The big reason to avoid BHP Billiton Limited, Rio Tinto Limited and Fortescue Metals Group Limited

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On Tuesday last week a ‘Key Economic Indicators’ headline from ABIX – Roy Morgan pronounced ”Iron ore price rallies”.

And rally it did, with the Iron Ore September Spot Price rising by US$4.66 to finish up at US$58.86.

Hang on, last Friday, from the same source, I read another headline and it said “Iron ore price falls”.

And fall it did, with the Iron Ore September Spot price falling by US$1.05 to US$57.01.

The above commentary on the short-term movement on iron-ore prices would normally look quite ridiculous, unless you watch these price movements regularly and you’re a shareholder in either BHP Billiton Limited (ASX: BHP), Rio Tinto Limited (ASX: RIO), or Fortescue Metals Group Limited (ASX: FMG).

The sustained fall in the price of iron ore in the last five years though, from US$175 to around US$57 today, is a serious matter for each of the companies above.

Consider this: for BHP Billiton, iron ore makes up 33% of group revenue and 58% of underlying earnings before interest and tax according to the company’s 2014-15 annual report.

For Rio Tinto, it’s a similar story. According to its 2014-15 annual report, iron ore comprises 41% of group revenue and a whopping 87% of underlying earnings, despite the fall in the iron ore price.

And then there’s Fortescue Metals. This is more of a direct play on iron ore though it has to be said the larger BHP and RIO could almost also be considered ‘iron ore’ companies given the significance it has to their overall respective group earnings.

Fortescue though is an iron ore miner with 97% of its revenue coming from the commodity, which comprises almost 100% of its earnings (Fortescue 2014-15 annual report).

For the big three, iron prices have a significant effect on their profitability, and by extension, sentiment towards their respective share prices will rise and fall with the price of iron ore.

The headlines such as those above, focused as they are on day-to-day movements, are really quite irrelevant to those focused on the long term.

However, over the last five years, BHP’s share price has fallen, in total, 43.7%, RIO has fallen 31.2% and Fortescue has fallen 20.5%, all in sympathy with the world iron ore spot price over the same time period.

The long-term concern I have with these companies is that each of them are captive to market prices for their main products, and there’s very little each company can do to value-add.

Unless you’re good enough to pick the troughs and peaks of world iron ore prices, and you can buy and sell each company’s shares at the right times, I’d actually avoid all three of these companies as being suitable for long-term investment from here on.

The one big reason to avoid each of BHP, Rio Tinto and Fortescue is the Australian Government’s Department of Industry, Innovation and Science forecast for iron ore prices. For 2017, it has slashed its forecast for iron ore prices and expects the commodity’s price to fall from the current US$57 to around US$45.

Given this, focus your investment dollars elsewhere. There are better opportunities around if you know where to look.

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Motley Fool contributor Edward Vesely has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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