FMG to pay down debt: analysts

DataRoom: Analysts predict Fortescue to benefit from strong operating conditions.

Analysts are forecasting a rapid paydown of debt by Fortescue Metals Group (FMG) as it draws on the quadruple benefits of strong iron ore prices, weaker currency, rising production and lower costs.

This is in stark contrast to a year ago when a short-lived collapse in iron ore prices became a near-death experience, forcing Fortescue into a big debt refinancing and a consideration of asset sales. But now it is a case of awe in just how quickly Fortescue can get to its preferred debt load.

To meet its own declared target of reducing its gearing to 40%, Fortescue has set out on a course of reducing its $US12 billion ($13bn) debt pile by as much $US5bn, without providing a rigid timetable for the paydown.

Analysts are split on the timing of Fortescue being able to get its debt back to the more comfortable $US7bn level. The split is caused by their differing iron ore and exchange rate assumptions.

But analysis by The Australian of market expectations has identified two camps – one that has Fortescue achieving its target gearing level by December next year, the other having it done and dusted by June 2015.

In previous briefings, Fortescue has said it does not really matter when it arrives at the 40% gearing level. It has said what is more important is that it is committed to the journey.

Fortescue, under chief executive Nev Power, takes the view that the iron ore prices will be what that are, needing the company to only be committed to paying down debt. Officially, the company has said previously that it will pay down hundreds of millions of dollars in debt this side of Christmas, and then it will potentially pay off billions of dollars of debt during 2014.

Because debt is a cheaper form of finance than equity, it is highly unlikely Fortescue would shoot for a gearing level of much less than 40%. That target is a balance of its cost of equity, the cost of debt, and how its balance sheet structure best sits. So while it would not necessarily stop at that point, it would never pay off all debt because it would end up with a "lazy" balance sheet.

The power of strong iron ore prices and rising production from the group's near-complete $US9bn expansion is reflected in the expectation that its 2013 revenue of $US8bn is likely to grow to more than $12bn in 2014. Last year it spent about $US6bn on capex, and about $US2bn on operating expenditure. This year it will roughly spend $US2bn on capex and $US6bn on opex.

So while it’s still spending roughly the same amount of money, it is just that most of this comes through opex, something that Fortescue and the rest of the industry would argue is great for the communities they operate in, the state government (royalties), and Canberra (corporate tax). Taxes and royalties from the firm could top $US2bn in 2014.

Fortescue began its attack on debt earlier this week, announcing it would buy back $US140m of preference shares that carried a 9% interest rate. That free cashflow was now humming was reflected in last month's surprise decision to pay a 10c-a-share dividend.

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