chinalco's iron-ore purchase has silver lining

Chinalco's iron-ore purchase has silver lining for Twiggy
Rio's sale price may mean Fortescue is undervalued.

The Age - 16th Feb 2009

Rio's sale price may mean Fortescue is undervalued.

Fortescue Metals

RIO Tinto's sale of family jewells in a debt-reducing garage sale to China's Chinalco would have given Andrew "Twiggy" Forrest reason to smile.

Not because the Fortescue boss is enjoying the beating Rio's London masters are getting over the controversial compact with Chinalco, Rio's 9 per cent shareholder. Nor because the deal is with a Chinese state-owned group that has China's best interests at heart, not those of Australia - the prosperity of which Forrest is passionate about.

No, his joy is over what the market will make of the valuation implied for Fortescue's Pilbara iron ore business from Rio's sale of 15per cent of its Hamersley iron unit to the Chinese for $US5.15billion ($A7.8 billion).

This big ticket item at Rio's Chinese-only $US19.5 billion garage sale came with a surprise right for Chinalco to hold marketing rights for 30 per cent of Hamersley's output. So after years of frustration in their customer dealings with the Pilbara pair of Rio and BHP Billiton, the Chinese get to become producer, marketer and customer.

But back to Fortescue, the most Chinese of the big three Pilbara producers in that China takes all its production. But only as customers, given it retains 100 per cent ownership of its operations.

Run a line through what Chinalco will pay for the Hamersley stake (it gives Chinalco 14.4million tonnes of annual production) and you arrive at an annual tonne valuation metric for Fortescue of $5.87 a share, based on its 2008-09 sales forecast of 30million tonnes of iron ore.

Assume Fortescue increases this to 55 million tonnes a year, and the figure becomes $10.77 a share. It was that sort of (admittedly loose) valuation that was behind Fortescue's 25 share gain to $2.81 on Friday: that's right, $2.81 a share. No one thinks Rio is getting an exceptional price for the Hamersley stake. So Fortescue could be hugely undervalued. Time will tell.