After a year-long rally that resulted in iron-ore prices jumping more than 130% off multi-year lows recorded in early-2016, the commodity has lost nearly 25% in less than two months and nearly 15% over the past week. This has also triggered a sell-off in some of the largest Australian miners with substantial exposure to iron-ore prices.
Fortescue Metals Group Limited (ASX:FMG) — pure play hurts more
Shares of the pure-play iron-ore miner fell almost 7% this Thursday after iron-ore recorded a high-single-digit decline on Wednesday, pushing the prices to the lowest level since Nov’16. While the company leadership has done a tremendous job at becoming one of the most cost-efficient iron-ore miner, they aren’t immune to the single biggest factor that reflects in their profits: iron-ore prices.
Interestingly, the company’s corporate insiders have retracted aggressively of late. The management had been cautious in its guidance about the short-term nature of China’s fiscal-stimulus-driven demand for the commodity. However, despite that and a league of analysts calling out a significant drop in iron-ore prices, shares rallied on optimism and probably with some expectations of a magic hand that would suddenly bring a replacement for China’s historic demand of unfathomable scale.
It seems, the realization has finally dawned on most and what we’re seeing is profit taking, which may accelerate if the drop in iron-ore prices continues. Irrespective of how supply-demand dynamics playout, the downside risk to iron-ore miners, at least in the short-term, has suddenly increased.
Both are diversified miners, but iron-ore accounts for a third of BHP’s revenue and slightly more than that for the revenue RIO generated in 2016. However, with the entire commodities market facing weakness, iron-ore accounted for nearly the entire operating profit generated by RIO and BHP in 2016. This high dependency on iron-ore reflected in shares prices as RIO and BHP lost 4.4% and 4.0%, respectively, in value on Thursday.
While the managements of both companies have presented a positive long-term outlook, driven by cost reduction, focus on high-quality assets and improving global economic improvement, the extensive exposure of their profits to the iron-ore price volatility has shaken investors’ confidence in the short-term.