The mining industry has been struggling to maintain growth since 2011. Plagued by overcapacity and high capital commitments, the industry has plunged into turmoil as concerns about the state of China’s economy have sent commodity prices spiralling downwards.
This commodity price crash sent shares in Rio Tinto (LSE: RIO), Anglo American (LSE: AAL) and Vedanta Resources (LSE: VED) to levels not seen since the financial crisis.
However, one of Rio Tinto’s largest shareholders now believes that the sector could be oversold and the price of iron ore, the commodity that holds the key to the future of these companies, could double in the medium term.
Iron ore set to double?
Aberdeen Asset Management Plc, one of Rio’s largest shareholders, believes that the price of iron ore could double after the industry’s overcapacity has been worked through — great news for Rio, Anglo and Vedanta. Iron ore accounts for a large part of these three miners’ earnings and recovery in iron ore prices, to around $100 a ton, would revive earnings.
Unfortunately, Aberdeen hasn’t indicated when it believes iron ore prices will recover, but the company has said that it believes Rio Tinto is best placed to ride out the current slump and produce impressive returns for investors when commodity prices eventually recover.
Rio is the world’s largest iron ore miner and has the lowest production costs in the industry, which is why the company is well placed to ride out the slump. What’s more, unlike many other miners the company hasn’t undertaken any expensive vanity projects during the past five years or so. This disciplined approach to capital allocation has kept debt under control.
The debt issue
Anglo is guilty of undertaking expensive vanity projects, and these mistakes have now come back to haunt it. It recently reported an annual loss of $5.5bn for last year and now intends to sell between $3bn and $4bn of assets to cut its net debt (currently about $12bn) to $10bn by the end of 2016. A recovery in iron ore would give Anglo’s cash flows a much-needed boost and help the company reduce debt. Although, as it struggles to turn itself around it may be wise for investors to look elsewhere for a play on the mining sector.
Vedanta would also see a huge boost to earnings if iron ore prices recovered. However, just like Anglo, Vedanta has a huge debt pile to deal with and for this reason may not be a suitable investment for everyone.
That being said, Vedanta is working hard to cut costs and reduce its debt pile. The group managed to cut its net debt by 17% to $7.5bn last year and has since bought back a further $500m of bonds. A recovery in iron ore prices would accelerate Vedanta’s deleveraging and enable the company to return to its policy of returning a large chunk of profits to investors via a dividend.