uploads///Iron ore

Lower unit costs offset price weakness in BHP’s iron ore segment

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Mar. 24 2015, Updated 2:06 p.m. ET

Steady production growth

BHP’s iron ore production increased by 16% in 1H15 to a record 113 million tons. BHP’s main iron ore asset is Western Australia Iron Ore (or WAIO), which consists of an integrated system of mines and ~1,000 kilometers of rail infrastructure and port facilities in the Pilbara region of western Australia. WAIO produced a record 124 million tons (on a 100% basis), an increase of 15% year-over-year. This was due to the ramp-up of Jimblebar and the improved availability and utilization of its supply chain.

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Lower prices impact profitability

The average realized prices for iron ore declined by 37.5% year-over-year in 1H15. The decline significantly impacted the profitability of the division. Underlying EBIT for the half year decreased by $2.3 billion to $4.2 billion, a decline of 35.4%.

Lower unit costs

WAIO reduced its unit cash costs by 29% to $20.35 per ton, as the operation benefited from economies of scale, a reduction in overhead, contractor, labor, and maintenance costs, and a stronger US dollar. Due to this, WAIO is well placed to achieve its targeted reduction in unit costs to below $20 per ton ahead of schedule.

There are currently no major projects in execution at WAIO. The company expects to achieve further growth in supply chain capacity to 270 million tons per annum (or Mtpa on a 100% basis) without the need for additional capex. As highlighted previously, inner harbor de-bottlenecking and Jimblebar Phase 2 projects have the potential to increase total capacity to 290 Mtpa by the end of fiscal year 2017 at very low capital cost.

Outlook

Production growth remains strong for large companies, including BHP, RIO, and VALE. This production growth, without a proportionate increase in demand, is putting downward pressure on prices. This could negatively affect pure-play, high-debt iron ore names like Cliffs Natural Resources (CLF).

It’s important to note that ETFs like the iShares MSCI Global Metals & Mining Producers ETF (PICK) also provide exposure to the metals and mining sector. BHP and RIO form 29.5% of the fund’s total assets. The SPDR S&P Metals & Mining ETF (XME) also invests in some of these stocks.

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