Fortescue project delay opens credibility crackThe credibility...

Fortescue project delay opens credibility crack

The credibility of the Fortescue Metals Group management team has taken a hit after its decision to postpone a portion of its $US9?billion expansion project.

In meetings with fund managers in Sydney last week, chief executive Nev?Power and chief financial officer Stephen Pearce did not raise the prospect of delaying their expansion plans and signalled all was fine so long as the dip in the iron ore price to $US90 a tonne was short-lived.

Certainly, most would have expected short-lived to mean more than five days, which was all it took before Fortescue chose a far more nuclear option than the non-core asset sales and pre-payments from customers flagged last week.

The miner admitted yesterday what had been clear for a week – that it is not profitable at current price levels. It expects cost cutting to restore earnings before interest, tax, depreciation and amortisation margins to $US15 to $US20 a tonne at today’s iron ore price.

But given its heavy interest payments of $US10 a tonne along with taxes, there is very little left to put in the bank at these prices.

To date most of the public discussion about Fortescue’s debt has been about interest payments. However, $US1.5 billion begins to mature in December 2013 and these depressed prices should make investors think about repayments on the principal – or at the very least the prospect of refinancing with higher interest.

The theory had been that Fortescue would benefit from at least two years of prices between $US120 to $US150 a tonne to help repay debt before they reverted to more long-term levels.

Most analysts peg the long-term iron ore price at $US80 to $US90 a tonne including freight.

But in an interview yesterday, Mr?Pearce told this reporter: “I would say analysts think the long-term level is around that $US100 to $US120 mark, above where we are today.”

If Fortescue is internally relying on those prices over the long term, after new capacity comes on stream from its peers, it may be of concern.

Even if Fortescue manages to reduce its costs by $US10 a tonne, that leaves only $US25 to $US30 a tonne of EBITDA margins if the price over the longer term is closer to spot and the dollar remains high.

Based on annual production of 115?million tonnes, that is $US2.8?billion-plus of EBITDA – of which about $US1 billion will be put toward interest.

But if the iron ore price plunged toward $US70 a tonne, the miner could be forced to cut production back to 95?million tonnes by closing its high-cost Cloudbreak mine.

Citigroup calculates Fortescue will have more than $US2 billion of principal to repay in each of the 2014, 2016 and 2017 financial years. That could constrain its ability to expand further or pay dividends.

Some fund managers – to be fair often ones not already in the stock – might argue Fortescue would have been better off raising $US1.5 billion of equity to complete the expansion.

Power argued that raising equity was a costly solution to fill a short-term funding gap. But unless the iron ore price shows strong signs of life within the next six months, the hole will start to look longer term.

The Australian Financial Review