Why The Future Is Bleak For Rio Tinto plc And BHP Billiton plc

Things seem to be going from bad to worse for Rio Tinto (LSE: RIO) and BHP Billiton (LSE: BLT). Indeed, this week the price of iron ore crashed below $50 per tonne, a low not seen for over a decade. And as two of the world’s largest iron ore producers, this development is terrible news for Rio and BHP. 

How low can you go?

Rio and BHP have some of the lowest break-even production costs in the iron ore industry. Analysts believe that the two miners need the price of iron ore to remain above $35 per tonne in order to break even.

However, as the price of iron ore continues to decline, the margin for error is shrinking. What’s more, BHP and Rio are both planning to add iron ore capacity this year, even though the market is severely oversupplied.  It is likely that this additional capacity will add additional downward pressure to the price of iron ore, squeezing margins to a level not seen for years.

But in reality, it is unlikely that the price of the key steel-making ingredient will fall below BHP and Rio’s break-even level.

Analysts believe that many iron ore miners have a break-even cost in the region of $50 per tonne, indicating that much of the industry is loss-making at present. With this being the case, high cost producers should start to shut up shop soon, taking excess supply out of the market. 

Nevertheless, there’s no telling how long the market for iron ore will remain depressed. With Chinese economic growth slowing, demand for iron ore is falling and stockpiles are rising. As a result, it will take time for the supply glut to clear even if high cost iron ore producers start to shut up shop. 

Can’t keep up

With the price of iron ore plummeting to new depths every day, it’s now becoming difficult to place a value on BHP and Rio, as analysts just can’t keep up.  

For example, this time last year, analysts were expecting Rio to report 2015 earnings per share of 420p. However, the City has now reduced its EPS estimates by 50%, to 220p. Even though Rio’s shares have slumped by nearly 20% over the past 12 months, based on these lower forecasts, the company is currently trading at a forward P/E of 12.2.

Similarly, earnings estimates for BHP have been slashed by 50% over the past year. The company now trades at a forward P/E of 14.7, which looks expensive, despite the fact that the company’s shares have slumped by 25% over the past 12 months. 

Heading lower

All in all, as the price of iron ore continues to fall, BHP and Rio could fall further still and shareholders shouldn’t expect fireworks from either company any time soon.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.