Cashed-up Fortescue recasts its ambitions

The continuing transformation of Fortescue Metals over a little more than a year is as impressive for the rate of that change as well as for its nature.

In late 2012, when iron ore prices crashed below $US90 a tonne, Fortescue was extraordinarily vulnerable. It was in the midst of massive production ramp-up, had relatively high cash costs and was carrying a massive and rapidly rising debt load.

That brush with disaster turned Andrew ‘Twiggy’ Forrest from a spendthrift, ever-optimistic entrepreneur with an insatiable appetite for debt into a financial conservative. In turn, Fortescue transformed from a maverick company with very shaky foundations into a far more stable, conventional and rapidly-maturing force.

Today Fortescue announced the early redemption of $US1.64 billion of two tranches of unsecured notes. Late last year the group made an earlier $US1.04 billion repayment of the larger tranche. Once the latest redemption is made in March, Fortescue will have repaid more than $US3 billion of debt since November.

As it said today, at its peak the group’s gross debt was $US12.7 billion. After the latest redemptions have occurred, gross debt will have fallen to $US9.6 billion and net debt to $US7.8 billion. The cost of servicing its debt will have been reduced by about $US300 million a year as a result of those early repayments, effectively halving its financing costs relative to its interests costs last financial year.

The actions that Fortescue has taken since that brief plunge in the iron ore price in the final quarter of 2012 have had a profound and leveraged impact as the iron ore price rebounded and settled at around $US130 a tonne. These actions included slowing its expansion plans, slashing costs, the sale of some assets and – most significantly – the restructuring, refinancing and reduction of its debt. It hasn’t hurt that the Australian dollar has also fallen quite significantly over that period.

With its capital expenditure having peaked last financial year at around $US6 billion and now tumbling as the group’s production heads towards its 155,000 tonnes a year target – its cash break-even price reduced from around $US90 a tonne to $US70 a tonne – Fortescue’s cash generation is soaring. This enables it to make very substantial inroads into its leverage.

Fortescue now has no scheduled debt repayments due until 2017. It isn’t until 2019, when nearly $US5 billion of debt matures, that it has any material principal payments due.  It has largely de-risked its balance sheet – a remarkable achievement in the space of a little over 12 months given the parlous starting point.

The group is now in a far stronger and more flexible position to respond to whatever might develop in China’s economy and in China’s demand for iron ore. While all the iron ore majors are confident of the longer term outlook for the economy and for iron ore, they are all also well aware that the price has been quite volatile in recent years and that there are no short-term certainties.

The scale of its debt reduction and the swelling of its cash flows have relieved the pressure on Fortescue to make further asset sales. It had planned to sell an interest in its rail and port infrastructure, but that process appears to have gone nowhere. Any urgency or necessity for a sale has disappeared with the improvement in Fortescue’s finances.

That improvement has created options for Fortescue that didn’t exist a year ago. Indeed, they couldn’t have been contemplated at that point. With a far more mature profile it could start significantly lifting cash returns to shareholders, embark on its next phase of expansion – or both. What is unlikely is a return to the risky debt-laden scramble-for-growth strategy that Forrest pursued to create his ‘new force’ in iron ore.