The fall in the iron ore spot price from a peak of $US180 a tonne last year to under $US90 a tonne will be causing executives at BHP Billiton and Rio Tinto plenty of headaches.
But it will also be vexing the mind of Gina Rinehart, who is currently trying to drive her flagship Roy Hill iron ore project – the project that will turn her into a miner in her own right – towards what now looks like an unlikely deadline of starting shipments in 2014.
A report in The Australian Financial Review last week claimed the economics of the $13 billion project relied on an iron ore price of at least $US100 a tonne. But this week, Morgan Stanley tipped spot prices to fall as low as $US83 a tonne, sending further shudders through the industry.
The price is being driven down by concerns about global economic growth, growth in China and supply increases. Falling iron ore prices won’t make Rinehart’s job of developing Roy Hill any easier. While Rinehart has signed sale agreements with two Chinese steel groups, she is still fighting to secure funding of up to $7 billion for the project.
While banks will look more at the long-term prospects of a project than spot price movements, sentiment can be a killer in deals like this. And sentiment is not exactly running with the mining sector right now – just ask Nathan Tinkler, Rio Tinto and Fortescue Metals Group.
Since May 24 – the day BRW named Rinehart the richest woman in the world with a fortune of $29 billion – Rio Tinto and Fortescue have seen their stock fall by 12.5 per cent and 19.9 per cent.
But how might the value of Rinehart’s empire be impacted by the drop in iron ore prices?
To assess this, I’ve gone back and looked the valuation method BRW used in its $29 billion valuation in May – which was based on an iron ore price of $144.73 – and done some back-of-the-envelope valuations using an iron ore price of $US90 a tonne and $US83 a tonne.
Clearly, these are only very rough estimates. But they do suggest that more than $9 billion could have been shaved from Rinehart’s valuation.
Rinehart receives 1.25 per cent of the revenue generated by Rio Tinto’s Hamersley Iron business. The Rio Tinto results show revenue for the six months to June 30 was $US9.12 billion – call it an annualised $18 billion. Rinehart’s annual royalty payment would be $225 million. Apply a multiple to this revenue stream – let’s use the 10.2 price-to-earnings ratio used by BRW back in May – and you can mount an argument this royalty is worth as much as $2.25 billion. No real change here.
Hope Downs I
Rio Tinto and Rinehart own 50 per cent each of the Hope Down I mine, which produces 31.4 million tonnes a year. BRW valued Rinehart’s stake at $9.7 billion back in May, based on an iron ore price of $US144.73 a tonne. But at the current price of $US90 a tonne, and using the 44 per cent profit margins Hamersley produced in the June half, and applying the 10.2 multiple, we get a total valuation of a bit under $13 billion, or $6.5 billion for Rinehart’s stake. That’s a big fall in the space of three months, but if the iron ore price did fall to $US83 a tonne, the valuation would drop further to $5.8 billion.
Hope Downs IV
This mine, developed again in conjunction with Rio, was valued at $3.1 million, using the same formula BRW used for Hope Downs I. Based on the decline in the iron ore price from $US144.73 a tonne to $US90 a tonne, the $3.1 billion valuation BRW ascribed to the project could have dropped to $1.9 billion. Based on a $US83 a tonne price, the value could have dropped to $1.8 billion.
The Roy Hill mine was the wild card in the Rinehart valuation. The sale of a 30 per cent stake in the project, which had been due to make its first shipments in 2014 but is now likely to be delayed, gave the project an implied value of $12.8 billion. Applying a discount based on the fall in the iron ore price from $US144.73 a tonne to $US90 a tonne could drop the valuation to $7.9 billion. Applying a discount based on an $US83 a tonne price drops the valuation to $7.3 billion. The value of Rinehart’s 70 per cent stake could have fallen from $9 billion to $5.1 billion based on an $US83 a tonne price.
It’s crucial to note that Gina Rinehart’s assets are both highly valuable and highly profitable and their value is not likely to be badly shaken by what could be a temporary fall in the iron ore price.
Indeed, it’s worth noting that long-term price predictions remain strong. Morgan Stanley is still predicting a price of $US133 a tonne for 2013, Fortescue Metals Group is expecting the price to return to $US120 to $US150 "in the short to medium term” and RBS has recently lowered its 2013 iron ore price forecast by 14 per cent to $US124 a tonne.
But the fall in the iron ore price and the general feeling that the peak of the resources boom is now well passed does suggest a more conservative reading of Rinehart’s fortune is required.
It does seem likely that her fortune will fall when the next rich lists are compiled next year – how far will depend on commodity prices and the progress of the Roy Hill project.
James Thomson is a former editor of BRW’s Rich 200 and the publisher of SmartCompany and LeadingCompany.