It's ore very well, Andrew, but . . .
It is highly leveraged to bad news in the same way it was disproportionately leveraged to good news when the price of iron ore was moving up.
It was not the only iron ore producer whose share price took a king hit on Thursday, but it is in the big league, so attracts more attention. So it's not surprising that when Fortescue boss Nev Power releases news, he aims for a positive spin.
And there were some good bits in Thursday's update, but on balance investors focused on the fact that iron ore production targets were downgraded - from 82 million to 84 million tonnes to between 80 million and 82 million tonnes - and the timetable on the sell-down of its infrastructure assets had slipped. It was the latter that got the market nervous.
The company has no control over the rain that pushed down production targets. But moving the transaction announcement date from June to September has left some investors worrying if Fortescue can find a buyer at the price at which it is willing to sell.
It must be said that over the past month the chances of reaching a deal on the infrastructure have been dwindling, and its postponement for another three months should not have come as a surprise to anyone watching the stock closely.
Fortescue is a well-run operation but its level of net debt - about $10 billion - explains why investors remain nervous. The sell-down of the infrastructure assets was designed to reduce the stockpile of debt.
In a perfect world Fortescue would not be selling part of the rail and port facilities of which the major shareholder, Andrew Forrest, is so vocally proud.
But in building these facilities and developing these mines at such a rapid rate Fortescue was always seen to be rolling the dice on the ore price being stronger for longer.
When the price fell below $US90 a tonne last year, Fortescue moved into DEFCON-4 alert around its debt servicing abilities.
Forrest headed for the US to handle the restructuring of its debt facilities and successfully negotiated some breathing space. It pulled back its expenditure and the timing on its production targets and mounted an attack on its cost base.
While the company took the view that the iron ore market would recover from what had been a build-up of Chinese inventories putting downward pressure on the price, it did not have the luxury of taking chances.
Over the Australian summer the iron ore price staged a revival and went close to $US160 in February, but since then it has been trending down again. Analysts are expecting it to move to about $US100 over the next quarter. (It spiked to $US120 on Thursday.)
To get its average cost of production down, Fortescue has needed to fast-track the development of the lower-cost Solomon mine.
The net effect of this work has been to reduce June-quarter costs to between $US38 and $US40 a tonne, and the full-year costs into the lower range of the company's guidance of $US45 to $US50.
While this is clearly good news, the company has not specified the Australian dollar rate it has factored into these numbers.
These are Australian dollar costs stated in US dollars, so the recent decline in the local currency will account for some of the cost decline.
The view on whether the company can sit comfortably at this point depends on what the iron ore price holds for the rest of the year (and for that matter over the next three years).
UBS sees the average price over the next quarter (to September) at $US100 a tonne, being lower than this at some point over the period.
It takes the view Fortescue moves to zero cash flow when the iron ore price is $US70 a tonne.
Fortescue said its expected range of $US110 to $US130 a tonne would underpin solid quarterly revenues.
So does Fortescue actually need to sell part of its infrastructure to raise funds? Certainly, it would remove the monkey from its back.
BHP Billiton and Rio Tinto will attest to fact that selling assets in the current environment is not easy - there are not many buyers and no one is willing to pay top dollar.
Power said the company was not under pressure to conclude a sale of the rail and port assets, and that the timing had been affected by the level of interest.
At the current iron ore price, the company has the capacity to continue to pay down most of its debt load in three years.
It may be just a question of whether Andrew Forrest is feeling lucky.
Frequently Asked Questions about this Article…
Fortescue has been highly sensitive to changes in market sentiment — even small hints of negativity can push its share price down. The company is heavily exposed to movements in the iron ore price and carries a large net debt burden (about $10 billion), which makes investors more nervous when production or asset-sale plans slip.
Rain forced Fortescue to lower its production guidance for the year from the prior 82–84 million tonnes to 80–82 million tonnes. Lower production can reduce revenue and increase short-term uncertainty, which is why investors focused on the downgrade alongside the delay to the infrastructure sell-down.
Moving the planned transaction announcement from June to September raised concerns because the sell-down was intended to reduce Fortescue’s debt. The delay made some investors worry whether the company can find a buyer at the price it wants, especially given a weak market for large asset sales.
Selling infrastructure would materially reduce Fortescue’s debt load and remove a big risk, but management says the company is not under immediate pressure to conclude a sale. The article notes that selling large assets is difficult right now because buyers are scarce and few will pay top dollar.
Fortescue’s financial comfort depends on iron ore prices. The company said an expected range of US$110–US$130 per tonne would underpin solid quarterly revenues. UBS estimates Fortescue reaches zero cash flow at about US$70 a tonne and forecasts an average near US$100 a tonne over the coming quarter.
Fortescue fast-tracked development of the lower-cost Solomon mine and cut expenditure and costs. The company expects June-quarter costs of about US$38–US$40 per tonne and full-year costs toward the lower end of its US$45–US$50 guidance. The company hasn’t specified the Australian dollar exchange rate used in those US-dollar cost figures.
According to Fortescue’s update in the article, at the current iron ore price the company has the capacity to continue paying down most of its debt within three years.
Investors should weigh Fortescue’s operational strengths and cost improvements against its high net debt (~$10 billion), sensitivity to iron ore price swings, and uncertainty around the timing/value of any infrastructure sale. If you’re risk-averse, consider how changes in iron ore prices (e.g., moves toward UBS’s US$100 forecast or down toward US$70) would affect cash flow and debt repayment timelines.
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