Iron Ore Prices Surge as Vale Ordered to Shut Itabira Mines

Iron ore prices gained as top Brazilian miner, Vale S.A VALE, has been ordered to shut its Itabira operations. This development along with the alarming spread of coronavirus in Brazil, which is just behind the United States in coronavirus numbers, have fueled concerns that the scenario will lead to an iron ore supply crunch. Meanwhile, demand in China remains strong. Iron-ore prices are currently trending above $100 per ton and clocked a year-to-date gain of 9%.

Brazil’s Iron Supply at Risk

Per latest reports, total number of coronavirus cases in the Brazil stood at 691,962 and the death toll at 37,312. Brazil is currently the second worst-hit country in the world. Considering that Brazil is the world’s second-largest exporter of iron ore, the aggravating COVID-19 situation has triggered worries that it might constrain iron-ore supply.

Vale has been ordered to shut operations at its Itabira complex by a Brazilian labor court after 188 workers tested positive. It will remain in effect until a binding ruling is issued and ascertained safe by labor inspectors. Notably, the three mines at Itabira churned around 36 million tons, or 12% of Vale's total iron-ore output last year.

In April, Vale had trimmed 2020 iron-ore production guidance to 310-330 Mt from the prior 340-355 Mt, citing the impact of the COVID-19 pandemic as one of the primary reasons. The company reiterated its production guidance stating that the range already factors in a negative impact of 15 Mt from eventual impacts resulting from COVID-19. However, Vale has cautioned that there may be a temporary shortage of pellets for the domestic market owing to the shutdown of the Itabira Complex.

The current situation in Brazil is concerning. Although mining has been allowed to operate as an essential business in the country, rising number of infections among workers might result in a reduced workforce, limit productivity or even lead to closure of mines.

Demand from China Continues to Pick up

The Official NBS Manufacturing PMI in China was 50.6 in May 2020 — the third straight month of increase in factory activity, as companies resumed operations. This indicates a major recovery from the all-time low PMI reading of 35.7 in February, which was weighed down by the coronavirus-induced lockdown. This indicates that China is gradually moving out of the crisis and is working toward full normalization of economic activities.

China, which makes about half of the world’s steel, imports more than 70% of the world’s seaborne iron ore. China produced 996.34 million tons (Mt) of crude steel in 2019, just shy of the 1 billion mark, per the National Bureau of Statistics of China. The figure also marked an improvement of 8.3% over 2018. China produced around 85 Mt of crude steel in April 2020, up from the 79 Mt witnessed in March, taking the total steel production to 318.7 Mt for the January-April time period.

Per the China Iron & Steel Association, China is likely to see a strong recovery in steel demand henceforth as the country's infrastructure investment and production resumption gains more momentum. Thus, the demand for iron ore is expected to remain strong.

The Zacks Mining – Iron industry has gained 34.2% over the past month, outperforming the S&P 500’s and the Basic Materials Sector’s growth of 14.4% and 15.5%, respectively.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright prospects in the near term. The Zacks Mining- Iron Industry, currently carries a Zacks Industry Rank #21, which places it at the top 8% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Going by the EV/EBITDA multiple (a preferred valuation metric for mining companies that have high capital expenditures), the iron-mining industry has a trailing 12-month EV/EBITDA multiple of 3.93, lower than the S&P 500’s EV/EBITDA multiple of 11.82 and the Basic Material Sector’s 9.44.

The impending supply-demand imbalance is expected to keep supporting iron-ore prices, which bodes well for iron miners including Fortescue Metals Group Ltd. FSUGY, Vale, BHP Group Limited BHP and Rio Tinto plc RIO. Further, the combination of higher iron-ore prices and lower oil prices, which make up significant portion of miners’ costs, is likely to translate into improved operating margins and higher free cash flow this year.

Vale, Fortescue Metals, BHP and Rio Tinto gained a respective 34.1%, 31.0%, 27.6% and 24.3%, in the past month. While Fortescue Metals Group carries a Zacks Rank #2 (Buy), Vale, BHP Group and Rio Tinto have a Zacks Rank of 3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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