Billionaire David Einhorn, the founder of Greenlight Capital and one of the world's most renowned short sellers, is bearish about iron ore. Speaking at the Great Investor's Best Ideas investment symposium in Dallas on October 30, Einhorn called iron ore prices "a bubble" and predicted a plunge in ore prices over the next few years. While iron ore prices in September of this year were already 44% lower than in the same month of last year, Einhorn predicts a continued decline from the current $100 per ton to as low as $60 per ton by 2014. Notwithstanding the forecasted decline, iron ore prices at $60 per ton would still be five times higher than in 2002.
So far, Einhorn's prediction has had a small impact on the stock prices of major iron ore producers. However, his gloomy outlook for China's growth and prediction of an extended weakness in the iron ore and steel markets could likely signal trouble for iron ore miners and steel producers. Given that Einhorn, more than any other money manager, is believed to have the power to move the markets with his short ideas, his bets against iron ore may lead to investors' dumping of the stocks of major ore miners, such as Vale S.A. (NYSE:VALE), Rio Tinto (NYSE:RIO), and BHP Billiton (NYSE:BHP). Also adversely affected will be steelmakers, including ArcelorMittal (NYSE:MT), the world's largest steelmaker and an iron ore miner, which, due to poor financial performance, is slashing its regular dividend by nearly 75%. [In line with his short-selling thesis in the steel complex, at the May 2012 Ira W. Sohn Investment Research Conference, Einhorn also recommended shorting U.S. Steel Corporation (NYSE:X)]
Below is a closer look at the four dividend stocks that are likely to be adversely affected by Einhorn's predicted drop in iron ore and steel prices. However, in most cases, despite the forecast adversity, dividend payouts look fairly secure.
Vale S.A. is the world's largest producer of iron ore. This Brazilian company saw its third-quarter profit tumble 61% from the previous year due to a decline in production and the plunge in commodity prices to three-year lows. The company's profit is hurt by slower growth in China, Vale's largest market, rising costs, and a number of new mines being behind schedule. Interestingly, earlier this year, Vale's management made a forecast that iron ore prices would climb to $180 per ton this year as demand from Chinese steel mills accelerated. (At prices below $120 per ton, higher-cost Chinese steel producers cease to be competitive.) Vale's upbeat forecast about iron ore prices failed to materialize, which led to a precipitous decline in its revenues and profits. In response to deterioration in its financial position and the poor market outlook, Vale put on hold its $5-billion iron ore venture in Guinea.
Vale pays a dividend yield of 3.3% on a payout ratio of 28% of trailing earnings. Over the past five years, the company's EPS and dividends grew at average rates of 26% and 25% per year, respectively. Analysts forecast that Vale's EPS will expand at an average annual rate of 12.7% for the next five years, depending on an expected rebound in the global economy. As regards its valuation, Vale's stock is trading on a forward P/E of 6.4x. The stock is down 30% over the past twelve months. Hedge fund Arrowstreet Capital holds a large stake in the stock.
Rio Tinto is the second-largest iron ore miner in the world. The company reported a 22% drop in first-half 2012 earnings due to weaker commodity prices. However, despite the weaker performance, Rio Tinto is maintaining its capital spending plan worth $16 billion, mainly based on the expected strength of the Chinese economy. Hence, the Chinese steel demand remains crucial for the continued performance of this iron miner. The company pays a dividend yield of 2.8% on a payout ratio of 66% of trailing earnings and 37% of last year's free cash flow.
Over the past half decade, Rio Tinto's EPS contracted at an average rate of 11.5% per year, while its dividends grew at average annual rates of 7.4%. The company's EPS is expected to expand at an average annual rate of 16.8%, based on an expected strength in the Chinese demand. The stock has a forward P/E of 7.1x. It is down 8.7% over the past year. Among fund managers, billionaire investor Ken Fisher has more than $546 million invested in the stock.
BHP Billiton is the world's third largest iron ore miner and another company that is extensively exposed to the Chinese steel market. BHP Billiton reported a 35% decline in profit in the year to June 2012, mainly due to weaker commodity pricing. The miner is pinning its hopes on a rebound in demand in the first half of 2013, when it expects the Chinese expansion to accelerate and the global economies to improve. Despite the weaker demand and commodity prices, the miner has been ramping up iron ore production. The company expects to boost iron ore output by 5% next year. However, the miner predicts that the global iron ore market will grow by 650 million tons this decade, down from 800 million tons in the past decade. In August 2012, BHP Billiton decided to scale back its iron ore investments in Western Australia. It is worth noting that the company is making money at any selling price of iron ore above its production cost of $40 per ton.
The company pays a dividend yield of 3.2% on a payout ratio of 39% of trailing earnings. Over the past five years, its EPS and dividends grew at average annual rates of 4.7% and 19%, respectively. Analysts forecast that the miner's EPS will grow at an average annual rate of 6.4% per year for the next five years. In terms of valuation, BHP Billiton has a forward P/E of 15.7x. Its stock is down 10.2% over the past twelve months. Fund manager Bernard Horn (Polaris Capital) owns more than $41 million in the stock.
ArcelorMittal is an integrated iron ore miner and steelmaker. This company just issued a dismal quarterly report, with profit sinking deep into the red. As a result of its poor financial performance and a push to reduce debt, the company is proposing a dividend cut from the current $0.75 per year to $0.20 per year in 2013, subject to shareholder approval.
According to Wall Street Journal, "ArcelorMittal, which tried to reduce its exposure to volatile swings in prices for steelmaking raw materials by acquiring iron-ore mines, said it was surprised by the steep drop in iron-ore prices and would be interested in finding a partner for its mining projects." Despite the lower commodity prices, ArcelorMittal still anticipates its own iron ore shipments to increase by 10% in 2012 from the year earlier. ArcelorMittal's forward dividend yield for 2013, based on the proposed $0.20 per share annual payout, equals 1.3%. The company had a negative free cash flow last year. As regards its valuation, the stock has a forward P/E of 9.0x. Over the past twelve months, the stock is down 27%. Billionaire Jim Simons initiated a new position in this stock in the second quarter of 2012.
It is worth noting that Einhorn's bearish outlook for iron ore in the medium term is a contrarian position. According to a recently released Reuters' survey of 12 analysts, iron ore prices are forecast to average $120 per ton in 2013, down from an estimated average price of $126 per ton this year. The price average should slip further to $119 by 2014 and to $115 by 2015, still almost double the Einhorn's price forecast.