Black Iron: A Low Cost High Grade Turnaround Iron Ore Play
January 19, 2018 5:55 pm ET
The best value investing opportunities often come from industries that are experiencing a turnaround after a prolonged decline. In these situations, many investors have moved on to other opportunities and it takes time for the market to catch on to the new reality. The market for iron-ore could be one of these opportunities with a unique twist: New Chinese environmental regulations are favoring high-quality producers over low-cost producers and this is being reflected in iron content grade premiums and penalties.
Black Iron Inc. (TSX: BKI, OTC: BKIRF) is a development-stage iron-ore miner that made significant progress towards commercialization prior to the market’s sharp decline between 2014 and 2016. With the rebound in iron-ore prices and new Chinese environmental regulations, the company is uniquely positioned to benefit from its near-term production of ultrahigh-grade iron-ore product in a region that’s geographically ideal for exports to many steel producing regions.
Back on Track
The market for iron-ore has experienced a rollercoaster ride over the past several years.
Between 2014 and 2016, iron-ore prices fell from nearly $140 per ton to a low of $40 per ton amid an increase in low-cost Australian production that outpaced Chinese demand. Iron prices were further impacted by high cost Chinese miners continuing to operate at a loss since majority of these mines are owned by steel mills that import significantly more ore than is mined domestically resulting in further oversupply to depress global prices. The good news is that prices have doubled since then from $40 per ton to nearly $80 per ton and could be heading higher given the state of the global economy.
Figure 1 - Iron Ore Prices - Source: TradingEconomics
China has recently undergone an environmental crackdown that could divide the iron-ore industry. According to Reuters, Chinese regulators recently cancelled one third of domestic iron ore mining licenses, mostly belonging to low grade high emitting mines, to curb pollution. Further, heavily polluting industries that operate in provinces like Hebei, Shanxi, and Shandong are being forced by regulators to reduce output and curb emissions over the winter heating season that runs from October to March. This means that mills have to either cut steel production or find ways to sustainably reduce emissions.
The good news is restrictions on emissions in China have driven the demand for higher quality feedstock. For the steel industry this means products with high iron content as the higher the iron grade in the mill feed the less coal required to burn and subsequent emissions released per tonne of steel produced. This has helped companies that produce a higher iron content product like Brazil’s Vale (NYSE: VALE), and Anglo-American (LON: AAL) at the expense of lowest-cost and grade Australian mines like Fortescue (ASX: FMG) or BHP Billiton (NYSE: BHP).
At today’s iron content premium of $7 to $8 per 1% iron, Black Iron’s ultra high grade 68% product will receive a $40 to $50 per ton premium over the ~$77 per ton benchmark price for a product that costs $31 per tonne to produce. Even if benchmark iron ore prices fall, iron content premiums are likely to remain at or above current levels given global concerns to curb pollution.
In a Good Place
Black Iron raised $38 million in an initial public offering on the Toronto Stock Exchange at $1.40 per share, completed a bankable feasibility study, several major permit milestones and received a $511 million construction finance commitment from Metinvest - the 9th largest iron-ore miner and 16th largest steel producer in the world - just before 2014. The company also had advanced discussions on prepaid offtake with a well financially backed international commodities trader to round out the financing required to construct the project.
What drew Metinvest and this commodity trader to Black Iron is production of an ultrahigh grade 68% iron content product and all major infrastructure including railway, port and power plus highly skilled relative low cost labour being in place close to the ore body. Having all of the major infrastructure allows for the project to be built at a much lower capital cost, in a phased manner and relatively short time frame.
The company’s Shymanivske, Ukraine-based project covers 2.56 square kilometers and is adjacent to ArcelorMittal’s iron-ore mine and steel mill and Metinvest and Evraz’s YuGOK iron-ore mine. In addition, the company has already secured rail, port, and power access to bring iron-ore to steel mills in nearby Europe, Turkey, and the Middle East. The distance to India and China is also about 20% to 25% lower than North and South American producers.
When iron-ore prices collapsed and war broke out in Ukraine, the company’s offtake negotiations were halted, Metinvest divested, and two of its largest shareholders sold their positions. These setbacks have since been remedied as the Ukraine situation has improved markedly and iron ore prices have recovered sharply to nearly $80 per ton. Iron content premiums have also risen to two to three times the historic levels given China’s new regulations.
The company’s high-quality iron ore translates to less emissions generated per ton of steel produced and increased steel blast furnace productivity that lowers the cost to produce steel. This combination means that the company’s iron ore output is uniquely positioned to address China’s new environmental needs.
Black Iron Inc. (TSX: BKI; OTC: BKIRF) is a little-known company that’s well positioned to benefit from the recovery in iron-ore prices and China’s move to more environmentally-friendly steel production. After experiencing some setbacks between 2014 and 2016, the company has become significantly undervalued relative to its peers based on ratios like EV-to-Contained Reserves and EV-to-Contain M&I Iron, despite its near-term potential, sound capital structure and highly experienced management team.
The company has a new go forward plan to construct the mine in a phased approach to significantly lower the initial capital required to get into production. Moreover, the construction can be financed largely through off-take, export credit, and bonds rather than solely equity capital as was successfully done in 2014.
Investors interested in capitalizing on iron-ore’s recovery and China’s move to environmentally-friendly steel production may want to take a closer look at the stock.
For more information, visit the company’s website at www.blackiron.com.