Home>Video>Will China Stay Iron-Strong?

Will China Stay Iron-Strong?

Tue, 28 Aug 2012

As Chinese steel production goes, so do companies like Cliffs Natural Resources.

+

Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Have China pressures left Cliffs Natural Resources' bonds looking attractive? I'm here with Dan Rohr, a stock analyst at Morningstar, to take a closer look at the company.

Dan, thanks for joining me today.

Dan Rohr: Hi, Jeremy.

Glaser: So, let's take a look at some of the fundamentals in the iron ore industry right now. What are the big drivers there? What's been happening recently?

Rohr: I’d say the three biggest drivers are China, China, and probably China is the third. The country consumes roughly two thirds of the global seaborne iron ore trade, and that's largely a function of the large fixed-asset investment growth that the country has undertaken over the past decade. So for someone like Cliffs that digs iron ore out of the ground, they are really a China play. As we've seen signs of softening in China, particularly as it pertains to the infrastructure side and the residential real estate construction side, you've seen iron ore prices take a tumble. And with those prices so have Cliffs' shares, and bond spreads on Cliffs have widened considerably as a result.

Glaser: So this has been a big question across a bunch of industries. Is China going to come in for the so-called hard landing where the country really sees things just fall off a cliff? Or can the country manage a softer landing into a more sustainable growth rate? What's your take on that, and how could it impact iron ore prices?

Rohr: As far as the precise definitions of what constitutes a hard landing and what constitutes a soft landing, I'm not going to delve into that. I don't think anyone knows because frankly there is no precise definition of that.

As far as Cliffs' financial health and the prices of its bonds are concerned, really you need to be focused on what Chinese steel production is doing. Year to date, we're running at about, I'd say low single digits in production growth over there. Now, that compares with midteens growth rates over the past decade. And why we've really seen iron ore take a tumble from 2011's average $170 to about $100 a ton right now is not so much the lower growth rate, but massive destocking activity that we've seen Chinese steel producers undertake in the past several weeks.

From our perspective, if we're looking at a slower, albeit nonnegative, growth rate in Chinese steel production, we're probably going to see iron ore prices recover considerably from prevailing levels, and Cliffs' finances should be in fine shape. If we see another lag down in Chinese steel production then we're not going to see much of a recovery in iron ore prices. Cliffs' balance sheet is going to be under much more stress, and that's really where the risk manifests in these bonds.

Glaser: Let's take a closer look at that balance sheet. What's the financial position look like right now?

Rohr: Well, on a trailing 12-month earnings before interest, taxes, depreciation, and amortization basis, [Cliffs' balance sheet is] looking pretty good because you're getting some fairly solid iron ore prices in 2011 that you're picking up in that number. So [with the debt/EBITDA ratio], you're running at about 1.7 times. So [the company is] not terribly leveraged, but that number can go up considerably if indeed we're looking at $100-per-ton iron ore for the foreseeable future.

Glaser: You mentioned that these pressures have caused a widening of the spreads on bonds, does that leave them attractively priced then?

Rohr: Yes, if you were to compare them versus the average BBB- name in our corporate bond index, they look cheap on that basis, so roughly 70 basis points wide. Now that said, most of the mining sector is trading very wide right now. So, for our part, we prefer to focus on issuers that would be able to endure the kind of sharp and sustained drop in commodity prices that would invariably accompany another lag down in China. And so that would be someone like a Southern Copper or a Vale, the latter is also a major iron ore producer, and those bonds look very cheap on an absolute basis relative to our rating on them, which is BBB plus. So, we definitely prefer those, you're trading up in quality and getting the same discount relative to the type of spreads implied by the rating.

Glaser: Sounds good, Dan. Thanks for joining me today.

Rohr: Sure.

Glaser: For Morningstar, I'm Jeremy Glaser.

  1. Related Videos
  2. Related Articles
  3. Comments
  1. Will Life Sciences Firms Fall Off the Fiscal Cliff?

    Even if the NIH is drastically cut, we don't see a doomsday scenario for these companies, and some of the industry's stronger players are now trading at attractive valuations.

  2. Taking Action

    Policymakers and corporate leaders appeared to take decisive steps this week, but are they moving in the right direction?

  3. Has China Hit Its Growth Limit?

    China's historical growth drivers have started to plateau, but many untapped industries--particularly in the services sector--are set to take the lead, says Seafarer's Andrew Foster.

  4. Reasons to Increase Your Stake in China

    BaoCap's Kevin Carter says there's no imminent landing--hard or soft--in China , and with the country's 35% contribution to global GDP growth, investors should up Chinese exposure in the consumer and tech sectors.

  5. How China's Consumer Sector Will Pay Dividends

    As investment in fixed assets declines, consumption will drive GDP growth in China , and consumer cyclicals offer high yields and good valuations, says Matthews Asia's Jesper Madsen.

  6. China's Perilous Rebalancing Act

    The investment-led economic model has run so long in China that transitioning to a consumption model could be very risky to the current system, says Morningstar's Dan Rohr.

  7. China's Consumer Shift to Bring Revenues Online

    As China seeks to rebalance to a consumer-led economy, several Internet firms in the country are poised to gain from higher advertising spending, says Morningstar's Dan Su.

  8. Health Care the Next Chapter of China's Growth Story

    Consumption-led industries will drive Chinese growth for the next decade, and health-care spending, in particular, should outpace China's overall economy, says Morningstar's Dan Rohr.

blog comments powered by Disqus
Upcoming Events
Conferences
Webinars

©2014 Morningstar Advisor. All right reserved.