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New highs for Iron Ore

Rivers of gold, not quite, but almost. As global iron prices, however, keep setting new highs, the resounding but old fashioned kerching will resonate this August reporting season for shareholders of Australia’s seaborne iron ore producers.

An embarrassment of riches to come of special and higher dividends from BHP, RIO and FMG further cornerstones the outperformance of these stock’s relative to the banks and the broader market.

Although the PROC (Peoples Republic of China) launched this week an investigation into trading on China’s Dalian iron ore futures market, alleging price manipulation, the inescapable truth is a shortage of high grade ore in the seaborne trade has created and will sustain record over the cycle iron ore prices.

And while the big three’s nameplate mines are running full tilt, there is a very orderly progression of bringing on new production. Rather than produce more for prices sake. A very disciplined and un mining like approach.

Unique circumstances at play in iron ore is the PROC’s stimulus for the Chinese economy, during the Trump tariff war. And that is not ending anytime soon given the size of China’s currency reserves.  Chinese steel production is breaking all previous barriers, but at the higher iron ore prices, mills are finding it difficult to pass on price increases for their finished products.

So it is possible to see iron ore prices retreating as mills slow seasonal production. A reversion to $70-80 a tonne will still see the big three continue to crank out extremely healthy profits and higher dividends. Mining costs are still well below $USD 20 a tonne

Citibank’s resource analyst reckons iron ore prices will moderate slightly to $US100 a tonne in the September quarter and $US95 in the December quarter, before settling at $US80 a tonne in calendar 2020.

The share prices increase of BHP RIO and FMG are nothing short of staggering.

Since March 2016 Rio and BHP’s shares are up about 145 per cent. FMG has more doubled as well in the time we have prognosticated about the miners beating the banks as the new high yields dividend payer. On average, in this period, all three dividend yields have been higher than 8% before franking.

RIO’s profit in calendar 2020 in this scenario will come in at a whopping $US12.5 billion – at least 37% ahead of current market consensus.

RIO could pay a total June half dividend, this year, of close to $US3.50 compared

With $US1.27 last year. RIO is limited in doing buybacks – foreign shareholders are

nudging the 15% FIRB limit. So cash is the only alternative.

BHP paid a special dividend in December to hand back the proceeds of its sale of its US shale assets, and FMG announced a special dividend in February to get ahead of potential franking changes.

BHP could pay a US85¢ ordinary dividend, plus a US39¢ special dividend, for a total capital return of $US1.25 a share for the June half. In comparison, the resources giant paid a dividend of US63¢ for the same period last year.

On these sorts of numbers we are reiterating our view it’s possible to see BHP with a $5 in front of its number, RIO at over $120 and FMG well through $10 a share as the cash generated from iron sales gets passed back to shareholders.

The balance sheets of the big three are in best shape ever, with historically low levels of debt. And the laser like focus on sweating mining assets harder means its unlikely management will veer off into mergers and acquisitions. Any deal BHP and Rio contemplate has to be large enough to turn the dial and it’s hard to add production growth when earning massive profits from iron ore. 

Which further shores our view shareholders are set to benefit as the miners pay out bigger dividends as profits increase? That is bolstered by what is happening with interest rates. The Australian dollar has de-coupling from commodity prices in a way not usually seen in previous cycles, which has given profits another boost.

Our canary in the coal mine is watching the iron ore price.  The commodity cycle jig might be up if iron ore falls below $USD 50 a tonne. While that seems unlikely never say never.

So there are opportunities to drag out decent returns from the miners over the 12-18 months. Remember to keep price targets in mind.

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