fmg today re-rated by bmo !!, page-5

Macquarie Report:

Fortescue Metals Group

Iron ore price drives strong margins

Event

 FMG reported December quarter operating results.

Impact

 Solid shipments continue: FMG?s own ore shipments continued at an annualised rate of ~40mtpa in 2Q11, decreasing marginally ~2% qoq to 9.9mt (Sept quarter: 10.1mt). FMG also shipped ~ 0.7mt third-party ore (Sept quarter: 0.17mt). FMG plans for its own production rate, excluding third-party shipments, to remain at ~40mtpa until the ramp-up to 55mtpa commissions in the March quarter of 2011.

 CIF price higher: FMG?s received price was US$150/dmt CIF China, up 20% qoq (Sept quarter: US$125/dmt CIF China). This is in line with the published 62% Fe spot prices adjusted for Fe units for the quarter.

 Increasing unit cost trend continues: Unit cash costs increased 19% to US$41.50/t (Sept quarter: US$34.83/t). This follows a 10% increase in 4Q10. In A$ terms, the unit cost increase was 10%. The unit cost increase was driven by a higher strip ratio (up 18% qoq to 3.6), a stronger A$ (up 8% qoq to US$0.988/A$ from US$0.915/A$) and high fixed costs due to ramp-up activities at Christmas Creek. Mooted cost reduction initiatives such as a new primary crusher and up-scaling of equipment fleet are yet to translate into tangible unit cost containment.

 Balance sheet bolstered by debt raising and operating cash flow:

FMG?s cash balance increased to US$2.37bn from US$1.30bn at the end of September, following a US$1.5bn debt raising. Based on FMG?s operational results, we estimate an EBITDA margin of ~US$0.7bn from iron ore (pcp: ~US$0.6bn). Cash outflow items included refinancing of senior debt (requiring a make-whole payment of ~US$0.7bn) and capex of ~US$0.15bn for the 55mtpa ramp-up. Early expenditure on the 155mpta expansion was small at US$20m.

Earnings and target price revision

 We adjust FY11E EPS to US$0.505ps from US$0.548ps, an 8% reduction. Target price unchanged as DCF valuation not changed materially.

Price catalyst

 12-month price target: A$7.90 based on a DCF methodology.

 Catalyst: On time and on budget delivery of ramp-up to 55mtpa.

Action and recommendation

 While we note that FMG has rallied strongly, following the quarterly, we continue to rate FMG Outperform with a target price of A$7.90ps. We believe FMG offers leverage to short- to medium-term iron ore price strength, combined with a capital-efficient expansion plan.