Ironclad Growth Prospects?
Friday April 11, 6:03 pm ET
James Detar
ca.us.biz.yahoo.com
Forget what the history books told you; the Iron Age never ended.
More than 3,000 years after its first appearance in the Near East, iron -- the main ingredient in steel -- is the vital component in a wide variety of modern-day goods: automobiles, trains, ships, boats and the skeletons of most buildings.
The companies that mine and refine metal ores are seeing sales and profits the likes of which they never have seen.
The reason for this boom can be summed up in one word: China.
China's economy continues to grow at a double-digit rate. Skyscrapers are sprouting up in China's large cities and a growing consumer class is buying more goods.
Analysts estimate that in recent years roughly 60% of the world's giant construction cranes have been put to use in China. India, the second most populous nation behind China, has started down a similar path as its economy improves.
But softness in the U.S. economy offsets growth overseas. Analysts say the likelihood is growing that the U.S. will slip -- or has already slipped -- into recession.
"We see declining construction and auto sales -- most U.S. steel consuming sectors are negative this year," said John Anton, director of steel services at research firm Global Insight. "And they will stay down next year."
When counting raw ore, the U.S. is a small player in the metals market. According to the U.S. Geological Survey, it produced and consumed just 3% of the world's 1.9 billion metric tons of mined iron ore last year.
But it's the second-biggest consumer of steel, and a severe recession could still hurt metal ore producers.
1. Business
All of the big mining firms dig for all sorts of metals, though iron remains the most widely used.
The biggest sector represented in the metal ores group is producers of iron ore, which mainly goes into steel. The USGS says world iron output reached 1.9 billion metric tons in 2007. The average price for a metric ton rose to $63 from $53.88 the year before.
The world's biggest miner is Australia's BHP Billiton. (NYSE:BHP - News) BHP posted revenue of $47.5 billion in 2007.
Brazil's Comp Vale Do Rio (NYSE:RIO - News), known as Vale, is No. 2 with 2007 sales of $34.1 billion. Australia's Rio Tinto (NYSE:RTP - News) rounds out the trio with sales of $29.8 billion last year.
The big three control most of the world's metal ores.
In the U.S., 160-year-old Cleveland-Cliffs (NYSE:CLF - News) is the biggest.
Ore producers sell the material, usually in the form of pellets, to steel producers. Some steel makers have their own ore operations.
Most ore is priced in an unusual process called the benchmark system: After one of the big three producers strikes a yearlong deal with a major customer, everyone else in the industry agrees to similar terms.
Some ore producers, including Rio Tinto and BHP, want more flexibility to recoup costs and cash in on rising demand.
As of Friday, the metal ores sector ranked No. 12 out of IBD's 197 industry groups.
IBD's metal ores index, which includes 60 companies, shot up to 652 recently from a close of 499.89 on Jan. 23.
Name Of The Game: Finding high quality ore and clawing it out of the Earth, says Joe Carrabba, chief executive of U.S. mining firm Cleveland-Cliffs .
"It's about the rock in the ground," Carrabba said. "If you don't have great ore deposits, you can't overcome it. You can't be the best miner with a second-rate deposit."
Because the benchmark system offers little pricing flexibility, managing costs also is key.
2. Market
The market has changed radically in the past 10 years. In the mid-1990s, both China and the U.S. mined about the same amount of iron ore.
The U.S. still mines roughly the same amount as it did then, 52 million metric tons in 2007, according to the USGS. But China's output has mushroomed to about 600 million metric tons last year.
Even amid this production boom, prices continue to rise as consumption, especially in China, outpaces supply.
China remains the world's biggest consumer of steel, followed by the U.S. and Japan. While India is still No. 5, demand there is growing faster than in more established markets.
"We expect in the future to see further demand from India," Rio Tinto CEO Tom Albanese said.
3. Climate
Metal prices are at historically high levels and rising.
The question is whether China -- which is trying to slow its economic growth to curb inflation -- is headed for a hard landing. A sudden slowdown could cut its metal ores consumption, dragging down worldwide prices.
At the same time, the industry is consolidating, which could spur even higher metal ore prices. BHP, Vale and Rio Tinto all have bought smaller players in recent years.
On Feb. 6, BHP made an offer for Rio Tinto in a proposed stock swap worth $140 billion -- which Rio Tinto rejected the same day as too low a price.
"Steel makers are terrified," Global Insight's Anton said. "It's already expensive with a triopoly. Make it a duopoly and control of prices would be even more concentrated."
Industry officials expect mergers to continue, although the number of potential targets is dwindling.
Rapid growth also has caused a shortage of skilled workers.
"We can't get technical people," Carrabba said. "The business has just exploded. The biggest challenge is finding competent people to work. And not just internationally," he said. There's a real shortage here in the U.S., too.
4. Technology
The biggest mining companies are vertically integrated. All have their own smelting operations, and some even make end products like copper wiring.
The gear they use to pull the metal out of the ground and smelt it hasn't changed much over the years.
IBISWorld's Van Horn says there's not much new under the sun in terms of mining technology.
"As equipment continues to improve, I'm sure there are productivity gains," he said.
The biggest advances may come from the metal ore sector's customers. New technology has let steel makers use lower-quality -- and cheaper -- iron ore. And the industry is working on ways to reduce the raw materials and energy used in the steel-making process.
5. Outlook
For now, industry officials say 2008 is setting up to be another in a string of growth years.
"What we're seeing is that the 2008 (metal ores) markets are set for a fifth straight year of cyclical strength," said Rio Tinto's Albanese.
A U.S. downturn likely will reduce domestic steel and ore consumption. But don't expect world metal prices to drop significantly. "This is an unprecedented time in mining of metals," said Cleveland-Cliffs CEO Carrabba.Rio Tinto's Albanese agrees. "We anticipate a very strong environment for the foreseeable future," he said.
Upside: Analysts expect China's economic growth to continue at a strong pace, fueling growth in the metals market.
Supply is lagging demand, so prices likely will remain high. And as the industry consolidates, the number of companies in the sector is shrinking, reducing competition.
Risks: Because it's still the world's largest economy, if the U.S. goes into a full-blown tailspin it likely would affect the metal sales and could even spark a global slowdown.
A BHP-Rio Tinto merger, meanwhile, would leave only two large metals companies.
That could mean a price spike for steel makers that eventually could hit end product consumers.
Higher prices eventually could slow sales and fuel a downward spiral.
Labor costs are rising, and higher energy costs are making ore transport more expensive -- costs not easily recouped under the ore industry's benchmark pricing system. |
