Fortescue revs its cash engine

With a falling dollar and a successful efficiency drive, Fortescue is on much more solid footing. That should mean it can retain full control of its port and rail assets.

As each month passes, the pressure on Fortescue Metals to raise a big lump of cash by selling equity in its Pilbara infrastructure assets is receding.

FMG’s June quarter production report shows costs falling, production and shipments increasing and its cash reserves building, easing the pressure of the near $US10 billion of debt the group is carrying – pressure that destabilised and then galvanised the group last year.

While the iron ore price has slipped back from the levels experienced in the March quarter – FMG’s average realised price fell from $US131 a tonne to $US113 a tonne – it is still well above the $US90 a tonne zone it fell through last year.

It was that brush with leveraged disaster that caused FMG to slash costs, slow its expansion program, restructure and re-finance its debt and put a minority interest in its rail and port infrastructure entity, The Pilbara Infrastructure (TPI) up for grabs.

The cost-cutting, and the re-started expansion program, have had a major impact on the group.

The so-called C1 cash costs (which exclude about as much as they include) fell from $US43.61 a tonne in the March quarter to $US36.01 a tonne in the June quarter, which FMG attributed to lower strip ratios, cost savings and operational efficiencies.

It said the total cost savings from the program adopted last September were now $US400 million, an indication of how effective the shock the group experienced last year has been in focusing the group on its costs.

The 12 per cent or so fall in the value of the Australian dollar this year is also having a positive impact, with FMG saying it had contributed $US1.89 per tonne to the reduction in C1 costs between March and June.

The combination of its lower cost base and the current value of the dollar have led FMG to forecasting C1 costs of between $US36 and $US38 a tonne for the 2013-14 financial year.

The group shipped ore at a rate of 120 million tonnes per annum in June and lifted its June quarter shipments 24 per cent when compared with the March quarter. It says its expansion projects remain on budget and schedule and are expected to produce at a run rate of 155 million tonnes a year by December, with a 2013-14 goal of producing and shipping between 127 million tonnes and 133 million tonnes.

As its production increases, costs decrease, the dollar remains well off its peak levels and its capital expenditure falls away significantly, FMG is beginning to build its cash reserves and reduce the risk of a still heavily-leveraged balance sheet.

The group has $US2.2 billion of cash, compared with $US1.5 billion in March, and with capital expenditure falling back from $US6.2 billion in the 2012-13 financial year to around $US1.9 billion this financial year the surge in its debt burden is slowing.

Given China’s slowing growth rate, the increase in supply steadily occurring from the Pilbara and the likelihood that there could be seasonal softness in demand later in the year the trends within FMG’s performance of lower costs and bigger cash reserves is useful insurance against another shock. FMG doesn’t have a scheduled principal payment on its debt until late 2015.

The improving financials remove some of the urgency from a sale of equity in TPI.

FMG announced the potential sale of a minority interest in TPI more than a year ago and still says it is ‘’progressing’’ commercial negotiations. It reiterated, however, that a sale would only be agreed if it received full value that reflected the longterm worth of the assets and the efficiency of its integrated logistics chain.

The sale process has been complicated by FMG’s insistence that it retain a majority interest and operational control of infrastructure vital to the efficiency of its operations, which has seen a couple of interested parties walk away, and by Brockman Mining’s attempt to use Western Australia’s rail access regime to get access to FMG’s rail line.

A sale would raise $3 billion-plus and substantially de-risk FMG’s balance sheet. A year ago it appeared an absolute necessity. Today, with the fundamentals of its position improving quite markedly, FMG isn’t under the same pressure to complete a deal.