortescue, it is also the cornerstone earner for both BHP and Rio Tinto – although BHP also produces metallurgical (steelmaking) coal, thermal (electricity) coal, oil and gas, copper and nickel, as well as small amounts of gold, silver and uranium at Olympic Dam in South Australia.) Rio Tinto’s pallet of products also includes aluminium (aluminium metal, alumina and bauxite), copper and diamonds, and energy and minerals (titanium dioxide, iron ore concentrate and pellets, and borates).
While these companies cannot control iron ore prices, they can control their costs of producing it – and they do great work in this regard. In FY21, Fortescue expects a cash cost of production of US$13.50–US$14.00 a wet metric tonne, based on an assumed FY21 average exchange rate of US$0.70–US$0.75
BHP reckons it can produce iron ore at US$12.46 – while Rio Tinto is running at US$15.40, and has told shareholders that in 2021 it expects to produce iron ore at a cost of US$16.70–US$17.70 a tonne.
Clearly, those cost levels flow into cashflow bonanzas and very good profitability at current iron ore prices. More importantly for investors, they still would do so if the iron ore price were to halve.
That possibility always has to be considered. While China is punishing Australia in a variety of commodities with trade curtailments, in iron ore the Middle Kingdom is trapped somewhat by the sheer demand of its voracious steel industry. Australia currently supplies 60% of China’s requirements and finding a replacement will not be easy. Restrictions on Australian iron ore imports would hurt China too much right now, given the supply shortages – but such action must at least a possibility in the future.
But in the meantime, for Australian investors, the expected profitability of the companies flows into expected dividend yields that, in the current context, are very hard to ignore.
1. Fortescue Metals Group (FMG, $21.99)
Market capitalisation: $67.7 billion
Three-year total return: +87% a year
FY22 forecast yield: 8.5% fully franked, grossed-up 12.1%
Analysts’ consensus valuation: $23.34 (Thomson Reuters), $23.24 (FN Arena)
On analysts’ consensus earnings and dividend expectations, Fortescue is the best yield stock on the Australian market, with a consensus expectation of 12.1% grossed-up. Just over the next 12 months, broker Cannacord Genuity says FMG is offering a forward yield of 12.2% fully franked, or 17.5% grossed-up, at a payout ratio of 83.8%.
Even if FMG only maintains its FY20 full-year dividend of $1.76 – remember, an interim dividend of $1.47 has already been paid – investors would still be looking at a fully franked yield of 8%, or 11.4% grossed-up.
And as always, every FMG shareholder has their own individual yield – which is determined by the share price they paid for the stock. If you paid $6 for the stock in 2019, or $4 in 2018, your actual yield on the current dividend will be a lot higher than that.
And there is still scope, according to analysts, for a bit of capital gain to augment your total return.
2. BHP (BHP, $48.63)
Market capitalisation: $246 billion
Three-year total return: +25.9% a year
FY22 forecast yield: 5.4% fully franked, grossed-up 7.7%
Analysts’ consensus valuation: $47.38 (Thomson Reuters), $47.18 (FN Arena)
Likewise, BHP is a strong yield stock – but analysts see it as a touch over-valued. Canaccord Genuity puts BHP on a 12-month forward P/E of 14.2 times earnings and a forward yield of 5.7% fully franked, or 8.1% grossed-up, at a payout ratio of 75.1%. Yield-oriented investors are going to like that.
3. Rio Tinto (RIO, $120.56)
Market capitalisation: $194.9 billion
Three-year total return: +23.3% a year
FY22 forecast yield: 5.3% fully franked, grossed-up 7.6%
Analysts’ consensus valuation: $127.01 (Thomson Reuters), $127.71 (FN Arena)
Rio Tinto is also a yield stock – with a bit of share-price potential thrown in. Canaccord Genuity puts Rio Tinto on a 12-month forward P/E of 13.5 times earnings and a forward yield of 7.5% fully franked, or 10.7% grossed-up, at a payout ratio of 71.2%. There is a strong case for owning RIO for income.
4. Mineral Resources (MIN, $38.43)
Market capitalisation: $7.2 billion
Three-year total return: +34.7% a year
FY22 forecast yield: 4.4% fully franked, grossed-up 6.3%
Analysts’ consensus valuation: $43.10 (Thomson Reuters), $40.22 (FN Arena)
Iron ore producer Mineral Resources is also picking up ESG kudos, being the operator of two hard-rock lithium mines in Western Australia: the company is one of the world’s largest owners of hard-rock lithium deposits. While lithium’s potential is taking a while to be realised on the ASX, MinRes shareholders have the diversification of the company’s iron ore mines and global mining services contracting business to sustain their investment.
And those businesses are combining to generate a dividend yield well above market average, with attractive upside potential also in the stock.
Canaccord Genuity puts MinRes on a 12-month forward P/E of 9.8 times earnings and a forward yield of 6.6% fully franked, or 9.4% grossed-up.
There are also two iron ore juniors on the ASX worth some research:
5. Mount Gibson Iron (MGX, 87.7 cents)
Market capitalisation: $1 billion
Three-year total return: +36.4% a year
FY22 forecast yield: 9.1% fully franked, grossed-up 13%
Analysts’ consensus valuation: $1.075 (Thomson Reuters), $1.075 (FN Arena)
Mount Gibson Iron operates the Koolan mine, on the eponymous island in Yampi Sound off the north coast of Western Australia, and the Extension Hill mine in the mid-west region of Western Australia. The flagship Koolan Island operation boasts Australia’s highest-grade hematite ore reserves, averaging 65.5% Fe.
Mining was interrupted in late 2014 when the main pit flooded, with full production and sales of high-grade hematite recommencing in April 2019.
Mount Gibson sold 2.3 million tonnes of iron ore in the first half of FY21, ahead of entering a new phase of operations at Koolan Island. Ore reserves at Koolan have been increased to 21 million tonnes at 65.5% Fe, extending the mine life to over five years. In the meantime, MGX is bringing onstream the Shine iron ore project, which is located 85 kilometres north of the Extension Hill operation. The target for first ore sales from Shine is the September 2021 quarter.
While Mount Gibson’s production costs are higher than its bigger peers, at about US$40 a tonne, it captures price premiums for its higher-grade ore – and analysts see strong grounds for earnings and dividend rises. MGX looks a particularly good buy at these levels.
6. BCI Minerals (BCI, 31.5 cents)
Market capitalisation: $188 million
Three-year total return: +24.9% a year
FY22 forecast yield: no dividend expected
Analysts’ consensus valuation: 51 cents (Thomson Reuters)
BCI Minerals main iron ore asset is its Iron Valley Resource, which is mined under agreement by Mineral Resources, and provides a royalty-like earnings stream. BCI also has a number of royalty agreements on other iron ore tenements at earlier stages of development. The cashflows from iron ore are helping BCI to progress its Mardie salt and sulphate of potash (SOP) fertiliser project in Western Australia, at which the company expects final investment decision (FID by June 2021, with major construction activities commencing in the September quarter. If all goes to plan the Mardie project will be a globally significant Tier 1 salt and SOP project, that is forecast to generate robust cash flows over an operating life of at least 60 years.
In the meantime, BCI combines an iron ore royalty-like business, that is throwing off very robust cash flows, with a large-scale salt and fertiliser project. While investors won’t see a dividend for the foreseeable future, analysts see very alluring value in BCI at this share price.
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