Adding steel to your portfolio

Junior iron ore miner BC Iron  (ASX: BCI) has stayed out of the limelight hogged by the major iron ore miners Rio Tinto (ASX: RIO), BHP Billiton (ASX: BHP) and Fortescue Metals Group (ASX: FMG).

But don’t let that stop you from having a closer look at the company. In the 2013 financial year BC Iron delivered a nice surprise to shareholders, announcing a 30 cent final dividend, to go with the 5 cent dividend it paid out earlier this year. At the current price of $4.27, that equates to a dividend yield of 8.2%, or a grossed up dividend yield of 11.7%. It’s also more than double the 15 cents BC Iron paid out to shareholders last year.

That came as the iron ore producer reported another strong year with underlying profit rising 41% to $71.4 million, on the back of record full year production of 5 million tonnes of iron ore at its Nullagine Iron Ore Joint Venture with Fortescue. BC Iron currently owns 75% of the Joint Venture, after buying back 25% from Fortescue in December 2012 at a cost of $190 million.

In 2009, BC Iron handed over 50% of the Nullagine mine, in return for access to Fortescue’s port and rail infrastructure, and is the envy of smaller iron ore miners such as Brockman Mining and Atlas Iron  (ASX: AGO), which are having difficulty getting their ore to port.

BC Iron’s shipments rose 78% from 1.8 million tonnes in 2012, to 3.2 million tonnes in the 2013 financial year, with cash operating costs dropping 40% to an astonishing $38 a tonne. Production is expected to rise to 6 million tonnes this year, with BC Iron’s share coming in at 4.5 million tonnes, and costs could fall further as production rises.

The strong cash flows have not only enabled big dividends, but also a reduction of debt. The company’s cash balance at the end of June stood at $138.5 million, with total debt of around $100 million, leaving BC Iron in a net cash position. All of the current debt is due to BC Iron paying Fortescue $190 million to buy back the 25% share of their joint venture. With production set to jump in FY2014, BC Iron should easily be capable of paying down some of the debt, while continuing to pay out decent dividends.

Iron ore prices

An article on BC Iron without a mention of iron ore prices would be remiss of me. The biggest risk facing BC Iron is much the same as other iron ore producers and that’s the commodity price, which is mainly driven by supply and demand.

China is the world’s largest importer of iron ore, accounting for 61% of total world iron ore imports, dwarfing imports to Japan, Europe and Korea – and demand continues to grow. In July 2013, China imported 26% more ore than it did in the same period last year, and 17% higher than the previous month. Rio and BHP both expect China iron ore demand to peak at around 1 billion tonnes in around 2030.

At the same time, expectations that the global supply of iron ore would massively expand to create a supply/demand imbalance don’t look like materialising. Yes, Rio and BHP are upping their production from the Pilbara, but in other parts of the world some major iron ore projects have stalled, including Rio Tinto’s giant Simandou project in West Africa. Elsewhere, Indian iron ore exports have fallen dramatically from 100 million tonnes in 2009 to just over 20 million tonnes now, and forecasts suggest the country will need to start importing iron ore by 2019.

Additionally, China is looking to improve the quality of its steel, which means using higher quality iron ore such as Australia’s. China itself produces iron ore, but it is low quality at a higher cost, and far away from the steel mills located along China’s coast, meaning it’s cheaper for them to import high quality Australian iron ore.

Foolish takeaway

With more than 100 million tonnes of iron ore resources, including 50 million in reserves at Nullagine, ready availability of rail and port infrastructure as well as low cost production, BC Iron should see a stronger result in the 2014 financial year. Add in high returns on equity, good profit margins, net cash of $35 million and a stated aim of delivering sustainable full franked dividends, and BC Iron could add some steel to your portfolio.

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