Simon Price, Azure Capital: Reviewing Investors Demands for Iron Ore in 2014

AZURE CAPITAL

Iron Ore – Investor Demands and Financial Markets SIMON PRICE | 26 NOVEMBER 2013

STRICTLY CONFIDENTIAL | 2

TABLE OF CONTENTS

THE YEAR IN REVIEW

PRIMARY HURDLE IS COSTS

CAPITAL INTENSITY IS THE KEY

EQUITY MARKETS

FINANCING ACTIVITIES


80

90

100

110

120

130

140

150

160

170

180

Sep-12 Dec-12 Mar-13 Jun-13 Sep-13

USD AUD

Iron ore spot price is up 36.3% in USD terms and 52.5% in AUD terms since we met at this conference last September…

WHAT A DIFFERENCE A YEAR MAKES

Notes: 1. China import Iron Ore Fines 62% Fe Spot (CFR Tianjin port) $/dry metric tonne. Source: Bloomberg as at 25-Nov-13.

62% Fe fines1

Iron ore spot price (USD, AUD)


0

50

100

150

200

250

Nov-12 Feb-13 May-13 Aug-13 Nov-13

FMG MGX GRR BCI MIN ARI

… bringing equity prices for local iron ore producers with it

WHAT A DIFFERENCE A YEAR MAKES

Source: Bloomberg as at 25-Nov-13.

Index

Relative Equity Prices for ASX-Listed Iron Ore Producers from Nov-11 (Rebased to 100)


THE FOCUS HAS SHIFTED

Source: News and Company Announcements.

Now One Year Ago Going Forward

FMG Atlas BHP Mitsubishi Jupiter Mines

– Selling assets, deferring expansions, refinancing debt

– Shares traded at a 3.5yr low of $2.97/share

– Cancel $3bn Ridley Magnetite Project

– Deferred Port

Hedland iron ore expansion projects

– Indefinitely delay Jack Hills iron ore project

– Indefinitely delay Mt Isa Magnetite project

FMG Atlas BC Iron BHP Gindalbie WA producers

– Record FY13 revenue US$8.1bn – S&P upgrade to BB – Near target 155Mt p.a. capacity – Sep Qtr Record production (10Mt

p.a. rate) – Record FY13 revenue $695m – Record production at Nullagine – Record iron ore shipments – 30c dividend

– 5Mt increase in FY14 forecast

production to 212Mt – Sep Qtr record production of 54Mt

– Sep Qtr: Hematite shipped 43% up

– Iron ore exports in FY13 up 13% – Value of sales dropped 7.3%

Expected US$10bn ($10.35bn) new investment in iron ore by BHP and Rio

BHP RIO FMG

– Plans to expand Jimblebar to 55Mt p.a.

– Plans to approve an expansion of its operations from 290-360Mt p.a.

– Plans to repay US$1b debt due in 2015 in December

The improvement in market conditions is being reflected by the change in iron ore business development pipelines.


In response to market and iron ore price pressure the major theme of the part year is stemming the tide of rising operating costs.

COST REDUCTION EFFORTS ARE STARTING TO SHOW

Source: Company announcements, reports and presentations. Analyst reports.

BHP has already achieved $US2.7bn ($2.79bn) in cost cutting

• Targeting nominal CIF China equivalent basis cash cost of c.US$39/t by CY2015 from c.US$43/t in CY2013

Rio has made total cost reductions of $978m post-tax from H1 2012 to H1 2013 ($655m of cash costs)

• Targeting all in cash cost of US$35/t in 2020 from US$47.7 in FY13

49

58

101

128

53

44

67 68

114

48

37

59 54

119

44 36

61

36

88

43

0

20

40

60

80

100

120

140

FMG AGO MGX GRR BCI

FY12 FY13 FY14e Long run

GRR costs are for magnetite which attracts a $20-30/t price premium

Cash Costs (A$/t)


In the long term the cost curve will go from this…

2013 GLOBAL IRON ORE COST CURVE

Source: Bloomberg.

Rio

Tin

to

BH

P B

illit

on

Val

e

Fort

escu

e

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

0 250 500 750 1,000 1,250 1,500

Cas

h c

ost

(U

S$/t

)

Cumulative Production (Mt)

2013 Global Iron Ore Cost Curve (62% Fe CFR China)


To this … as new production is increasingly cost efficient

2020 GLOBAL IRON ORE COST CURVE

Source: Bloomberg.

2020 Global Iron Ore Cost Curve (62% Fe CFR China)

Rio

Pilb

ara

Ph

ase

1

Rio

Pilb

ara

Ph

ase

2

BH

P R

PG

5

Rio

Tin

to e

xist

ing

Fort

escu

e T1

55

BH

P e

xist

ing

Val

e

Fort

escu

e ex

isti

ng

-

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

0 250 500 750 1,000 1,250 1,500 1,750 2,000 2,250

Cas

h C

ost

(U

S$/t

)

Cumulative Production (Mt)


Despite operating cost improvement, rising capital costs remain a challenge for new production

CAPITAL INTENSITY

Notes: 1. In 2011-dollar terms. Source: Bloomberg Industries.

96

150

100

195

0

20

40

60

80

100

120

140

160

180

200

2007 2011/2012

Rest of the world Australia

Capital Intensity (US$/tonne of capacity)

Capital Intensity (US$/tonne of capacity)1


Capital intensity represents an even greater challenge for magnetite projects

CAPITAL INTENSITY - MAGNETITE

Source: Bloomberg.

266

105

0

50

100

150

200

250

300

Magnetite Hematite

Capital expenditure (US$/tonne of capacity)

Capital Intensity: Australian New Iron Ore Projects

60

46

0

10

20

30

40

50

60

70

80

Magnetite Hematite

Cash Cost (US$/tonne of capacity)

Cash Costs: Australian New Iron Ore Supply

Though prices for Magnetite are typically $20-30/t more than Hematite, this remains inadequate to compensate for the higher costs in most projects


IS IT CHEAPER TO BUY OR BUILD?

Despite share prices of Australia’s iron ore producers increasing by 40% over the past year1, a comparison of annual production multiples of Australia’s iron ore producers to the capital intensity of new projects suggests buying is cheaper than building

Notes: 1. Based on an equally weighted index consisting of Fortescue Metals Group, Mount Gibson Iron, Grange Resources, BC Iron, Mineral Resources and Arrium. Source: Bloomberg as at 28-Oct-13, Mineral Council of Australia (MCA), company reports & filings.

0

50

100

150

200

250

300

350

400

450

FMG

BC

Iro

n

Atl

as

Gra

nge

Gin

dal

bie

Min

as R

io

Mb

alam

Rio

Tin

to -

Pilb

ara

BH

P -

RP

G5

FMG

- T

155

Ro

y H

ill

Kam

i

Pep

el35

Car

ajas

Ser

ra…

Avi

ma

Mar

amp

a

Mt

Web

ber

Blo

om

Lak

e

Wilc

her

ry H

ill

Mar

illan

a

Bu

nga

roo

So

uth

Bal

mo

ral S

ou

th

Car

ajas

II

Bu

ckla

nd

Jack

Hill

s

Sin

o Ir

on

Cen

tral

Eyr

e

Kar

ara

May

oko

Ap

uri

mac

Market Value ASX-listed Companies Hematite Projects Capital Intensity Magnetite Projects Capital Intensity

Magnetite average: US$225/t

Implied market value versus capital intensity for global iron ore projects (US$/tonne of annual capacity)

US$/t

Hematite average: US$154/t

ASX-listed average: US$99/t


The iron ore price has had a benign 12 months … where is it heading? Short term views are generally positive…

THE IRON ORE PRICE OUTLOOK

Source: Australian Financial Review, Broker Reports.

Broker Long Term Price Forecast (US$/t)

Hartleys Deutsche Bank RBC Capital JP Morgan UBS Goldman Sachs

80-90, FOB 80, fines CIF ~75, CRF China, 62% Fe 115, TSI benchmark 70 (revised this up) 88

Commentary

– “…it seems more and more likely that there will be upgrades to those [iron ore price] estimates in the coming months…” Hartleys

– “With iron ore inventories still at modest levels, we continue to expect iron ore prices to be well supported through Q4 (the fourth quarter) 2013” RBC

– “We have seen a bounce that should be supported into December” Platypus Asset Management

– “While we expect prices to remain supported near term, oversupply in mid CY14 will see prices retreat to marginal support levels thereafter” Goldman Sachs


But analysts diverge on the big question: what will be the long term price for seaborne iron ore?

LONG TERM VIEW UNCHANGED FROM LAST YEAR

Source: Australian Financial Review, Bloomberg, Broker Reports.

Consensus view (Nov 2013 presentation) Current views?

China’s growth may slow but there is enough urbanisation and ongoing construction that new iron ore projects will need to be developed for another ~5 years until supply catches up

Chinese domestic production costs set a floor around $100-120/t CFR

Rising costs will continue to underpin the price...

– new supply has a habit of running late...

– ... but in time significant new supply will dampen the price in the long term

Short term views are generally buoyant …

…but many analysts are concerned about rising supply and over-supply

Consensus long term expectations is ~$80

However it is hard to reconcile that with the capital intensity of new investment. At US$80/t long term it is not worth bringing most greenfield projects into production

My preferred view hasn’t changed from last year


After 5 years of high volatility, a bull market has emerged for equities. US markets are above their post GFC highs and Australian markets are getting there. The ASX accumulation index (includes dividends) is above 2008 levels.

EQUITY MARKETS – THE BULL MKT APPEARS?


40

50

60

70

80

90

100

110

120

130

2008 2009 2010 2011 2012 2013 2014

ASX 200 Index

ASX All Ordinaries Index

ASX 200 Accumulation Index

40

50

60

70

80

90

100

110

120

130

2008 2009 2010 2011 2012 2013 2014

Dow Jones Industrial Average Index

S&P 500 Index

Aust Capital Markets: ASX200 & ASX All Ords from

Jan-08 (Rebased to 100)

US Capital Markets: Dow Jones & S&P 500 from Jan-08

(Rebased to 100)


Australia remains middle of the road compared to Europe, Japan and China…

RECOVERY IS NOT A GLOBAL THEME … YET


20

40

60

80

100

120

140

2008 2009 2010 2011 2012 2013

HK Hang Seng FTSE 100 Nikkei 225 Euro Stoxx 50 SSE Composite ASX All Ords S&P 500

← ASX All Ords

Major Stock Exchange Indices from Jan-08 (Rebased to 100)


After the crash, the initial recovery and a (very protracted) period of consolidation, the final stage – a multi year bull market – is what investors are now hoping for...

LOOKING FOR THE LAST (BULL MARKET) PHASE OF THE

MARKET CYCLE


3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

2008 2009 2010 2011 2012 2013 2014

3. Consolidation - market trades sideways for 3 years

from 4800 in Oct 09 to ~5,5000 now

1. Market crashes – post GFC severe at -56% over 17

months

2. Market bounces off the bottom - +53% over

8 months

4. Finally the bull market - rally commences in

2013

ASX 200 Index from Jan-08


IPO MARKET STAGES A TURNAROUND

Capital raised by Australian companies has been extremely low for the last few years with the IPO market virtually non-existent… but the year end pipeline gives us hope

Note 2013 is YTD June. Source: Bloomberg as at 22-Sep-2013.

Australian Equity Issuances (A$billions)

A$37B

A$41B

A$25B

A$14B

A$11B A$10B

2008 2009 2010 2011 2012 2013YTD

IPO's Secondary

Significant re-capitalisation /debt reduction

Company Ticker Industry Raised / Target

(A$m)

Selected 2013 IPOs

99 Wuxian NNW Mobile Phones 20.0

Australian Industrial REIT

ANI Real Estate 129.0

OzForex OFX Online Payment 439.4

Freelancer FLN Freelancing 15.0

iSelect ISU Online Comparison 479.3

Selected Planned IPOs

Nine Entertainment

NEC Television 3,000.0

Life Healthcare LHC Health 100.0

BIS Industries - Mining Services 1,500.0

Dick Smith DSH Electronic Retailer 344.5


While the IPO market has boomed in sectors such as healthcare, media and financials there is no IPO activity in mining and relatively low secondary issuance.

NO RECOVERY IN MINING EQUITY ISSUANCE

815 419

173 54

2,731 3,407

1,981

1,277

3,546

3,826

2,154

1,331

-

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2010 2011 2012 2013 YTD

Secondary Issuances

IPOs

Primary and secondary market issuances for ASX listed mining companies (A$m)

A$m

Source: Bloomberg.


5.9

5.4

4.4

5.1 5.0

3.9 4.1

6.1

5.5

4.5

5.3 5.1

4.0 4.2

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 YTD

ASX200 Index ASX All Ordinaries Index

ASX Liquidity has fallen since GFC – reflective of lack of investor confidence and reduced international participation due to high A$. This has started to recover but not in small caps.

LIQUIDITY TURNING - BUT REMAINING LOW


267 253

165

261 251

146

119

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 2013YTD

ASX Small Cap Resources Index

↓ 55% since 2007 for Small Cap Resources Index

Small recovery in liquidity from 2012 lows, but still below historical levels

Average Daily Value Traded (A$billions) Average Daily Value Traded (A$millions)


-600

-400

-200

0

200

400

600

2008 2009 2010 2011 2012 2013 YTD

Equities Bonds MM

After the GFC, funds withdrew dramatically from equities and flowed aggressively into Money Market and Bond Funds. 5 years later, that money is returning to equity funds.

INCREASED FLOW INTO EQUITY FUNDS

Source: JBWere.

Asset Flows (A$billions)


Since last year there has been considerable multiple expansion in Australian equities with little earnings growth

MULTIPLE EXPANSION AND EARNINGS GROWTH


ASX 200 12 month forward EPS and P/E

6

8

10

12

14

16

18

200

250

300

350

400

450

500

Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13

12

mo

nth

fo

rwar

d P

/E

ASX

20

0 1

2 m

on

th f

orw

ard

EP

S 12 month forward EPS 12 month forward P/E


Market valuations of some of the largest global mining companies have continued to decline over the past 3 years.

MINING COMPANY VALUATIONS COMPRESSED

Notes: FY13 is YTD. Source: Bloomberg as at 29-Oct-13.

232

162 155

51

87

20

42

29

15

167

105 101

31

69

15

37

17 13

167

97

74

59 59

9 17

8 6

0

50

100

150

200

250

BHP RIO Vale Glencore ChinaShenhua

FMG Barrick Newcrest AngloGold

FY11 FY12 FY13

Market Cap at Financial Year End (A$billions)


Mining equities continue to underperform the underlying commodities in AUD terms, the strong dollar no longer hides the difference…

MINING EQUITIES UNDER-PERFORMING COMMODITY PRICES

Notes: 1. All indexes are presented on monthly intervals. Source: Bloomberg as at 29-Oct-13.

HSBC Global Mining Index vs. RBA Commodity Price Index in US$ terms (Rebased to Jan 2007)

40

80

120

160

200

240

2007 2008 2009 2010 2011 2012 2013

HSBC Global Mining Index

RBA Commodity Price Index (in US$ terms)

HSBC Global Mining Index vs. RBA Commodity Price Index in A$ terms (Rebased to Jan 2007)

40

80

120

160

200

240

2007 2008 2009 2010 2011 2012 2013

HSBC Global Mining Index

RBA Commodity Price Index (in A$ terms)


62% Fe fines spot price1

Mid cap iron ore peers index2

Similar theme applies to the Australian iron ore sector… (chart excludes majors as they are diversified)

THE SAME TREND CAN BE SEEN IN IRON ORE

Notes: 1. China import iron ore Fines 62% Fe spot (CFR Tianjin port) – denominated in US$/dmt. 2. Mid cap iron ore peers consists of Aquila Resources, Atlas Iron, Gindalbie Metals, Grange Resources and Mount Gibson Iron. Source: Bloomberg as at 25-Nov-13.

20

40

60

80

100

120

140

Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13

Index (rebased to 100)

62% Fe Fines Spot Price v. Mid Cap Iron Ore Peers Index from Jan-12 (Rebased to 100)


EQUITY RAISING FY13 AND FY14 TO DATE – IRON ORE

Date Company Amount

Raised (A$m) Type

Premium / Discount

to last close Purpose/Comments

8-Nov-13 Western Desert

19.43 Share Purchase

Plan 12.75% discount

Development/construction of Roper Bar iron ore project

22-Oct-13 Sundance 40 Convertible Notes Issue

Half at 9% premium: Half at 30% premium to

1mth VWAP

Working capital requirements for Mbalam-Nabeba Iron Ore Project

16-Oct-13 Pluton 3 Private

Placement Less than 1%

discount

Bolster balance sheet and progress growth opportunities

13-Sep-13 Legacy 1 Convertible

Notes 10% discount

Had to cancel Entitlement Offer to raise $25m due to market volatility

24-Jan-13 BC Iron 10 Share Purchase

Plan 6% discount to 5

day VWAP Working capital for Nullagine JV

Source: Thomsonone and company announcements.


Miners have been seeking where possible to raise cash through asset sales … however, the big transactions have not come through yet (e.g. IOC)

RECENT IRON ORE ASSET SALES

Seller BHP Billiton FMG Western Desert

Resources Cliffs Asia Pacific Iron Ore Holdings Pty Ltd

Harbinger Capital Partners

Target Jimblebar (15% stake) Nullagine JV (25% stake) Western Desert

Resources Cockatoo Island iron ore

assets

Asian Coast Development

(Canada Ltd) and Ferrous Resources do

Brasol Ltda

Bidder Mitsui & Co Ltd; Itochu

Corporation BC Iron Meijin Energy Group Pluton Resources

Australia Acquisition Corp

Amount (A$m) 1,626.4 190.0 342.1 n.a. 341.1

Announced

Date 20-Jun-13 18-Dec-12 18-Sep-12 1-Aug-12 11-Jul-12

Source: Company announcements.


Despite the gloom in equity, raising US Dollar high yield debt (ie non-investment grade) is cheaper in absolute terms than pre GFC! Although in spread terms, not quite as cheap...

US DEBT MARKETS – NEVER BETTER


0

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011 2013

0

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011 2013

Cheaper in absolute terms than the last ~ 10 years

Median: 8.7%

Median: 5.4%

Spreads not as low, yet still attractive

Credit Suisse High Yield (CS HY) Index (%) High Yield Spread – CS HY Index v. 10-yr US treasuries (%)


The onset of tapering has moved the 30 year bond rate (which is the reference rate for most US mortgages) to ~3.5% …

TAPERING EXPECTATIONS PUSHING UP LONG TERM YIELDS

Source: Company announcements.

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13

Yield

US 30 Year Government Bond Index


KEY THEMES AND CONCLUSIONS

Source: Australian Financial Review.

Global Equities Resource Equities

Global economic outlook is improving even though sovereign debt issues remain

Key Australian and US markets have (more or less) recovered GFC losses and we are entering a bull market phase

Major Equity markets racing along… now including Australia…. and IPOs are back

Interest rate cuts in Australia have sparked a return to equities

Liquidity low but may have bottomed

Small caps looking very cheap and out of favour

Resources have underperformed significantly and may be next in line for a rally

Clear underperforming sector of the past 12

months having been the outperformer through the bear market.

Reasons include major M&A failures, lack of confidence, rising costs and concern around China growth / commodity prices

Overall equities have lagged commodities – and mining equity markets are weak and unloved right now

This has kept the marking for raising money for early stage explorers very subdued

Access to debt for good quality projects remains good

In iron ore specifically:

- Iron ore prices have been strong, bringing equities with it

- Operating costs are coming down

- The challenge remains capital intensity and access to funds


QUESTIONS & ANSWERS

Questions?

AZURE CAPITAL

PO Box Z5340

Perth Western Australia 6831

Level 34 Exchange Plaza

2 The Esplanade Perth

Western Australia 6000

Phone: +61 8 6263 0888

Fax: +61 8 6263 0878

www.azurecapital.com.au

AZURE CAPITAL

Simon Price, Azure Capital: Reviewing Investors Demands for Iron Ore in 2014

Business

Transcript of Simon Price, Azure Capital: Reviewing Investors Demands for Iron Ore in 2014