Iron Ore Prices Plunge Over Chinese Demand Concerns
Valuations for Producers Remain Very Attractive
Iron ore prices have fallen close to 40% since peaking in mid-May amid concerns over slowing Chinese steel demand and government intervention aimed at curbing prices and carbon emissions. Benchmark iron ore prices (62%- Fe, CFR China "P62") have fallen US$71/t since the start of Q3/21 to ~US$149/t, while high-grade iron ore prices (65%-Fe, CFR China "P65") have corrected by US $83/t to ~US$169/t over the same period.
While we were expecting prices to retreat from recent highs over the back half of this year, the speed and severity of the correction has been much worse than forecast. Iron ore has come under pressure as Chinese steel production has softened on weaker construction and automotive demand, with Chinese daily crude steel output averaging 2.8Mt/day in July, the lowest levels since March 2020. Furthermore, the Chinese government has ordered steel mills to maintain 2021 output levels on par with 2020 in an effort to curb emissions. This could pose a significant challenge given Chinese steel production is up 11.8% YTD through June and would imply Chinese steel production from July to December would have to decline by 59Mt according to S&P Platts.
The outlook for iron ore demand may not be as bearish as the recent correction would suggest. In our view, China will likely continue to look to steel intensive infrastructure projects to soften the impacts of an economic correction. Also, the rest of the world is still in recovery mode from the pandemic with global steel production (ex-China) up 21% y/y in July. Prices for U.S. HRC steel remain exceptionally strong at ~US$1,900/t. Furthermore, prices for Atlantic blast furnace pellets, an indicator of the health of European steel markets, also remain very robust at US$77.50/t.
Implications for our coverage universe – P65 iron ore prices have averaged US $220/t through Q3/21 which remains above our quarterly estimate of US$215/t. That said, if spot prices remain at current levels, our Q4/21 P65 price forecast of US$180/ t may prove to be too optimistic. Champion is also likely to see negative provisional pricing pressures this quarter as 1.2Mt of sales were subject to final settlement in calendar Q3.
Valuations remain attractive – Champion is now trading at 2.4x FY2022 EV/ EBITDA using an average iron ore price of US$190.5/t and 3.0x FY2023 using an iron ore price of US$129/t. At current P65 spot prices, Champion is trading at 2.5x FY2022 and 1.8x FY2023 (Champion's fiscal year begins April 1). This compares to our mid-cap coverage universe which is trading at 5.6x FY2022 EV/EBITDA.
Similarly, Labrador Iron Ore (LIF) is trading at 9.6x our FY2022 CFPS using an average price of US$135/t. At spot prices of US$169/t, LIF is trading at 8.3x FY2022 CFPS, which compares to its historical average of 12.0x.