The major global iron-ore producers— BHP Group , Vale , and Rio Tinto —look appealing after the recent sharp declines in their stock prices because they are now discounting lower commodity prices.
The stocks are discounting an iron-ore price of $86.37 a metric ton, against the current spot price of $107 a ton, Chris LaFemina, a Jefferies analyst, says in a note titled “What Iron Price is Priced In.”
“If the reality in China is a soft landing in which the government manages the Evergrande collapse without causing contagion, these shares are undervalued and would likely outperform,” he wrote. “This is our cautiously optimistic base case, and we reiterate Buys on Rio, BHP and Vale.”
China is the largest consumer of iron ore, accounting for about half of global demand. Its property sector is a major user of steel.
Iron ore prices have fallen by more than 50% from spring highs reflecting a slowdown in China and efforts by the government to curtail emissions from steel mills.
LaFemina sought to determine the iron-ore price that would lead to a price-to–earnings ratio of 10, a free-cash flow yield of 10%, and a ratio of enterprise value to Ebitda (earnings before interest, taxes, depreciation, and amortization) of five for the major producers. He arrived at an average iron price of $86.37 a metric ton. BHP and Rio’s estimated cost to mine and deliver iron ore to China is about $35 a metric ton, making them still profitable at lower iron-ore prices.
Barron’s wrote favorably recently on the five major mining companies, including BHP (ticker: BHP, BBL), Rio Tinto (RIO), and Vale (VALE). We argued that the stocks looked inexpensive based on strong balance sheets, ample free cash flow, and attractive dividends. Our view was that the stocks were anticipating more weakness in Chinese economic activity.
