Fortescue’s debt move is an iron-clad insurance policy
5 MAR, 4:14 PM
In an earlier phase of his life and career Twiggy Forrest might have been something of a gambler, building the foundations of a world-scale iron ore miner on foundations of debt. He’s now firmly into a risk-averse, wealth and business-protecting mode.
After its flirtation with something unpleasant in 2012, Fortescue has focused intently on reducing costs and lowering leverage and risk, with considerable success.
So successful had its debt-reduction and debt-rescheduling program been that it didn’t face another meaningful debt repayment until 2017 and even then, with $US1.6 billion of cash on hand today and a business that remains solidly cash-positive, it was well positioned to deal with maturing facilities until 2019, when $US4.9 billion of senior secured debt and $US1.5 billion of unsecured notes would have to be dealt with.
Today, however, Twiggy’s CEO, Nev Power, announced that Fortescue was launching a new $US2.5 billion senior secured debt issue and offers to buy back its 2017, 2018 and 2019 issues of unsecured notes.
One of the cleverer things Fortescue has done in the past couple of years to give it flexibility to manage a still-daunting $US9.1 billion of gross debt is to ensure that it has locked in pre-payment options. Most of its borrowings have an early payment option exercisable by Fortescue.
That has enabled it to push out the maturities of its debts and lower their cost at a time when interest rates globally are at historically low levels. It has repaid $US3.7 billion of debt and reduced its interest payments by $US330 million a year in the process.
The latest attempt to reconfigure its borrowings would, if fully taken up, push the maturities of the majority of its borrowings into the middle of 2021 and presumably lower its interest costs even further.
That would buy time for Fortescue, which has lowered its delivered cost of ore to $US43 a tonne and expects it to reduce to $US35 a tonne in the second half, to continue to reduce costs and increase free cash flows now that it has passed the hump of its capital expenditures. Capex is expected to be halved, to about $US650 million, this financial year.
Pushing significant repayments of debt out into the next decade is akin to taking out insurance against whatever might happen to the iron ore price in the meantime.
While the price appears to have settled around the $US62 a tonne level, with China targeting economic growth rates of ‘’around 7 per cent’’ this year (effectively a lowering of the target), the Eurozone economies still anaemic and verging on recession and production volumes from the major seaborne iron ore producers still rising, the potential for further falls in the price is real.
Only this week the World Bank said the glut of iron ore might persist for up to another two years, although it also forecast a price averaging about $US75 a tonne this year, which appears optimistic.
As Nev Power has said, however, stocks at China’s ports have been running down, China’s high-cost domestic production has been curtailed by perhaps 80 million tonnes a year already and the price has been stable.
Even at 7 per cent, China’s GDP growth is still phenomenal by developed world standards. The China Iron and Steel Association forecast earlier this year that imports would rise by more than 7 per cent to more than one billion tonnes this year. Imports rose 13.8 per cent, to a record 932.5 million tonnes, last year so CISA is anticipating another record and growth of about another 70 million tonnes in the seaborne trade.
The growth in output from Rio Tinto, BHP Billiton, Vale, Anglo American, Gina Rinehart’s Roy Hill project and other big producers will be greater than that, so either more high-cost production is taken out of production or the price will fall further.
It is, given Fortescue’s continuing high debt levels, that latter possibility that would be continuing to be at the forefront of Forrest and Power’s thinking. By 2021 the dust should have settled and the surplus of supply over demand should have been worked through.
Fortescue is making the right moves to try to ensure that it isn’t on the wrong side of the resolution of the current imbalance.
(20min delay)