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China, capacity and commodities

Both Rio Tinto and Fortescue have a heavy skew to Chinese economic growth and BHP Billiton is not immune either. But has volatility in iron ore prices and apparent weakness in Chinese growth tainted the story for owning these stocks?

China’s new government has re-adjusted the country’s growth expectations as well as its composition. That entails an adjustment to investment thinking in regard to resource companies that are beneficiaries of China’s urbanisation decade.

GDP growth of 7.5% is a more than acceptable target that keeps a surging property market in control and yet allows the economy to modernise its housing stock and associated infrastructure without imperilling inflation.

If demand for crude steel ticks up towards 700mtpa in China, representing about half of world consumption at present, then Australia’s increasing exports of iron ore and coking coal should be comfortably accommodated.

Exports of Australian iron ore represent approximately half of China’s seaborne imports of iron ore averaging around 30mt per month. Despite the volatility in the iron ore price, the trajectory of China’s iron ore imports has been unswayed:

Price has been the dominant factor in the operating earnings of BHP, RIO and FMG in the last six-month period but all three companies are now rapidly closing in on completion of big capacity expansions in iron ore.

FMG will reach its target 155mtpa annualised capacity target around mid-year. RIO’s capacity will hit 290mtpa by September and BHP’s capacity is approaching 200mtpa (100% basis).

The emphasis on earnings from iron ore for each company will always be sensitive to the commodity price, but volume will become an increasingly important factor.

It is also important to remember that all three companies have large, long life resources that are in the lower quartile in terms of cost of production.

Although we thnk of China as being the primary driver of earnings for BHP and RIO, it’s interesting to note that China represents about 30% of total reveneu for each of BHP and RIO.

2 Responses to China, capacity and commodities

  1. Ben Dehlsen says:

    Hi Greg, In order of rankings, which of these 3 big miners is your preferred stock for long term investors?

    • Greg Fraser says:

      A straightforward question, Ben, but not an easy one to answer. We prefer BHP for its diversity and particularly its US shale gas assets (despite the writedowns) and its portfolio of world class assets-in-waiting (Olympic Dam expansion, Jansen Potash). Rio Tinto has the best iron ore business (volume expansion, technology, low cost reserves) while Fortescue Metals will look much better when the infrastructure sales can facilitate its debt reduction. Thanks for your question.

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