By Rhiannon Hoyle
SYDNEY--Iron-ore prices have tumbled to an eight-month low,
putting a squeeze on mining companies' profits as they race to
repay massive loans used to expand their operations.
A slackening in demand from Chinese steel mills has pressed down
iron-ore prices in each of the past six trading days. China buys
around 60% of the iron ore traded by sea, which it uses to make
steel for industries ranging from construction to auto
manufacturing. In recent days, China's steelmakers have been
spooked by concerns that credit to property developers is drying
up, as that could portend a slump in the real-estate market and a
tumble in demand for building materials.
Robert Montefusco, a senior broker at London-based Sucden
Financial, said iron-ore prices may have further to fall as
steelmakers are likely to delay new purchases until they can secure
cargoes at a heavy discount.
To companies like Rio Tinto PLC and Fortescue Metals Group Ltd.,
which have pledged to cut debt and boost returns to investors,
falling prices are a worry. Fortescue, in particular, has been
racing to pay down debts with cash flow from record sales of iron
ore produced at its Australian mines. Rio Tinto says iron ore
prices averaged US$126 a metric ton last year, which enabled it to
shave US$4 billion from its debt load in the latter half of
2013.
But with prices of ore with 62% iron content delivered to
Beijing's Tianjin port--the industry benchmark--falling to
US$117.80 a ton on Wednesday, miners may have to slow their debt
repayments. Iron-ore prices haven't been lower since July 1, 2013.
Prices edged 0.2% higher Thursday to US$118 a ton.
Fortescue built up massive debts during a decadelong campaign to
break the dominance of rivals such as Rio Tinto, BHP Billiton Ltd.
and Vale SA in supplying China with iron ore. At its peak,
Fortescue owed more than US$12 billion.
The miner began paying off its debt last year, but still had
US$8.6 billion in debt after subtracting cash on its balance sheet
at the end of December.
Chief Financial Officer Stephen Pearce said Fortescue wanted to
pay back "another couple of billion" dollars by year-end, but
acknowledged the pace at which the miner would be able to repay its
debts would depend heavily on the strength of iron-ore prices.
Australian broker Morgans forecasts Fortescue could reduce its
debt-to-equity ratio to 41% by December versus an estimated 57% a
year earlier if prices hold around US$124 a ton over 2014. At an
average of US$100 a ton, the miner would only be able to cut its
gearing to 53% by December, it estimates.
"If the iron-ore price holds up our profit will be strong...but
it depends on where the price sits" as to how fast Fortescue can
repay its loans, Mr. Pearce said.
Rio Tinto has also made debt reduction a priority amid an
industrywide push to cut spending and make mines more profitable.
Executives want to rein in the debt pile that built up as the
Anglo-Australian company expanded its mines and infrastructure in
dozens of countries around the world, including Australia, the U.S.
and Mongolia. It also used loans to help fund several ill-timed
acquisitions, including the US$38 billion purchase of Canada's
Alcan.
Rio Tinto is the world's second-biggest producer of iron ore,
after Vale, and relies on sales of the steelmaking material for the
majority of its earnings. Underscoring the risk that volatility in
prices poses to its bottom line, Rio Tinto in February said US$1.2
billion would have been wiped off last year's US$10.2 billion
underlying earnings had iron-ore prices averaged US$113 a ton.
Rio Tinto wants to cut its net debt to the "midteens" of
billions over the next few years, from around US$22 billion in
mid-2013.
To be sure, some analysts don't expect iron-ore prices to keep
falling.
Perth-based Morgans analyst James Wilson attributed recent price
falls largely to seasonal changes in demand, as China's
construction activity slowed during the northern hemisphere winter.
He expects prices of between US$110 a ton and US$130 a ton in the
coming months, supporting mining sector profits.
"Even at current prices it is still a reasonable profit for
these guys," said Mr. Wilson.
Still, if prices do start to fall below US$110 a ton "then
that's when you'll probably see people starting to re-evaluate
their expectations," he said.
Write to Rhiannon Hoyle at rhiannon.hoyle@wsj.com
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