However, the country's impact on BHP Billiton's earnings is even bigger than that. The company’s future is closely tied with China, which is the biggest consumer of iron ore. Despite the current slowdown, China’s economy has expanded by more than 5 times in the last 10 years. Currently, it is eyeing a 7.5% growth in its gross domestic product for 2013, which could slow down to 7.4% in 2014. However, anything above, or even close to 7%, is considerably more than the expected growth rate of some of the other leading economies. Moreover, by 2028, around 250 million people in China will move to the cities from rural areas, which will fuel the demand of commodities in general, and iron-ore in particular. BHP Billiton wants to capitalize on this growth and is aiming to expand its annual production by 8% for the next two years.
In the previous quarter, BHP Billiton posted an 11% year-over-year increase in overall production, led by a 23% increase in iron-ore production to 48.84 million tons. Historically, BHP Billiton has generated around 40% of its earnings from iron-ore. This increase in production corresponds with better pricing environment (discussed below) as compared to last year and a strong demand from steel mills in China.
Since China is the primary buyer of iron-ore, the country plays a crucial role in the determination of the price of the commodity. The price of this commodity underpins BHP Billiton’s earnings; therefore, besides directly contributing to BHP Billiton’s top line, China also has a considerable (indirect) impact on the company’s bottom line.
Currently, the miners have been enjoying the bull in iron-ore prices. The commodity’s price bottomed out at $99.47 per dry metric ton in September last year, but has since risen by 33% to nearly $133 per dry metric ton in October this year.For the three months ending September, the iron-ore prices averaged $132.8 per dry metric ton, showing a significant improvement of 19% from the corresponding period last year. BHP Billiton has capitalized on this favorable trend by increasing its iron ore production.
As I have mentioned earlier, iron ore prices are closely linked with the demand from China. Therefore, it is not surprising that the current increase in prices corresponds with an increase in iron-ore imports and steel production from China.
Earlier, in September, China imported a record 74.58 million tons of iron-ore, which then dropped to 67.83 million tons in October, which, despite the drop, still shows a 20% increase from October 2012. Meanwhile, in the first 10 months of the current year, its steel production has risen by 8.3% to 652.48 million tons.
More importantly, analysts believe that the current stability could continue, and there is very little chance of a significant drop in prices. Morgan Stanley believes that the iron ore price would average $125 per ton for the first half of 2014 due to the robust demand from China. Meanwhile, Australia's Bureau for Resources & Energy Economics (BREE) has upped its 2014 forecast to $119 as it believes that China’s imports in 2014 would increase by 8.3% to 872 million tons. The World Bank is slightly more optimistic and believes the prices would average $135 in 2014. In short, the markets believe that iron ore prices will likely remain stable, or will witness a slight increase.
Amid a relatively better pricing environment, BHP Billiton now looks more confident and has increased its iron ore production guidance for fiscal 2014 to 212 million tons from 207 million tons. The company is currently working on its Jimblebar mine expansion, which will be completed in the first quarter of 2014 while it will also install four iron ore crushers. More recently, the company has announced that it will spend $301 million to replace two ship loaders in Western Australia which will considerably increase its loading capacity by 5,000 tons per hour.
Like BHP Billiton other leading global miners, such as Rio Tinto (NYSE:RIO), are also planning to expand their production, despite their focus on cost cutting measures. In its recent investor presentation, Rio Tinto has pointed out that it has targeted a 20% increase in production capacity by 2017. On the other hand, the world’s biggest iron ore miner Vale (NYSE:VALE) has reduced its 2014 additional iron ore guidance by 70% due to operational issues. However, the company will still increase its output from this year’s expected 306 million tons to 312 million tons in 2014.
BHP Billiton operational review for the quarter ended 30 September 2013 [Pdf]
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.