3 Iron Ore Stocks Likely to Strike Gold - Analyst Blog

Almost every tangible product we see -- ranging from aircraft, vehicles, engines, ships, bicycles, to beams used in buildings, furniture and paper clips, reinforcing rods, magnets, pots, pans, fences and ornamental items -- are made of steel. Iron ore is the basic ingredient for steel-making, and apparently over 99% of iron ore is commercially used for this process. It is no wonder iron ore is often considered the most important mining commodity.

Iron ore production has come a long way, with total production increasing manifolds from 884 million tons in 1990 to 2,430 million tons in 2010. Despite being the most used mining commodity, iron leads to higher volumes but lower margins. Before we cherry-pick from the mining stocks that specialize in iron ore, let us rehash some of the various turn of events.

China: The Leading Player

China tops the list of iron-ore producers, accounting for nearly 43% of the global iron ore production in 2012. With high domestic consumption, China is also one of the major importers of iron ore, importing as much as 692 million metric tons in 2011. Hence, any sudden change in the demand-supply graph of the country also impacts the global iron ore topography.

Recently, a private survey by HSBC Holdings plc (HSBC) quantified a lower-than-expected Purchasing Managers' Index (PMI) for China in Mar 2014, which fell to an eight-month low of 48.1. A PMI score of 50 and above is usually considered favorable. The primary reason for the decline is assumed to be weaker domestic demand, as export orders increased sequentially. However, it is widely believed that a lower PMI will compel the Chinese government to introduce measures to enhance growth and stability in its economy, thereby spurring more consumption.

Plummeting Iron Ore Prices

While in 2000, iron ore price was a meager $12 per ton, it soared to $187 per ton by 2011. Due to higher demand-supply imbalance, where supply is currently exceeding demand, prices are on a downward trend. Most of the mining companies experienced a decline in revenues in the three months ended Dec 2013 due to a sharp reduction in iron ore prices.

Growth Potential

Although iron ore prices have continued to move southward in 2014, there seems to be a silver lining down the road. According to a study, steel production in Asia is expected to increase nearly 25% between 2012 and 2020. Total imports are also anticipated to increase 35% over the same timeframe.

Major market players are realigning their asset portfolios to reflect the current demand scenario by hiving off unproductive assets and venturing into new productive assets. Big players in the industry like Vale S.A. VALE, Rio Tinto plc RIO and BHP Billiton Ltd. BHP are revising their asset portfolio to cope-up with the changing dynamics.

With such concerted efforts, the market is expected to reach equilibrium over time. In this context, let us have a closer look at three top iron-ore stocks with attractive valuation metrics backed by a solid Zacks Rank methodology

Three Top Picks

Kumba Iron Ore Ltd. (KIROY): Based in Centurion, South Africa, Kumba Iron Ore engages in the exploration, extraction, beneficiation, marketing, shipping and sale of iron ore in South Africa. With a forward P/E of 8.4x, this Zacks Rank #1 (Strong Buy) stock appears to be a lucrative investment. The company recorded healthy year-over-year revenues in 2013, mainly due to increased exports to China.

Vale is considered to be the biggest player in the mining industry with a 31% market share. With a current market capitalization of $77.2 billion, the stock sports a Zacks Rank #3 (Hold). With a forward P/E of 7.5x and long-term earnings growth expectations of 164.6%, the stock is one of the top picks in the industry. The company expects to increase its iron ore output in the upcoming quarters via its Northern Systems, which registered record quarterly iron ore production in the fourth quarter of 2013.

With 21% market share in the global mining industry, Rio Tinto is considered to be the second-biggest player. This Zacks Rank #3 stock has a market capitalization of $102.9 billion. With a forward P/E of 11.1x and long-term earnings growth expectations of 12.6%, the stock looks well positioned. Rio also reported record iron production of 199 million metric tons in 2013, up 5% year over year.