Long-term upside remains for iron ore miners. Here are the stocks Macquarie is backing

It's been a volatile year for iron ore spot prices. After rebounding from a low in November last year, iron ore prices had been on a stellar run, increasing more than 65%. But since peaking in mid-March at US$134.50 a tonne, prices have fallen more than 20%. 

That said, Macquarie analysts note that spot prices are currently trading below the investment bank's short-term price forecasts. While this presents short-term earnings headwinds for iron ore miners, analysts argue upside remains for investors with strong stomachs over the years ahead. 

For example, BHP Group's (ASX: BHP) earnings are estimated to increase by 20% from FY24 to FY25, while Rio Tinto (ASX: RIO) is estimated to face some earnings downside of 3% in FY24, but an upside of 17% in FY25. In comparison, Fortescue Metals Group (ASX: FMG) boasts the most upside, analysts estimate, at 32-88% for FY24 to FY26. 

In this wire, I'll summarise Macquarie analysts' latest outlook on the short and long-term future of iron ore miners, as well as their updated recommendations on favourites such as the above stocks. I'll also canvass their views on Mineral Resources (ASX: MIN), Champion Iron (ASX: CIA), Deterra Royalties (ASX: DRR) and Mt Gibson Iron (ASX: MGX). 

Macquarie's iron ore outlook 

Over the past week, shipments for RIO, BHP and FMG rose 11%, with higher throughput from FMG and RIO offsetting lower exports at BHP. 

And while FMG recently announced that it had produced and transported its first magnetite product at grades higher than 68% Fe iron ore at its Iron Bridge project, Macquarie analysts still prefer BHP as their large-cap exposure to iron ore as it boasts "stronger organic growth options". 

At current spot prices (US$107 a tonne), analysts believe the major iron ore miners will be able to continue to generate solid cash flows over the short to medium term, with free cash flow yield upside driven by "buoyant" iron ore prices. 

"At spot prices, FY23E free cash flow yields are 6% for BHP, 5% for RIO, and 11% for FMG," analysts wrote. 

"For the smaller names, the spot-free cash flow yields are 5% for DRR, -3% for CIA, and -40% for MGX. MIN’s free cash flow yield at spot is close to zero for FY23 due to capital spending for its iron ore and lithium growth." 

In addition, the note revealed that Macquarie's Commodity Strategy team has recently updated their iron ore cost curve. They have now incorporated the December and March quarter results from iron ore miners as well as the Q1 average 62% Fe iron ore spot price benchmark price of US$125/tonne. 

"Since the June 2022 update, the cost curve (CFR China) has moved lower, driven largely by an approximately 40% reduction in freight rates, which has more-than-offset increased cash costs," analysts wrote. 

"This suggests that the iron ore price could fall by approximately US$30 a tonne from [current spot prices] until there is a meaningful supply response. 

"However, there are multiple factors that could step in to support prices before the cost curve is truly tested, one of which being restocking by mills taking advantage of the lower iron ore price following almost a year of holding low raw materials inventories."

Macquarie's recommendations

Macquarie's preference, as mentioned earlier in this piece, is BHP. But it also has a positive view on Mineral Resources despite the weaker short-term outlook for iron ore – thanks to its strong outlook on lithium. 

The analysts also believe Deterra Royalties could benefit from here, and have an OUTPERFORM rating on the stock. That's thanks to its "low volatility exposure to iron ore via its royalty derived from BHP’s production at Mining Area C which is tracking ahead of schedule". 

BHP Group (ASX: BHP) - Outperform 

• Market Cap US$150.2 billion 
• Price A$43.97/£23.02/R528.80 
• Price Target A$52.00/£28.50/R640.00 
• TSR 26%/32%/29% 

Rio Tinto (ASX: RIO) - Neutral 

• Market Cap US$103.0 billion 
• Price A$110.14/£48.70 
• Price Target A$122.00/£55.00 
• TSR 19%/23% 

Fortescue Metals Group (ASX: FMG) - Underperform 

• Market Cap US$41.8 billion
• Price A$20.28 
• Price Target A$17.00 
• TSR -10% 

Mineral Resources (ASX: MIN) - Outperform 

• Market Cap US$8.8 billion
• Price A$68.63 
• Price Target A$115.00 
• TSR 71% 

Champion Iron (ASX: CIA) - Outperform 

• Market Cap US$2.1 billion 
• Price A$6.27/C5.61 
• Price Target A$7.80/C7.00 
• TSR 31%/31% 

Deterra Royalties (ASX: DRR) - Outperform 

• Market Cap US$1.6 billion
• Price A$4.64 
• Price Target A$5.00 
• TSR 15% 

Mount Gibson Iron (ASX: MGX) - Neutral 

• Market Cap US$366 million
• Price A$0.47 
• Price Target A$0.50 
• TSR 8%