Lex Hall: Can the iron ore price keep rising? And what does it mean for Australia's major miners? With me to discuss that today is Morningstar's director of equity research, Matt Hodge. G'day Matt.

Mathew Hodge: How's it going, Lex?

Hall: I'm well thanks. Matt, as we speak, the iron ore price is about $206. Why is it so high? I imagine China's got something to do with it.

Hodge: Yeah, big part. So they basically stimulated coming out of COVID. And steel consumption in China was very strong last year, and it's continued to grow. So and that was on the back of an already strong 2019. So China's been stimulating its economy, both infrastructure and spending on construction as well. So that's been on the demand side. On the supply side obviously, the Vale failure knocked about 100 million tonnes of iron ore out of the market, very little of that has come back. Vale has had a lot of issues, rectifying its problems with its tailings dam, and it's taken longer to come back. But really, stimulus is a big driver of why we're here right now.

Hall: Okay, you've just written a report in which you talk about BHP, Rio, and Fortescue Metals Group, and you look at several scenarios, but at the moment, you've got them all in about sort of one to two star territory, which means they're overvalued. What are the sort of the some of the key reasons why they're overvalued?

Hodge: Well, the returns are just amazing at the moment, you're looking at kind of Google, Amazon type returns, from what is essentially just a commodity business. In the long run, the supply is not fixed, right, in the short run it is, right. So that's why we've had the price where it's at. If we were to run through kind of $200 iron ore price, BHP and Rio, their iron ore divisions, making well over $1 -- for every dollar of investment that they have, right, that's per annum, so over 100%, return that's phenomenal returns. And even if you look at Fortescue, it gets pretty close to that, roughly well over 50%.

Hall: Alright, so as you say, you've mapped out some of these scenarios in your report, let's look at that, and the iron ore price is changing, it seems all the time. For instance, what price is needed to make Fortescue Metals Group look cheap, if we can use that term.

Hodge: It's the most leveraged of the group, right. And I think for all of them, to get to a scenario where we think they're all fairly valued, they roughly all crossover about the same point that is about $30 higher than our forecast deck. And if you take a look at the report, you'll be able to see the exact numbers, if you're really that interested. For long term, what that means is a bit over $70 per tonne at that point, right. Anything above that, and Fortescue would be the cheapest, but I would counter that with the company is well in the third quartile of the cost curve, qualitatively it's no moat, it produces a lower grade iron ore product. And as ESG and carbon emissions become more important, that's going to place them at probably an increasing disadvantage. And if we ran that $70 a tonne number through our Fortescue model, you're getting returns of over 20%. So still, very strong returns in what is qualitatively not a "moaty" business.

Hall: Matt, one line that stuck out to me in your report on iron ore, you say the short-term outlook was strong, but we think perspective is required and prudence valuable. Can you expand on that a little bit?

Hodge: Yeah, I think there's a tendency, when you look at the iron ore prices and say, okay, it's at $200. Right. Holy smokes, that's a phenomenal price. And it's kind of been here for a while, and you kind of say, okay, that feels like it's a normal kind of price, right. But it really underestimates just how phenomenal that price is, for the iron ore miners, right? And what kind of returns come from that? Even $100 bucks is amazing. And there's any decent iron ore project worth its salt, if you could guarantee them kind of $60, $70, it's going to get out like the potential supply from Guinea, whatever Vale can bring back on. So there is definitely supply at a price that's vastly lower than here. And we are way above the cost curve, like, BHP, Rio breakeven would be probably in the 20s, Fortescue in the 30s. And Vale similarly, probably coming down over time, but we're way above that.

Hall: Okay. And one last question without notice. I suppose the miners look overvalued now, but they're still attractive dividend payers, are they not?

Hodge: Yeah, but it all depends on, what those commodity price inputs are. In the long run those inputs are the key drivers of total shareholder returns, right? So this is more about a capital gain, than dividend payment. Intrinsically mining companies tend to be fairly capital intensive. We've gone through a period where they've not really expanded much since kind of 2014-15. And a lot of that capital has just been returned to shareholders, which has been, you know, the right thing to do. But that's not a permanent state of affairs.

Hall: Okay. Matt Hodge, thank you very much for your insights today.

Hodge: Thanks, Lex.

Hall: I'm Lex Hall for Morningstar. Thanks for watching.