Christine St Anne: Investor unease over the mining sector has certainly increased over the past few weeks as iron ore prices continued to fall. To put this one into perspective, I'm joined by Morningstar's Mark Taylor.
Mark Taylor: Thanks Christine.
St Anne: Mark, with the dramatic fall in the iron ore prices, would that also mean a dramatic impact on the earnings for BHP and Rio?
Taylor: Well, it will be quite meaningful, particularly for Rio Tinto where iron ore has represented the lion's share of their earnings in recent years. Lesser for BHP where it represents a smaller share of earnings overall, but you can still expect a meaningful hit to earnings on both companies.
St Anne: Now, we've also certainly got bad news from China, with the country indicating that a number of steel projects could be halted. Would that also have a significant impact for these miners?
Taylor: Look, I don't think it will be a huge impact, just one-off projects here and there. But steel is an early-stage commodity in the cycle of development for developing countries. So you would expect the steel to sort of have its big bull run and then sort of taper off later on, even with increasing volumes.
It's the extreme increase in volumes that drives the pricing impact. So, once it starts to taper off a bit, you are going to see some swings and roundabouts. But genuinely we've long expected a gradual decline in iron ore prices from, sort of well over $100 to our long-term target is $80 per ton and it has been for quite some time.
St Anne: Mark, now domestic miner Fortescue, certainly derives a lot of its revenue from iron ore. What's the outlook for that miner?
Taylor: Well, it all depends on the degree of price fall and how long it stays where it is. But as a general rule of thumb, if you're expecting commodity prices to rise very strongly then you're going to get the most leverage in the companies that sit higher on the cost curve, whose margins were perhaps narrower. You don't need much of an increase in price to get a doubling, tripling in their margins.
The reverse is true on the way down. So those companies are the ones whose margins are going to be squeezed in percentage terms the most when prices fall. So, companies like Fortescue who are slightly higher on the cost curve are going to be more at risk. It's not to say that say that they are at risk, but just obviously it goes without saying, the lower on the cost curve you are, the better really.
And then on top of the operating cost side of things, you've also got to consider the capital cost side of things and the balance sheet - the debt situation. Companies like BHP who've got very low debt overall are going to be able to weather any hiccups or storms better than companies that are very highly geared and are very reliant on what happens from month-to-month in terms of their revenues.
St Anne: Mark with falling commodity prices will the resources sector essentially be just a volume growth story?
Taylor: In some respects, yes, because you're not going to see the big increases in price. You might see some quick recovery from lows and things, but you're not going to see that long continual uptrend in prices I don't think again. So, it is going to be about volumes, who is increasing volume, who can sort of make up a little bit of the lost ground.
But really the other side of the equation is, your capital cost. Do you really want to be investing large sums of money, if you're not going to drive the returns on that investment that you have historically. So it's not all about volumes, it's about return on invested capital as well and looking after your cost side of things.
St Anne: Finally, Mark, given the subdued outlook for the sector, should investors do keep their faith in the miners?
Taylor: Well, I mean, definitely keep your faith in the quality blue chip companies. That's not to say their earnings wonï¿½t be hit, they will because they are in the business of selling commodities. But when you invest in mining stocks - resource companies, it goes without saying that there will be ups and downs and they are, by definition, more cyclical and more volatile than some of the more stable blue chip companies. You have to expect that when you buy them and if it's not something you're willing to expect then you shouldn't really be in that space.
St Anne: Mark, thanks so much for your insights.
Taylor: Thanks Christine.