I’ve had a couple folks ask me about iron ore and “black rock fuel” (which was a phrase invented by copywriters selling Benjamin Shepherd’s Global Investment Strategist newsletter), so I thought that on this Memorial Day, when no one is strolling the halls here at glorious Gumshoe Headquarters, I’d take that teaser solution I shared with the Irregulars about six weeks ago and let the whole gang check it out.
The stocks teased by Shepherd, by the way, are little changed in those six weeks — they’re down one or two percent, while the S&P 500 has been up by 3 or 4%. So if the tease was brilliant, well, you haven’t missed anything yet. What follows is an excerpt from the Friday File of April 11 and has not been updated.
Benjamin Shepherd is touting a way to effectively buy China’s growth (yes, even slowing growth is still growth) without investing in a worrisome Chinese company, here’s how he puts it:
“What’s So Special About This Rock?
“Known simply as Black Rock Fuel, this seemingly ordinary stone will propel China’s growth for decades to come.
“Here’s the story behind why Asia is racing to snatch up every last bit of this fuel… and how YOU can profit (without touching a Chinese stock) when they do.”
That “Black Rock” is, as he eventually admits a bit later on, iron ore — which means he’s sticking his neck out a little bit, talking up the major ingredient of steel at a time when many pundits are terrified that China’s massive infrastructure-building push (infrastructure, from bridges to skyscrapers, requires massive amounts of steel).
So that’s interesting — as you’ve probably noticed, the press is quick to talk about the oversupply if iron ore (the first line of the last article I read on this yesterday was, “The world is mining more iron ore than steelmakers need.”) And prices remain historically quite high if your time frame goes back a while — iron ore has vacillated from about $100-180/tonne over the last five years, mostly on fluctuating demand (and demand expectations) from China, but ten years ago it was under $20.
Iron ore is the most valuable export from Australia, which also happens to be the closest major exporter to China (Brazil and Canada are also major iron ore exporters, but they’re a bit further away … and shipping the stuff is expensive because it’s heavy, that price is only about six cents a pound for iron ore so shipping is a bigger consideration than it is for, say, copper at $3 a pound or zinc at 90 cents a pound), so it’s probably no surprise that Shepherd decides to talk up some Aussie iron ore exporters. Which ones?
Well, this ain’t exactly a small cap newsletter — Shepherd’s previous newsletter was about ETFs, I think, and he seems much more focused on playing the big trend than on finding the undiscovered gem of a stock. That’s probably pretty rational, even as it’s not terribly sexy or exciting.
So with that caveat, which stocks do you reckon he’s touting? You’re right — it’s Rio Tinto (RIO) and BHP Billiton (BHP). The two largest mining companies in the world (yes, I hear you whining, Vale, but your weakness at home in Brazil means you’re now firmly down at number three).
Here’s his full pitch on each of them:
“Black Rock Fuel Profit-Maker #1
“Your first opportunity to profit from China’s explosive growth is a world-class miner founded in 1873 and headquartered in London.
“This company is an essential partner to China because it plans to expand Black Rock Fuel production over 20% in the next three years, from 290 million tons to 350 million tons.
“That will help feed China’s voracious appetite for the fuel.
“As a result of its expansion plans, its share price has shot up 37% since July.
“Best of all, I think this company’s share price has plenty of room to run.
“In addition to being one of the oldest publicly traded mining operations in the world, it’s also one of the most diversified.
“With mines all over the world ranging from copper to gold and from alumina to Black Rock Fuel, it’s uniquely positioned to take advantage of demand for virtually any natural resource needed around the world.
“That includes its coal business, which it expects will grow in lockstep with China’s steel demand because of the heavy amounts of coal burnt to make steel.
“It has an aggressive, forward-looking management team (uncommon in the mining business) that has been aggressively expanding to capitalize on demand and reducing costs at the same time.
“Expansion creates more opportunities.
“And cost reductions equal higher profits.
“That’s important because these efficiencies will likely lead to a nice jump in the already-respectable 3.2% yield it’s paying out.
“Its next dividend payment is set to be paid in just a few weeks, so you’ll want to grab shares as soon as you finish reading the special report, ‘How to Bank Triple-Digit Gains from Black Rock Fuel.'”
That one’s Rio Tinto (RIO), which was originally founded as a partnership to build a mine in Spain 140 years ago but is now built on the foundation of its huge Pilbara iron ore mines in Australia. As one of the biggest mining companies in the world (market cap $100 billion or so, really only BHP Billiton (BHP) is bigger — Vale (VALE) is a little bit smaller) it does also have dozens of other substantial projects and mines around the world — including their controlling interest in the Oyu Tolgoi mine in Mongolia that’s a political football but also one of the largest mines in the world, as well as plenty of other projects producing gold, aluminum, coal, diamonds, potash and other good stuff from underground. Growth in their iron ore export capacity in Australia has been a big focus of late, so the company is certainly levered to that “black rock”.
And for those keeping track of teaser stocks past, Rio also last year wrote down (and, just this week, donated to charity) its stake in the Pebble Mine in Alaska that Northern Dynasty (NAK, NDM.TO) has been trying to develop for years. That mine was beloved by many mining stock newsletters and approval for its development was pitched as a “slam dunk” about five years ago. A nice cautionary tale of how difficult the mining business can be (NAK was a newsletter fave around $4 or $5 in 2009, it got up as high as $20 briefly in 2011 but is now down to 80 cents and probably isn’t worth that much). Thankfully for RIO, the Pebble Mine was never huge to them and it wasn’t a massive writedown — which is perhaps an argument that, yes, if you’re bullish on commodities in general or on China’s long term growth, it’s a lot easier to just pick up one of the major miners than it is to pick and choose among the explorers and the juniors. Less lucrative sometimes, sure, but a lot less risky.
According to their year-end press release, RIO grew revenue and earnings last year despite volatile commodity prices, and is expected to grow again this year. Analysts say you’re paying about 10X next year’s earnings if you buy today, and they do pay a good dividend — the current yield is in the neighborhood of 3-4%, though it isn’t steady or all that predictable (they pay twice a year, like many UK and Aussie companies).
And here’s how Shepherd pitches his other recommendation …
“Black Rock Fuel Profit-Maker #2
“Everything you get in my first pick, you’ll get in spades with Profit-Maker #2.
“Not only is this company the largest miner in the world, but it has significant Black Rock Fuel operations in Australia.
“That means its mines are less than 3,000 miles from China’s southernmost port, which gives it a distinct advantage in shipping times.
“More importantly, it gives this company an incredible cost edge because Black Rock Fuel barges charge miners nearly $33,000 a day to move their product.
“For a company whose shipments to China have jumped 43% year over year, shaving off days on the ocean for each trip adds up to game-changing savings.
“Its share price is up almost 13% since July, and I fully expect it to continue growing at a strong pace along with its shipments to steel-hungry China.
“Best of all, it’s increased its dividends virtually every single quarter for the past 10 years, a sure sign of a winner if there ever was one.
“The current yield is a respectable 3.8%… so you can sit back and get paid to wait for its share price to take off.
“That’s the power of riding a massive trend in a growing market: large capital gains and strong dividends.”
Yep, that’s BHP Billiton (BHP), which is almost twice as big as giant RIO and is the largest diversified natural resources company around. BHP is also a major iron ore player in Australia, and is in many of the same commodities as Rio Tinto elsewhere, like copper and aluminum … but the big difference between the two, other than size, is that BHP also has a major energy business, mostly oil & gas in North America and in the Gulf of Mexico. You can see their latest annual presentation to get a better picture of the whole company, but just as with RIO they are quite levered to the price of iron ore — in fact, for both companies the relatively strong price of iron ore in 2013 helped to make up for declining prices in other commodities.
With both of these stocks you’re getting strong exposure to Chinese and other emerging market growth, and, indeed, to global growth generally — and both are fairly well diversified across base metals and other commodities, but are particularly levered to iron (and, therefore, steel). They’re also so large that they’ve gradually been able to effectively let the MBA’s loose on their operations and become more efficient at capital allocation, debt management, forecasting and cost cutting, which means they aren’t quite as sensitive to fluctuating prices as the little guys are.
Over the last five years BHP and RIO have pretty much traded together, they’ve both done well and there haven’t been major differentiators over the long term despite the fact that RIO is substantially more levered to iron than is BHP Billiton.
I’ve been more interested in royalty plays like Altius (which does have some smaller deals with RIO in Canada) when it comes to iron ore, but there’s something to be said for going with the behemoths. Iron ore is one of the more profitable commodities around at this price, at least for the huge producers who have had decades to develop huge, highly efficient mines, so if you think Chinese demand will remain strong or that iron ore has any chance of re-testing those highs up near $200, well, either one of these stocks would probably be a no-brainer… and if you just think iron ore will stay steady in the $100-140 range over the next couple years then both will probably do quite well, too, the problems really come if investors are convinced that China’s falling apart and iron ore drops to $80.
It’s probably wise to be somewhat conservative when you’re guessing at iron ore prices out a few years, because a lot of new capacity is coming online both from these two leaders and Vale and from others by 2016 (including Altius partner Alderon (AXX), hopefully). Short-term dynamics are much iffier — traders always overreact to the latest news out of China, and they seem to care more about infrastructure stimulus spending than they do about GDP growth when it comes to iron ore demand, so the news that China may be stimulating their economy again got everyone excited and drove these stocks up about 10% over the last month despite relatively disappointing GDP and growth numbers out of the Middle Kingdom.
Which is a long way of saying I have no idea what these stocks will do over the next few months… but if you love the prospects for iron ore then RIO is probably a fine choice, and if you just want one general commodity stock to play global growth then it’s hard to go wrong with BHP, the biggest miner in the world.
Have any thoughts on iron ore? Feel free to comment on this article and etch your opinions in cyberspace.