Iron Ore Pricing 201: Current Spot Pricing Suggests Further Downside

The share prices of iron ore miner stocks are pricing in much higher iron ore prices that the market is delivering, suggesting the sector could see significant downside ahead.

Axiom analyst Gordon Johnson recently derived implied iron ore prices using the current share prices of five of the world’s largest iron ore producers and now believes expectations are so high that there is a major opportunity for short sellers in the space.

Johnson started with the net debt balances to market caps of Rio Tinto plc (ADR) RIO, Fortescue Metals Group Limited, BHP Billiton Limited (ADR) BHP, Vale SA (ADR) VALE and Cliffs Natural Resources Inc CLF, derived enterprise values for each, estimated total EBITDA using Bloomberg consensus estimates, and then removed all other EBITDA sources other than iron ore sales. Johnson could then single out expected profit per ton of ore, which could be used to determine implied spot price.

Johnson found that the five stocks are currently pricing in a 62 percent Fe ore price of about $65/t, roughly 22 percent above current market price. The difference between the current ore price of $53.40/t and the implied $65/t implied price that Johnson calculated is statistically significant, he said.

“Resultantly, barring a big, sustained reversion higher in iron ore prices, we argue the time is ripe to add to short positions in FMG, CLF & RIO,” Johnson wrote on Wednesday.

Related Link: Analysis: US Steel's Investment Needs Are 'Grossly Misunderstood'

In addition to the three stocks mentioned as short ideas, Axiom has Sell ratings on the following stocks:

  • United States Steel Corporation X
  • United Rentals, Inc. URI
  • Caterpillar Inc. CAT
  • GATX Corporation GATX
  • Trinity Industries Inc TRN
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