Production reports from Australia's three largest iron ore miners have helped boost investor confidence in the sector over the last few weeks.
While BHP Billiton Limited (ASX: BHP) announced a record production of 225 million tonnes of iron ore last week – absolutely smashing analyst forecasts – Rio Tinto Limited (ASX: RIO) and Fortescue Metals Group Limited (ASX: FMG) also posted optimistic reports. Shares in all three miners have risen since their respective results were released.
Although the commodity has fallen heavily in price this year, it is believed that enormous levels of cost-cutting and increases in export volumes should support the miners' profits when they report next month.
But that could all change in the years ahead…
While the miners will continue to focus on improving margins by cutting costs and increasing production, large declines in the iron ore price are still expected. In fact, according to The Australian Financial Review, consensus is suggesting the benchmark price could decline by a further 15-20%, compared to a 12% rise in iron ore exports. Iron ore is currently trading at US$94.30, so that suggests the price could fall below US$80 a tonne.
The pure iron ore plays like Fortescue and Atlas Iron Limited (ASX: AGO) would likely be affected the most. Despite plans to continue ramping up their output, their profits are still likely to come under substantial pressure. Earnings of the more diversified miners, being BHP Billiton and Rio Tinto, are also expected to be impacted, although probably not as significantly as those smaller miners.
What does that mean for you?
Investors wanting to bet against the crowd could choose to put their money behind Fortescue, which is trading on a projected P/E ratio of just 5 – keeping in mind that earnings are expected to drop in 2015. The stock offers a very decent yield and as production rates continue to increase, the miner's cost base should improve considerably.
On the other hand, BHP Billiton and Rio Tinto would be better alternatives for investors wanting to gain exposure to the sector at the same time as limiting their risks. BHP boasts the greatest level of diversification amongst operations, while Rio Tinto is striving for a much greater production rate – which should help stabilise its earnings.
A much better bet than the miners
I currently don't own any of the miners. While I might regret that in years to come, I have also been uneasy about the level of reliance miners put on commodity prices to grow their earnings.
