Iron Ore in $30s Seen Near Tipping Point for Largest Miners

  • Big Four’s highest-cost mines pressured: Capital Economics
  • Miners’ shares retreat, with BHP sliding to lowest in 10 years

Iron ore’s tumble into the $30s threatens the world’s biggest miners as prices approach break-even costs, according to Capital Economics Ltd. BHP Billiton Ltd. shares slumped to the lowest in 10 years and Rio Tinto Group dropped to the lowest since 2009.

The most expensive operations at the four largest suppliers are on the verge of making losses at rates below $40 a metric ton, said John Kovacs, senior commodities economist at Capital Economics in London, who estimates their break-even levels at $28 to $39, taking into account freight and other costs. While these producers will keep output strong, they’ll be constrained by low prices, he said by e-mail on Monday.

Iron ore’s plunge below $40 comes as producers including Vale SA in Brazil and Rio and BHP in Australia press on with expansions to cut costs and defend market share just as demand from the largest consumer China slows. They’re the world’s biggest suppliers along with Fortescue Metals Group Ltd. Prices of the raw material have lost 45 percent this year and have plunged 80 percent from their peak in 2011.

“The big four will find it hard to maintain output at below $40,” Kovacs said in response to questions. “If prices remain weak, output from the highest-cost mines of the big four will be under pressure.”

Price Sinks

Ore with 62 percent content delivered to Qingdao sank 1.1 percent to $38.65 a dry ton on Monday, a record low in daily prices compiled by Metal Bulletin Ltd. dating back to May 2009. The raw material peaked at $191.70 in 2011.

Kovacs said that while rates will stay low over the next year, he doesn’t believe they’ll remain below $40 for a significant length of time. He expects prices to recover slowly because demand won’t fall much further and the biggest miners will find it difficult to keep up output at these levels.

Mining company shares retreated. BHP declined 5.2 percent to A$17.05 in Sydney, the lowest since 2005. Rio dropped 4.3 percent to the lowest in more than six years and Fortescue closed 3 percent lower. Top producer Vale closed at an 11-year low in Sao Paulo on Monday.

UBS Group AG estimates that of the four biggest producers, Fortescue has the highest break-even cost of $40 and Vale’s is $34 in terms of ore landed in China with 62 percent content including interest. BHP’s break-even level is $29 and Rio’s $30, the bank’s data show.

“There is not much production outside of the big four that can make money at these levels — eventually, we should see the juniors be forced to cut production,” said Jeremy Sussman, a New York-based analyst at Clarksons Platou Securities Inc. “It can also take some time for uneconomic production to come offline.”

Miners’ View

The top mining companies have justified their strategy. In response to questions on Tuesday, Rio Tinto referred to comments last week in Perth by Andrew Harding, head of its iron ore business, who told reporters the unit was “set up to deal with long-term price outcomes, and deliver great margins over the long period of time.”

BHP said Chief Executive Officer Andrew Mackenzie set out the company’s view last week, saying the producer remains “relatively bearish about the long-term projections for prices,” of steel and its raw materials, including iron ore.

“Fortescue has worked hard to ensure we can respond to market conditions,” CEO Nev Power said in an e-mail. “As one of the lowest cost iron ore producers in the world, we will continue to drive productivity, efficiency and cost improvements to maintain our strong financial position.”

Luciano Siani, Vale’s chief financial officer, said last week the company will continue to lower its break-even costs so it can deliver cash flows no matter where prices may be.

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Baltic Dry Index Keeping Iron OreMiners Afloat

AS OF 08:03 EDT

These are nervous times for iron ore producers.

Fortescue Metals, the fourth-largest miner of the steel-making material, starts to lose money if prices at Chinese ports fall below $39 a metric ton. After a 37 percent drop this year, Metal Bulletin’s benchmark is now just 16 cents above its record-low $44.59 a ton.


So it’s no surprise the Australian company’s chief executive officer, Nev Power, is pulling every lever to keep his red dirt in the black. He’s reducing the cost of mining, processing and then hauling the ore to port to $15 a ton from its current $18 a ton, according to a presentation last month. Interest expenses add another $4 a ton, so Fortescue announced Nov. 10 a tender offer aimed at paying back as much as $750 million ofdebt early.  Beyond that, he’s looking at developing a joint venture with Baosteel and Formosa Plastics to produce magnetite, according to Bloomberg’s David Stringer. That variety of iron ore requires costly processing but attracts a higher price and a lower government royalty tax than the hematite Fortescue mines at present.

One unexpected benefit comes from the Baltic Dry index, a benchmark for the cost of hiring freight ships that dipped below 500 on Friday for the first time since it started in 1985. When China’s industrial demand was strong, the cost of both raw materials and the ships used to transport them soared. Now that it’s slumping, commodity prices and ship rates will have to fall to clear supply gluts built up during the boom.

Looking at the cost of hiring a Capesize ore carrier gives you a sense of the benefit:

Flat Iron
The cost of hiring a large ore carrier has been slumping
Source: Baltic Exchange

Fortescue probably pays more than the current spot rate so as to reserve its cargo space and lock in prices for months at a time, but the benchmark is a good guide to the general direction of its expenses. A Capesize vessel carrying up to about 170,000 metric tons of iron ore will spend some 30 days making the round trip to deliver its cargo and get back to port, judging by the last voyage of the Bulk Prosperity, a bulker owned by China Development Bank that anchored off Australia’s Port Hedland on Monday after returning from Qingdao.

At current rates of $4,713 a day, transport on the spot market for the whole voyage would come to about 83 cents a metric ton on a fully laden ship. 12 months earlier, the day rate was $22,192, and transport was $3.92 a ton. When you’re only making $5.75 a ton of profit, as Fortescue is now, that’s a significant difference.

There’s potentially a virtuous circle here for iron ore producers. With operating costs for a capesize vessel averaging about $7,400 a day, according to consultancy Moore Stephens, shipowners are mostly losing money at current rates. But the alternative is less attractive these days, too. Thanks to that glut of iron ore, breaking up a ship and turning it into steel scrap only nets about half what it did a couple of years ago:

Breaking Up Is So Very Hard to Do
Low scrap prices are making it more difficult to remove ships from the market
Source: Metal Bulletin

That may keep more vessels on the market and ensure shipping costs stay lower for longer, helping iron ore miners stay in the black.

Don’t get too comfortable. Companies only book a ship if they have real cargo to move, so there’s no speculative activity in the Baltic Dry to take the edge off price swings. The index almost doubled during June and July and Capesize rates were above $14,000 a day as recently as September. Fortescue’s cushion is thin enough now that even a small spike could leave investors feeling sore.


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Splunk : Update Raising Target Price

SPLK : NASDAQ : US$64.94

Target: US$80.00 

Splunk software collects and indexes machine-generated big data
coming from the websites, applications, servers, and mobile
devices that power business. The firm’s software enables
organizations to monitor, search, analyze, visualize and act on
massive streams of real-time and historical machine data. Splunk
is headquartered in San Francisco, was founded in 2003 and has
been public since April, 2012.
All amounts in US$ unless otherwise noted.

Technology — Enterprise Software — Infrastructure

It is quite clear to us that investors are shifting money back into business software and
that the investments are tightly targeted toward perceived quality names. We strongly
believe Splunk is one of the best-in-class systems software firms, and arguably one of the
most promising companies in the broader software space. Obviously, SPLK is expensive,
but in software stock investing, execution trumps valuation for long periods of time. We
expect to see SPLK shares higher in three months, six months and a year. BUY.
 Bullish items. A larger revenue upside than last quarter. Product and use case
momentum. Major wins in Public Sector, Sporting Goods, Healthcare, Education and
Telco. Broader use cases for stream wire data. Sales restructuring by functionality
generated strong wins in security. Real-time data and analytics now deployed in
sports stadiums.
 Bearish items. Frankly, not much. We would like to see continued progress toward
the high end of 25-35% ratable revenues as a percentage of total revenues.
Operating margins were guided to be roughly flat next year, although we believe
there is upside to margin assumptions if revenues upside a bit. Finally, the obvious –
SPLK is highly valued at 13x and 10x our C2015 and C2016E EV/revenues.
 Sales excellence. The call had a large focus on continued strong sales performance
with 500+ new customers added, 290 orders above $100k, positive data points from
the segment-focused model, more than 70% of bookings from existing customers,
2/3rds of upsells from horizontal expansion and the largest ever transaction for
cloud (7 figures). The list goes on, but ultimately shows how SPLK’s sales organization is firing on all cylinders and a major reason for the company’s growth.

 Guidance update to bring positive revisions. Management increased revenue
guidance for the full year by $13.5M at the midpoint, mostly reflecting the $10M
beat in Q3. Operating margin guidance at 1-2% for the full year was increased from
1%. The company also released initial F2016 guidance for revenue of $575M. While
possibly still conservative, implying 31% growth over F2015 guidance, it was above
both our estimate and consensus, which should bring about positive revisions to

We raised our F2016 revenue estimate by $21.5M to $580M


EAC : NYSE : US$13.80
Target: US$17.00

Erickson Air-Crane is a provider of heavy and medium-lift
air services for government and commercial customers.
Key markets include firefighting, personnel transport,
construction, and oil and gas. The company is the largest
operator, and type certificate holder, of the SH-64
Aircrane. The company is based in Portland, Oregon.

Transportation and Industrials — Aerospace and Defense
Investment recommendation
EAC reported adjusted Q3/14 EPS of $1.22, compared to our estimate of
$0.95 and consensus of $1.01. Cash flow in the quarter was a positive
~$17M. Note that Q3 is usually seasonally the strongest quarter for EAC.
However, the company indicated that full year results would likely be at
the lower end of its guidance range, which was unchanged from prior
quarters. In the Government segment, firefighting revenues were up
12% over Q3/13, while Defense & Security revenues were down 25%
year-over-year. Much of the growth was in Infrastructure (oil and gas)
markets. We continue to see risk associated with the timing of the
commercial market ramp, while revenues in the defense segment
seemed to be declining slighter faster than we had modeled. We are
maintaining our HOLD rating and lowering our price target to $17.
Investment highlights
 The company saw a nice step-up in bill rates across markets.
However, the company indicated that Q4/14 results will drive full
year results at the lower end of the guidance range. We are
maintaining our full-year 2014 $0.46 EPS estimate.
 While there was good cash flow in the quarter, the outlook for 2015
is still about the ramp down in Government revenues, and how fast
they can be replaced by commercial revenues, specifically in oil and
gas. The company did announce a win in Ecuador, which should be
positive for 2015.
We are lowering our price target to $17. Our price target is based on the
average of a 12.0x EPS multiple and a 5.25x EBITDA multiple applied to
our 2015 estimates

Service Now BUY

NOW : NYSE : US$58.07
Target: US$72.00 

ServiceNow is a leading provider of cloud-based services
that automate enterprise IT operations — this includes a
suite of applications built on the firm’s proprietary
platform that automates workflow and provides
integration between related business processes.
ServiceNow was founded in 2004, is headquartered in
San Diego, CA and has been public since June 2012.

Technology — Enterprise Software — Infrastructure
Investment thesis
Whether we get a Q4 software rally or not, we continue to believe that the first place
investors will look is going to be open-ended, leading growth firms in relatively
uncrowded segments. This describes ServiceNow. While more than 9x revenues on
2015E is at the high end of where we like to recommend the most premium growth
names, we believe NOW warrants the premium. Indeed, even with a likely
degradation of the multiple, we believe this stock should easily generate more than
20% upside over the coming 12 months. Reiterate BUY.

No surprises here, another upside quarter. NOW reported strong Q3/14 results
with revenue of $178.7M (+61% y-o-y) and operating income of $10.2M, which
were respectively $3.7M and $8.0M ahead of our estimates
Calculated billings of $200.7M (+ 58% y-o-y) were $2.3M better than our Street-high
forecast and well ahead of management’s $190-193M guidance.
 Customer metrics. Average revenue per user was $275K, up 21%

Outlook: momentum continues,


inching forecasts higher again. NOW’s Q4/14
guidance set expected revenues roughly $1.5M ahead of our previous estimate
(despite a $4M FX headwind) and calculated billings ~$10M ahead. Our revised
Q4/14 revenue and billings estimates imply respective y-o-y growth of 55% and
50%. We have similarly increased our C2015 revenue and FCF estimates by
$7M and $25M to $940M (+39%) and $127M, or $0.74 per share

Splunk – Analyst Day Update Target Price $68

SPLK : NASDAQ : US$57.25
Target: US$68.00

Technology — Enterprise Software — Infrastructure

With the 26% increase in SPLK shares since the firm last reported results at the end
of August, the stock is again sporting a top decile valuation, at more than 11x
C2015E EV/revenue. While this may be hard for some to stomach in today’s skittish
tape, we continue to believe that continually increasing use cases will drive capacity
expansion (and revenue growth) beyond what current estimates capture. An upside
estimate bias combined with the scarcity value of being the only public company, big
data pure play on the “Internet of Things” warrants a premium valuation. Our call on
SPLK continues to be that we anticipate revenue growth to more than outpace a
gradual multiple compression so that investors can expect 15%+ gains over the next
9-12 months. Reiterate BUY.

Analyst day.

On Tuesday SPLK hosted an analyst day in conjunction with its 5th
Annual Worldwide User’s Conference in Las Vegas.
 Splunk Enterprise 6.2. From a product standpoint, news centered on the firm’s
end of October release of the latest version of its machine data analytics
platform. Highlights include: enhanced event pattern detection to make the
software more intuitive to less technical users, simplified onboarding of any
machine data, and efforts aimed at reducing total cost of ownership through
increasing concurrent user capacity and eliminating shared storage
requirements (reducing underlying infrastructure investments).
 Evolving to a segment-focused sales model. This area of continued investment
will focus on augmenting normal field reps with subject matter and industry
vertical experts – not only will this help to drive new customer adoption, but it
should also increase horizontal expansion (i.e. new use cases) within the firm’s
nearly 8,000 customer installed base.

 What’s it mean for the numbers?

An increase in ratable bookings, while tough
to predict in the near-term (~25-35% of deals, up from 10-20% at the time of
IPO), will drive improved revenue visibility over time. Longer-term, SPLK
continues to manage the business towards a 20-25% operating margin, the
timing of which will be determined by the pace of top line growth.

Stantec Inc.

STN : TSX : C$70.12
Target: C$78.00

Focused on fee-for-service work, Edmonton-based
Stantec plans, designs, and manages projects in the
North American infrastructure and facilities sector. The
company’s business model incorporates diversity across
regions, end markets, and all phases of the infrastructure
life cycle to manage risk and deliver growth. 2013
marked Stantec’s 60th consecutive year of profitability.

Sustainability — Infrastructure

C$78.00 (FROM C$75.00)
Investment recommendation
We are maintaining our BUY rating and increasing our one-year target
price to C$78.00 from C$75.00 following better-than-expected Q2/14
financial results, an increase in our estimates, and as we roll forward
our valuation base by a quarter. We still believe that Stantec’s 5%
targeted organic growth rate for 2014, paired with the strong pick-up in
acquisition activity (closed and announced deals), are supportive of the
company’s long-standing growth targets. In our view, Stantec should
remain a core holding: management has a clear and consistent strategy
and game plan, no lack of opportunities to drive average annual revenue
and earnings growth of ~15% for the foreseeable future, and a long
track record of very disciplined and consistent execution. We also expect
regular annual dividend increases of 10% or more for the foreseeable
We rely on our five-year DCF model (10.5% discount rate) to value
Stantec. Our target price equates to a P/E multiple of 20.0 times and an
adjusted EV/EBITDA multiple of 11.4 times our 2015 estimates. Given
the company’s available growth opportunity and consistent ROE (~18%
level), we view these multiples as supportable, although nearer to the
higher end of the historical range. We are comfortable with this given
current overall momentum, where we are in the cycle, and what we feel
are relatively conservative forward estimates.