Fortescue: The long view from Andrew Forrest

If there's anyone that understands the joy and the inevitable pain of the waxing and waning of commodity cycles, it is Andrew Forrest.

Having topped the ranking of Australia's wealthy in 2008 with an estimated fortune of over $9 billion, the billionaire founder and chairman of Fortescue Metals Group has watched his fortune – built on a 30 per cent stake in the world's fourth largest iron ore miner – shrink to $2 billion as the price of the steel making ingredient has tumbled from a record $US180 a tonne in 2011 to around $US60 a tonne.

Not that he seems worried about the hit to the hip pocket when Barron's Asia caught up with one of Australia's most colourful business identities. Forrest, who is also known by his nickname “Twiggy”, has a deep appreciation of how fortunate he is, with the mining mogul visiting Hong Kong to promote his global anti-slavery foundation, Walk Free.

Photographer: Aaron Bunch/Bloomberg

Many challenges have been confronted by Forrest and Fortescue chief executive Nev Power over recent months: The precipitous drop in the iron ore prices has seen Fortescue Metals Group shares take a beating, as investors zeroed in on the company's ability to generate the cash flows needed to sustain its leveraged balance sheet. Concerns about the company's balance sheet went into overdrive in March when the company pulled a $US2.5 billion senior note offering because the 8.5 per cent yield rate demanded by lenders was too demanding, only to unveil a $US2.3 billion deal the following month pitched at 10.25 per cent. While the yields were much higher than many expected, it was a price worth paying to push the company's debt repayments out to 2019.

At the heart of concerns about Fortescue is the parlous iron ore price, the financial lifeblood of a company that lacks the diversification of BHP Billiton and Rio Tinto, its heavyweight iron ore rivals which also operate in the Pilbara region of northern Western Australia. The rout in the iron ore price has been attributed to a collision between waning Chinese demand as growth in the world's second largest economy slows and a surge of supply brought on by the big miners, including Fortescue itself which is targeting annual production of 165 million tonnes.

But Forrest sees one culprit for the dramatic slump in iron ore prices: “certain multinationals”. That's code for BHP Billiton and Rio Tinto who have declared they will run their mining operations at full bore despite the carnage that has been wrought on the price of the commodity, a strategy that Forrest claims is aimed at squeezing out smaller players and consolidating the market rather than defending Australia's market share against non-Australian producers like Brazil's Vale.

The aggressive approach embraced by Fortescue's rivals clearly rankles Forrest and explains his very vocal, but ultimately unsuccessful, attempts to prod Australia's Abbott government into launching a review of an industry that has been the bedrock of Australia's recent prosperity.

He is unapologetic about his attempts to bring pressure to bear on BHP Billiton and Rio Tinto, two very powerful and politically well connected companies in Australia's capital, Canberra: ‘When we see actions which we think are going to concentrate supply unhealthily in the long term masquerading as free markets at work, we're going to do our small bit to arrest that.”

But Fortescue's rivals were quick to hit back at the claims made by the company that sees itself as the new force in iron ore. BHP Billiton chief executive Andrew Mackenzie dismissed an inquiry as a “ridiculous waste of taxpayers' money” and then called out what the Big Australian viewed as Fortescue's hypocrisy. “In 2006 the price of iron ore, relative to today, was about 20-25 per cent lower, at that time Fortescue was more than prepared to invest,” Mackenzie told the Australian Broadcasting Corporation.

Not that Forrest holds much regard for the current volume based strategies of its rivals. “The pronouncements from certain companies that we will run our machines at full capacity no matter what tells you that strategy is being set by a machine not by the strategy of a human being.” He notes that commodities trader-cum-miner Glencore takes a different view, one built on maximising the value of a resource rather than the volume of tonnes pulled out of the ground. “Their corporate strategy isn't driven by the machines they've built. Just because you built a machine to deliver a certain level of production doesn't mean you necessarily do it if it's bad for your company, or industry and your host economy.”

Fortescue's prospects are very much entwined with the trajectory of iron ore prices. The industry has been breathing a sigh of relief as the commodity has rebounded from a low of $US47 a tonne in April to around $US63 a tonne currently. However, there are many analysts who believe that rally may be short lived.

But Forrest is adamant the company will not only survive but prosper over the long term, underpinned by the industrialisation and urbanisation of China and India. “Fortescue is a multi-generational company. It's made the really tough decisions to ensure that it is.”

While the company has bought itself some breathing room on its debt repayments, it has also moved to aggressively pare its costs. The miner is targeting a C1 cost, or basic production cost, of $US18 a tonne in the 2016 financial year, down from $US33 a tonne in the first half of the 2014 financial year. Its all-in-cost, which includes interest and sustaining capex, is expected to fall to $US31 a tonne in the 2016 financial year, down from $US66 a tonne in the first half of the 2014 financial year. Forrest says that at “any iron ore price that the majors can survive at Fortescue will prosper.”

Fortescue has long been viewed as a leveraged play on China's development. Forrest claims not to be concerned about the current pace of growth given the focus on development and poverty alleviation by China's president Xi Jinping, whom he has met a number of times. Forrest believes that Xi will move to develop the country faster than many experts currently anticipate.

“We've set the corporate policy settings of Fortescue on government policy pronouncements. I'm not seeing today anything different from what I saw a decade or so ago and we're continuing to set Fortescue's corporate direction on government settings, so we're listening very closely to India, we're listening to China.”

While the share price has rebounded off its April lows of around $1.80 a share to around $2.20 currently, many analysts and investors remain cautious given the uncertain outlook for iron ore prices and the short term prospects for China's economy. Investors are also awaiting further updates on plans the company may have to bolster its balance sheet. While admitting the company would like to get its gearing down, one avenue that appears off the agenda is a selldown by the chairman. “I'm really about building up this company not selling out of it,” says Forrest.

Another option to provide some relief to the balance sheet is a sale of a stake at the asset level, or a sale of an interest in one of Fortescue's mines or infrastructure assets. While Forrest wouldn't be drawn on specifics, he mused that “would we retain a friendly attitude to investors in the company and at the asset level, the answer is yes.”

“For us it's about timing and if there's an attractive proposal then we'll take it seriously.”

Having accused his rivals of talking down the iron ore price, Forrest is not shy about talking up what he sees as the value in Fortescue. But with the iron ore price at the beaten up levels, it would appear potential buyers would be in a dominant bargaining position. Not so, argues Forrest. He argues that there needs to be a recognition of the value in the company having de-risked its business by developing projects in one of the world's premier mining provinces, having become an embedded part of China's steel industry supply chain, and driving down costs.

“We can see the value of our assets. If you look through the value of the assets, you can see an $8 to $10 share price because assets in the Pilbara, which is the world's most protected resources sector and the most attractive if you're coming in from the outside, and the most premium part of the world resources sector is export iron ore, and the most premium part of that premium industry is the Pilbara.”

This piece has been reproduced with permission from Barron's.