Iron ore juniors rush to the exits

Arrium is reverting back to its roots as a steel business. Mt Gibson is considering a switch out of iron ore, and Mineral Resources is planning a grand adventure in 21^st century materials handling by building a 330km ore-hauling monorail in WA's Pilbara region.

There's a pattern in those moves by three companies which have been closely associated with the iron ore business over the past few years, and it's a pattern that can be seen forming in other companies as low prices destroy profits and management looks for something else to do.

Shareholders should also be taking an interest in what's happening because a switch could mean that the company in which they originally invested is not the company they're about to get.

Some investors might be happy with a change but others might prefer cash back today rather than being exposed to a fresh set of risks in a business that might catch the eye of management but which is not suitable for their portfolios.

Atlas Iron and BC Iron, two other players in the small to mid-tier iron ore sector have not publicly declared their plans to quit the industry but a few shareholders are probably thinking they might after both this week revealed big losses for the six months to December 31.

Atlas incurred a trading loss of $139 million in the December half, a number which blew out to more than $1 billion after asset value write-downs, bringing with it an auditor's warning that the company might need to raise fresh capital. BC reported a trading loss of $96m.

Other recent results in the iron ore sector include Arrium posting a loss after asset-value write-offs of $1.49bn with a small underlying profit of $189m, while Mt Gibson lost $869.8m after accounting for non-cash asset impairments, with a small underlying profit of $2.7m. Mineral Resources incurred a loss of $30.3m in the December half compared with a profit of $100m in the previous six month period (to June 30).

All iron ore miners are being squeezed by the fall in the price of their principal product which has more than halved over the past 12 months and while it ticked back above $US64 a tonne last night most smaller producers of the material are struggling to stay in the business.

That's not the case with the three leaders of the industry, Rio Tinto, BHP Billiton and Fortescue Metals Group. They have been able to drive costs down almost as fast as the price has fallen, cutting profit margins but not by so much that an exit from the business is being considered.

The smaller miners are now stuck in a desperate race to keep ahead of the price which has devastated their profits and left them with a hard choice: hang in and hope cost cutting is deep enough to survive for a price recovery, or switch into a business with greater potential.

For investors who own shares in small iron ore stocks that situation triggers an equally tricky choice because while they originally acquired exposure to iron ore they might soon find themselves exposed to something completely different – while also hoping that they are not about to suffer a “frying pan into the fire” experience.

In the case of Mt Gibson and Atlas conditions could probably not be much worse than where they find themselves today.

Atlas, according to yesterday's half-year report, is still producing iron ore for very close to what it is being paid. Mt Gibson has lost the production from its biggest asset, the Koolan Island mine off the Kimberley coast, after a sea wall protecting the pit from the Indian Ocean collapsed.

Of the small iron mining companies which once attracted strong investor support Mt Gibson is both the hard luck story and the clearest pointer to what might soon happen.

An insurance claim could add a handsome pot of cash to the $354m Mt Gibson had in its bank account at the end of December, a reminder of the good years in iron ore and an interesting number because it is well above the stock's current market value of $256m.

Having cash is one thing. Knowing what to do with it is another and all that shareholders know today is that management is looking at opportunities after what chief executive Jim Beyer describes as “getting our backyard in order”.

“The board's view is that we are a mining company and that's where we want to grow but I think in the short term if we were looking at anything it might be considered a distraction from what is a pretty important focus inward,” Beyer said last week.

“What commodities and what form is something that's opening up more than it was in the past. But we see no reason or no point in rushing it.”

Decoded, Beyer is obviously seeing iron ore as a tough business likely to be dominated for years by the big three, especially Rio Tinto and BHP Billiton as they drive their cash costs per tonne down to just $US17 and $US20 a tonne respectively – less than half what most small miners are able to achieve.

Arrium was the first of the smaller iron ore producers to unveil a switch – that is if you exclude the companies which simply shut the mine gate, such as IMX at its Cairn Hill mine in South Australia, Sherwin Iron at its Roper River mine in the Northern Territory, Western Desert at its Roper Bar mine also in the NT, and Pluton Resources at its Cockatoo Island mine which is close to Mt Gibson's Koolan Island mine off the Kimberley coast.

While not completely out of iron ore Arrium has mothballed its Southern Iron operations, incurring a $1.7bn asset value write-down and 580 people their jobs.

Arrium is persisting with mining iron ore in the Middleback Ranges but the cutely named “re-design” of the business puts a revised emphasis on the OneSteel division which was once part of BHP Billiton, and mining consumables such grinding medium – or heavy steel balls used to crush ore.

Mineral Resources, a business that started as a service provider to mining companies, is persisting with its iron ore mining business through exposure to the Carina and Iron Valley mines in WA.

But it is significant that the company's founder and managing director, Chris Ellison, spent more time in a strategy presentation earlier this week on the service provision operations of Mineral Resources and less on its struggling iron ore mining assets.

The highlight of Ellison's 22-page presentation was a vision for an ore-hauling monorail which could theoretically make a deep cut into the cost of transporting ore from remote orebodies in the Pilbara to Port Hedland.

Source: Mineral Resources

Novel in its approach to shifting a heavy commodity the Bulk Ore Transportation System (BOTS), or Skyrail as it has been dubbed, is being trialled on a 3.5km track in China.

If it works Mineral Resources might be able to revolutionise bulk mining because the design envisages a single rail standing on a long line of posts which should mean less route clearing and easier crossing of river valleys.

Ellison said the system would be driven by a diesel (or gas) powered electric system with each 15 tonnes ore car having its own propulsion system.

Challenges lie ahead for Skyrail, including getting government approval for the design, demonstrating that a monorail can compete with the heavy-haul railways of the major producers, raising up to $800m to build the system, and in securing lower government port charges.

What the Skyrail also demonstrates is that management at Mineral Resources is thinking less about mining iron ore and more about the business of transporting it.

In effect, the company appears to be reverting to its original status of assured cash flows from selling services to the mining industry rather than being exposed to the risks of mining.

Skyrail, while being a 21^st century concept, is effectively a variation of the oldest rule in mining: that the people who really make money are those selling the pick axes, not those digging the hole.