Rio Tinto “best positioned” to capture iron ore market share, says Investec

Rio Tinto (LON:RIO) is “best positioned” to capture market share as iron ore producers swap profit margins for growth after a recovery in prices this month. So says Investec Securities, which has a ‘buy’ rating for Rio and a target price of 4,170 pence.

Investec noted that the iron ore spot price bounced back by 26 per cent in November to US$147.60 per tonne after falling 35.5 per cent since September. “However, this is not business as usual and, in our view, the recent price changes marked significant changes in the market,” said the investment bank, which said these changes included: a strong move to spot pricing by Chinese customers; Chinese steel mills moving from price takers to price makers; Chinese domestic production being more resilient than expected, although grades continue to fall; and the passing of peak profitability.

Investec also said that although supply and demand fundamentals look delicately poised for the next few years, these coincide with what the bank sees as an aggressive push by ‘Big Three’ producers – Vale, Rio and BHP Billiton (LON:BLT) – to fight for market share, which will see margins squeezed further.

“We believe this is led by Vale who, given weaker demand in its traditional European market, needs to regain market share in China. However, its recent attempts to improve its distribution system have actually alienated some Chinese clients, weakening its position in the Chinese market,” said Investec.

But the bank sees Rio as best positioned to capture market share, both in terms of asset and infrastructure base, due to its strong ties to the Chinese market.

Investec added that it also believes that there is a strong risk that smaller developers and producers could be squeezed out unless they can come to market quickly, control costs and build strong links with customers, particularly those in China. “The Chinese government wants 40 per cent of iron ore imports to be under Chinese control or ownership by 2015,” it said.

With the move to spot pricing by Chinese customers, Investec has reduced its average realised price in the current half year for BHP its mines in the Pilbara region of Western Australia from US$156 million per tonne to US$142 million per tonne. For Rio it is reducing the average realised price from US$160 million per tonne to US$143 million per tonne.

As a consequence, although Investec has ‘buy’ ratings for both BHP and Rio it has revised its price targets for their shares down. BHP’s price target has been recued to 1,918 pence from 1,941 pence, while Rio’s is reduced to 4,170 pence from 4,227 pence.

In mid-morning trading today Rio’s share price was down 1.9 per cent at 2,997.5 pence, while BHP’s shares were down 1.2 per cent at 1,744 pence each.