The problem is that declining iron ore prices could persist until 2019, and no-one really knows where the bottom of the market could be.
An indication of how serious the problem is came two weeks ago, when Investec Asset Management said Anglo American should sell its iron ore assets.
Analysts Hunter Hillcoat and Marc Elliott write that Anglo could raise up to R55,1bn by selling iron ore assets in SA and Brazil. "A disposal of the entire iron ore portfolio would be a game-changing transaction, strengthening the balance sheet, reducing the risk profile of the group and potentially enabling a substantial re-rating."
Kumba is also looking at possible sales. In a recent trading statement, CE Norman Mbazima says the company might sell or close down its Thabazimbi mine in Limpopo. Operations at Thabazimbi have already been suspended.
"We have cut head office staff by 40% and reduced capital expenditure. Last year we reduced dividend payouts by 42%," says Mbazima.
But why is the price of iron ore so low?
It's largely because the four largest producers of iron ore in the world - Rio Tinto, BHP Billiton, Vale and Fortescue Metals - have been on a merciless low-cost production output drive as they fight for market share. This production far outstrips demand.
"Major producers remain intent on expansions and a battle for market share is under way as miners attempt to reduce costs faster than prices are dropping," says Credit Suisse
This is the position Kumba finds itself in.
In its trading statement for the six months to June 30, Kumba warns that headline and basic earnings are likely to be 20% lower.
"The decrease in earnings is primarily attributable to the significant decrease in export iron ore prices during the period," says Mbazima.
It does not help that one of the main export markets, China, is heading for its worst GDP growth, about 6%, in 25 years. The People's Bank of China says the economy is still facing "relatively big downward pressure". This is not only affecting demand for iron ore but adding to the global glut because China, itself a large producer of iron ore, subsidises its companies to increase production.
And lower iron ore prices are here to stay. "The growth in demand for iron ore is happening at a slower rate than the addition of low-cost supply," BHP Billiton CE Andrew Mackenzie recently told a presentation. Ironically, his company is one that is causing the oversupply of low-cost iron. He adds: "We're bearish about iron ore prices in the medium to long term."
"There's just a huge amount of overcapacity," writes Richard Knights, mining analyst at Liberum Capital, in a recent report. "It's very clear that for at least the next three years the new supply additions are going to outstrip any incremental demand growth."
Many analysts and consensus forecasts have Kumba as a sell. It's not hard to see why, and the Financial Mail would have to agree. The share price, down 59% in the past year, looks attractive on present ratings. The p:e ratio is 4,3 and could reach 9,8. The dividend yield is also a generous 15,8%.
But no-one knows where the bottom of the share price could be. And if forecasts that iron ore prices will keep dropping until 2019 are correct, the share price could go much lower.
Source: Financial Mail
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