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Morningstar | Vale’s Brucutu Restart May Cool Iron Ore Prices, BHP Group and Vale FVEs Retained

No-moat Vale expects its 30 million tonne Brucutu mine to restart in just a few days. We expected Brucutu to return in 2019 but the timing was uncertain. Vale is mending its credibility and faces elevated regulatory scrutiny. With China’s iron ore futures down nearly 5% intraday in response, it seems some were betting Vale’s supply woes would persist to support the elevated iron ore price.

Brucutu coming back is important to sentiment. We’ve seen euphoria in the iron ore stocks, fuelled by a series of supply shocks and iron ore price action. But Brucutu’s return suggests we’ve seen the worst of the supply shocks. This may be when the market’s focus changes from fearing further supply disruptions to considering how much production returns and when. Vale’s 2019 iron ore guidance is maintained, as is our USD 10.60 per share fair value estimate.

Like peer Rio Tinto, BHP Group had a soft March 2019 quarter for production, particularly iron ore. Iron ore shipments fell 7% versus a year ago to 62.9 million tonnes. BHP’s share was 55.6 million tonnes. The company lowered fiscal 2019 volume guidance by about 10 million tonnes or 4% to 265 to 270 million tonnes. BHP’s share is 235 to 239 million tonnes. The reduction in guidance was slightly worse than expected and our fiscal 2019 forecast is reduced by 1.8% or 5 million tonnes to 268 million tonnes. While BHP’s Pilbara assets were not damaged, the post-cyclone restart was hampered by flooding and wet ore.

Our AUD 28 per share fair value estimate for no-moat-rated BHP Group remains. The shares are overvalued, though less so than peer Rio Tinto given the lower exposure to iron ore. Our expectation for steel demand and production to fall in China is the key driver of our call. The price of iron ore is inflated and trades well above cost curve support. This reflects the approximate 100 million tonnes of temporarily lost supply from Vale and Cyclone Veronica. These losses equate to about 6% of traded iron ore supply.

Lower volumes due to Cyclone Veronica will see higher iron ore unit costs. BHP now guides to costs of less than USD 15 per tonne in the Pilbara, versus less than USD 14 per tonne previously. We’ve increased our near-term costs slightly as a result. Outside iron ore, we also reduce forecast copper production by more than 1%. Escondida and Olympic Dam output is tracking towards the bottom end of guidance. BHP’s unit cost guidance for fiscal 2019 at New South Wales Energy Coal has also increased by 12% to USD 51 per tonne. But the elevated costs are likely to be temporary. Temporary labour shortages are being addressed and mine plan changes should reduce future haulage costs. Energy coal accounts for only about 4% of fiscal 2019 EBIT. Petroleum was the key bright spot with production in line with the top end of guidance for 113 to 118 million barrels of oil equivalent, or mmboe. Our 118 mmboe forecast is unchanged.