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Iron Ore Slump No Bar to Rio, BHP Buybacks at JPMorgan

Iron ore’s slump to a five-year low isn’t expected to prevent the world’s two biggest miners, BHP Billiton Ltd. (BHP) and Rio Tinto Group (RIO), returning cash to investors, a JPMorgan Chase & Co. fund manager said.

“You have to remember the very large operating margins which can still be achieved within iron ore,” James Sutton, a portfolio manager at JPMorgan’s $1.6 billion Natural Resources Fund in London, said in an interview. There’s “a lot of scope for shareholder returns,” as Rio and BHP are curbing investment in marginal projects, he said.

The steel-making ingredient slumped to the lowest in five years this month prompting Goldman Sachs Group Inc. to declare the “end of the Iron Age” after a Chinese-led demand spike over the last decade prompted record profits for BHP and Rio. As investors demand a greater share of mining industry profits, the largest iron ore producers are flooding the market with new supply, trimming prices.

“Looking at the bigger picture, I think that the two things are not incompatible,” Sutton said. “These businesses will have to get used to a lower iron ore price environment. They may become more boring as a result and focus on those core assets and focus on getting more and more margin out of them. That will ultimately lead to higher dividends and buybacks.”

The JPMorgan Natural Resources fund has Rio as its fourth-largest holding, with a 4.7 percent weighting, and BHP as it the sixth at 4.1 percent.

This year’s 37 percent decline in iron ore was partly responsible for BHP shying away from a widely anticipated buyback last month, chief executive officer of the world’s biggest mining company Andrew Mackenzie said at the time.

Disappoint Again

“We fear the group could again disappoint (excessively high) market expectations on capital return next year,” if prices for iron ore and copper fail to rebound sharply, Exane BNP Paribas analysts led by Luc Pez wrote in a report this week in which BHP was downgraded to underperform.

Rio Tinto CEO Sam Walsh, who derives almost 90 percent of the London-based company’s earnings from the iron ore division, last month described the world’s second-biggest iron ore exporter as a “cash machine” as a cost-cutting drive starts to bear fruit. The company has a vision to “deliver on increased shareholder returns,” he said in an Aug. 8 interview.

Chinese Port

Iron ore with 62 percent content at the Chinese port of Tianjin fell 0.8 percent yesterday to $84.50 a dry ton, according to The Steel Index. Prices retreated to $81.90 a ton on Sept. 11, the lowest level since September 2009.

“At current prices we think they will announce a significant dividend increase and a buyback,” said Rob Clifford, a London-based analyst at Deutsche Bank AG, who rates Rio Tinto a buy. “I’m convinced that today’s iron ore price remains above both BHP and Rio’s internal view of what long term prices are ,so as far as they’re concerned they’re still making excess margins on iron ore.”

Still, the price may find a floor near $80 a ton as lower cost Australian supplies displace higher cost Chinese production, according to JPMorgan’s Sutton.

Hit a Floor

“We are seeing increasing signs of production falling off in China and other parts of the world as well being displaced by this very low cost Australian production which is coming on stream ahead of time,” he said. “We might be starting to hit a floor.”

Mine closures around the world spurred by the slump in prices will help the price to level out, according to the government forecaster in Australia, the world’s biggest exporter. It may average $90 a ton to $95 a ton over the next five years, according to Wayne Calder, deputy executive director at the Canberra-based Bureau of Resources and Energy Economics.

The expanding global glut will more than triple to 163 million tons next year from 52 million this year, according to Goldman. The surplus is seen expanding to 245 million tons in 2016, 295 million tons in 2017 and 334 million tons in 2018.