Why High-Grade Iron Ore is Poised to Rise and How to Invest
November 5, 2018 10:07 pm ET
Benchmark iron ore prices have risen from less than $66.00 per ton in early September to more than $75.00 per ton in recent weeks, driven by a 4.7% increase in global steel production during the first nine months of 2018 compared to last year. In addition, China could introduce a new stimulus package to combat rising trade tensions with the United States and bolster its domestic economy—a move that would surely increase demand for steel.
On the other hand, China has been cracking down on steelmaker emissions as they’re a primary contributor to pollution. Steelmaking provinces, like Hebei, have issued “orange” smog alerts in recent weeks that have forced steel mills to halve their output to improve air quality. The government has also started limiting steel production and encouraging steel mills to favor recycling over raw material to reduce pollution.
Why Grades Matters
Many iron-ore producers are concerned over these trends, but some companies have seen their revenue soar. For example, Vale SA (NYSE: VALE) has seen its share prices rise 53% over the past 52 weeks compared to a roughly-even year for BHP Billiton plc (NYSE: BPH). The difference between Vale and many of its competitors is that the company is a leading producer of high-grade iron ore, which has captured much higher premiums.
The gap between benchmark and high-grade iron ore has increased threefold over the past two years and is poised to continue to rise amid the environmental crackdown in China. Benchmark 62% iron-ore trades at around $73.64 per ton, compared to $98.05 for high-grade 65% iron-ore—a $24.41 or 33% premium. Investors may want to consider investing in producers of high-grade iron ore to capture greater profit margins.
In addition to these higher margins, high-grade iron ore producers have seen stronger revenue. Vale recently announced record iron ore production during the third quarter at a time when many other benchmark producers have been suffering from lower sales. In fact, the company plans to cut its net debt in half to $10 billion and increase returns to shareholders thanks to its strong top-line and bottom-line financial results.
Investing in Producers
There are a handful of high-grade iron ore producers with existing production and revenue, but many of these companies are already trading at high valuation multiples. Instead, investors may want to check out development-stage companies that are close to commercialization, but still trade at discounted valuations. These companies could see the greatest long-term benefit as high-grade iron ore continues to go into vogue.
Black Iron Inc. (TSX: BKI) (OTC: BKIRF) (FFT: BIN) is a development-stage opportunity that aims to produce 68% ultra-high grade iron ore. Management believes that this level of purity could command a $40 per ton premium over benchmark iron ore, especially since less than five percent of global producers are able to achieve this grade. The lower pollution dynamics could also lead to greater demand than even 65% iron ore.
The company has a 100% owned project in Ukraine that was initially derailed by the Russian crisis, but is quickly coming back online. Assuming a conservative $62 per ton long-term price for benchmark iron ore, the company projects a 40% after-tax levered internal rate of return. At current prices, the company estimates that it could achieve a 68% after-tax levered return given the strong pricing and premium for high-grade iron ore.
Black Iron Inc. (TSX: BKI) (OTC: BKIRF) (FFT: BIN) recently announced that it received a formal proposal from Ukraine’s government to lease a plot of land connected to its Shymanivske iron ore body for location of the processing plant, tailings, and waste rock. This marks a significant milestone for the company and demonstrates the Ukrainian government’s support for the mine to be constructed in a timely manner starting mid next year.
Management has also been recently holding discussions with potential offtake partners including large steel mills and metals traders to provide the right to purchase its product over a period of time in exchange for a meaningful investment to help fund the project’s construction and build out—the final piece of commercializing the venture. Investors may want to capitalize on this opportunity ahead of these anticipated catalysts.
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