Another ugly dip in the price of iron ore will not tempt Australia's fund managers back into the sector, with investors saying conditions are still too poor even for bargain hunting.
The iron ore price tumbled 4.3 per cent to $US63.54 a tonne overnight Monday – its lowest price since May 2009 when the current pricing system was introduced. It is a price at which production for most of the country's miners – aside from Rio Tinto, BHP Billiton and Fortescue Metals Group – is unprofitable.
However, growing concerns about Fortescue's cash flow and debt position saw the stock hammered in early trade, falling by as much as 10 per cent in early trade on Tuesday.
Fortescue shares traded below $2 on Tuesday for the first time since 2009 before recovering to close 2.3 per cent lower at $2.08.
Shares in BHP Billiton fell by 1.46 per cent to $28.95.
Ric Ronge, head of global resources at Melbourne-based fund manager Pengana Capital said that even though bargains could be emerging in iron ore, uncertainty remained too great to justify investing.
"When you're right in the thick of it, it is a very hard call. We'll probably be looking back in a few years' time and going 'that was a great opportunity'.
'Insolvency risk'
"But it's too hard a call at the moment, for us to be flooding our clients' money into iron ore."
He said some smaller miners faced an "insolvency risk", which made investing more precarious.
Pengana has holdings in FMG, as well as BHP and Rio Tinto.
Investors Mutual senior portfolio manager Hugh Giddy said it is "buyer beware" in the iron ore sector.
"If you're not making money and you have debt, that's a very dangerous position to be in," he said. "You have to be aware that they [iron ore miners] have so much leverage to the price.
"When price is falling, your margin gets squeezed a lot, and you can lose all your profit very quickly. When the price goes up, they look like heroes."
Investors Mutual has holdings in BHP and Rio. But Mr Giddy said he would avoid most other companies with iron ore exposure.
Fortescue has by far the highest "break even" price of the three Pilbara majors and is making just $US6 a tonne in cash at current prices.
Ross Barker, chief of the Australian Foundation Investment Company, said Fortescue's $US7.3 billion ($9.2 billion) debt position "is challenging in almost every environment.
Weather the ups and downs
We've tended to stay with companies such as BHP and Rio that are well down the cost curve and can weather the ups and downs of what happens with commodity prices."
Mr Ronge says Fortescue's debt pile – which it will not have to make a major repayment on until April 2017 – looms as a potential issue for the position.
"Fortescue has managed its gearing to the point that there is no immediate pressure, but if this environment deteriorates or hangs around longer than expected, then it is going to become an issue," Mr Ronge said.
Fortescue is cash neutral – that is, not making or losing cash – at $US58 a tonne, on UBS estimates, putting its current margin at about $US6 at current prices, equating to about $US950 million in annual operating cash flow. But that can change very quickly. Just six months ago, Fortescue's margin was closer to $US45 a tonne.
Arnhem Investment Management managing director Neil Boyd-Clark said there is little hope the pressures plaguing the iron ore sector will abate, and growth prospects look dim.
The iron ore miners are in a breakneck race to cut costs and have been granted some grace by the falling Australian dollar and a big drop in freight prices, driven by the oil price collapse.
Together, those factors had shaved about $US10 a tonne from miners' break-even points in the past month alone – a shot in the arm of about $US650 million.
Relief will increase
If the Australian dollar continues its fall below US80¢, that relief will increase further. Freight prices have fallen about $US5 a tonne since December, from $US9 to $US4 a tonne.
The industry-wide relief also makes the majors' enviable profits even better.
But that relief can disappear fast if currency rates and oil prices change quickly.
Arnhem's Mr Boyd-Clark said the iron ore sector "remains challenging".
"The fundamental problem is that supply continues to increase, yet there is not much you can point to that suggests demand is suddenly going to accelerate again. From a growth perspective, it is difficult to see an attractive organic growth story being able to offset price declines."
Slim near-term earnings growth prospects were a big deterrent to increase investment in Rio Tinto or BHP, which Arnhem has holdings in.
"If you are looking for yield, you might be able to make the case for Rio or BHP, but if you are growth investors, it is more difficult to make the case. The production growth they are delivering is being offset by price declines," Mr Boyd-Clark said.
And second-tier players with a strong balance sheet were a risky play given most are currently running their operations at a loss. "If you are producing iron ore and still losing money, then you are eventually going to see any balance sheet strength whittled away anyway," Mr Boyd-Clark said.
Knife taken to forecasts
A string of analysts have taken the knife to iron ore price forecasts in the first few weeks of the year, tipping it will average in the $US60s for 2015.
Citi is the most bearish, with a forecast of $US58 a tonne for the year.
On Friday, beleaguered steel maker Arrium announced it was shuttering one of its two mining precincts, taking 4 million tonnes out of the market.
The savings delivered by the Australian dollar and lower freight prices have shaved Rio's and BHP's break-even prices to about $US34 a tonne, from about $US43 a month ago.
The break-even price at Gina Rinehart's Roy Hill mine – where production is scheduled to start later this year – would be about $US41 a tonne, down from $US51 a month ago.
