Iron ore juniors stage a comeback

Small iron ore stocks are showing signs of life, but remain high risk.

Summary: There are signs already that the potential recovery in the largely forgotten small iron ore sector will be worth watching.

Key take-out: Having been pushed to the edge of a cliff, a rising price and high-grade deposits may make some iron ore juniors the sweetest 'fish' off all. 

Key beneficiaries: General investors. Category: Commodities, shares. 

Life is returning to small iron ore stocks devastated three years ago by soaring costs and a plummeting iron ore price, which combined to wipe out much of the sector and left the industry to large miners.

The future of iron ore will remain largely a business for big companies able to operate in a way that delivers the economies of scale needed in bulk mining, where transport costs are critical to success or failure.

But flying below the leaders  that group comprising BHP Billiton, Rio Tinto, Fortescue Metals Group and Hancock Prospecting  are a band of minnows which own high-grade ore deposits which can command a premium price and which are benefiting from a massive fall in costs.

It is the combination of a price, which has crept up from less than $US40 a tonne during the depths of the crash to around $US55, and the sharp costs decline which has seen a restart in development plans by small miners.

Two of the possible restarts have the benefit of minimal transport costs because they are on islands off Western Australia’s Kimberley coast, have most necessary handling equipment in place, and have ore so high in quality that it sometimes has to be blended down to meet steel mill specifications.

Koolan Island, one of Australia’s oldest iron ore projects, was developed by BHP in the 1950s and brought back to life in 2007 by Mount Gibson Iron, only to be closed two years ago when a sea-wall protecting the main pit on the island (which is below sea level) ruptured, flooding the workings.

Cockatoo Island, in the same area of Yampi Sound north of Derby, is also showing signs of being revived with a complex legal dispute moving closer to a settlement and the receiver of failed owner Pluton Resources offering the business for sale, promoting the exceptional grade of ore remaining as up to 68 per cent iron in part versus the industry standard of 62 per cent.

A third small iron ore revival situation emerging is BC Iron, which is currently posting reasonable profits from its Iron Valley mine in the Pilbara region of WA (shadowed by the majors), but has also recently dusted off plans for the much bigger Buckland project.

Atlas Iron, one of the small iron ore miners to suffer a near-death experience, remains in production but is essentially controlled by its creditors while Mineral Resources, a diversified service provider, has its own Carina mine and operates the Iron Valley mine for BC Iron.

There is no guarantee that the small iron ore miners will get any bigger, but some of them are examples of an old investment saying about “little fish being sweetest”.

Chart 1: Iron-ore junior share prices, past 12 months

Source: Bloomberg, Eureka Report

The small survivors are also an example of the benefit flowing to the industry from the sharp reduction in operating costs that are a result of stronger management able to enforce wage reductions, tighter operating schedules and an abundance of surplus (and cheap) capital equipment.

All producers are also benefiting from the modest price recovery and the lower exchange rate against the US dollar – two moving parts in the profit equation which can change suddenly and are beyond the control of the miners. Fitch Ratings, in a recent report on the iron ore industry, forecast a fall soon to $US45/t, a level which it reckons will become the long-term price.

Of the three small-iron case studies, BC’s Buckland project looks the hardest to achieve given its cost and the need to develop the mine, a railway connection and port facilities.

Two possible development options are being considered and both depend of signing up a partner with deep pockets but the potential iron ore cash cost on a per tonne basis is interesting.

If developed as an eight million tonne a year project costing $880 million it could produce ore at a cash cost of $32/t, less than half the current Australian dollar iron ore price of $72. At 18 million tonnes a year the cash cost per tonne of Buckland ore falls to $29.

On the market, BC has come close to doubling over the past month with a rise from 13.5c to 24c.

Pluton’s primary asset, the Cockatoo Island mine, is a more complex possibility given the legal issues which include a breakdown in the relationship between the Australian company and its Chinese partner in the project.

However, if Cockatoo Island does get a simplified ownership structure it is a mine which Pitcher Partners, the receivers of Pluton, reckon still contains more than 46 million tonnes of ore averaging 68 per cent iron (which is diluted to 62 per cent).

Like Koolan Island the mine itself sits below sea level and is being kept dry by continuous pumping. The sea wall is believed to need repairs but most major items of capital equipment, including a ship loader, remain in place, ready for a restart.

Mount Gibson, the owner of Koolan Island, is the small iron miner most likely to re-invest in the industry thanks to four factors.

  1. It has an existing operation on the Australian mainland at Extension Hill, inland from Geraldton in WA’s Mid-West region, with another nearby orebody, Iron Hill, an option to keep cash flowing amid a restart at Koolan;

  2. It received a hefty $86m insurance payment in June a result of the sea wall failure (with more possible under business interruption insurance);

  3. It already has around $400m cash in the bank from earlier year operations, and;

  4. Redeveloping Koolan Island, according to a Macquarie Bank analysis, would probably cost less than $90m, roughly the same as Mount Gibson’s insurance payout.

Macquarie reckons redeveloping Koolan Island is highly likely with cash costs after a restart expected to be around $35/t and annual production expected to be around four million tonnes.

On the market, Mount Gibson got its biggest kick along after the insurance settlement was announced in mid-June, lifting the stock from 19c to 33c. It has since retreated to 29.5c, but Macquarie reckons it has a 12-month price target of 47c.

Multiple factors could swing the revival of the small iron ore sector. The price of ore is obviously a critical factor, but so too is the exchange rate and the ability of the miners to keep a lid on costs.

But having been pushed to the edge of a cliff (and with some going over the edge) the potential recovery in a largely forgotten sector should be worth watching.