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How iron ore price collapse affects iron ore names

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Iron ore price hits 5-plus-year low

China’s cost and freight 62% (iron content) iron ore price—the benchmark—hit a five-and-a-half year low of $70 per ton. That’s a 49% decline year-to-date in the cost and freight (or CFR) price. The supply glut and weaker demand factors that we’ve touched on previously in this series led to this collapse.

Investors may want to know which iron ore companies are hit the hardest and which are doing relatively fine. We’ll answer that question now.

Year-to-date performance

Rio Tinto (RIO) is the best performer among all the iron ore producers. It is down just 19.8% year-to-date (or YTD). Meanwhile, BHP Billiton Ltd (BHP) is down 24.1% YTD. This fall, however, is not only because of the iron ore price decline, but a portion is because of a recent slump in oil prices. We’ll cover the impact of the oil price decline on BHP’s petroleum division in a separate series.

Vale SA (VALE) is down 51.6%. The pure plays and midcaps like Fortescue Metals Group (FMG) and Cliffs Natural Resources (CLF) are down 58.3% and a whopping 73.6%, respectively.

The bigger, the better

The above chart shows that Rio Tinto and BHP Billiton are relatively shielded from falling iron ore prices. Strong cost positions allow them to do better in this price environment. For these two players, break-even is between $45 and $55 per ton, which provides a cushion at current levels.

Both companies have recently announced yet more capacity additions. But, at lower capital costs, economies of scale are such that the cost per ton produced could be further reduced. The resulting savings might shield the companies somewhat from the probability of a continued decline in iron ore prices. However, even these companies are feeling the pressure on their cash flows. The major reason was their inability to reach their debt targets or defer their capital management plans.

For pure plays and smaller players like Fortescue Metals and Cliffs Natural Resources, the remaining margin cushion is too low at the current levels, making them much more sensitive to iron ore prices. Cliffs Natural Resources has company-specific issues such as activist problems and acquisitions gone wrong, which made matters worse.

ETFs such as the SPDR S&P Metals and Mining ETF (XME) are good ways of gaining exposure to this sector without picking individual company stocks.

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