citi today........

Fortescue Metals Group Ltd (FMG.AX)
Royalty Driven Loss
ƒæ A$975m Loss for DecH07 ¡X Key feature of DecH07 was US$1b revaluation
charge (A$1.4b pre-tax) on the Leucedia royalty. There was no other new
information in the reported NPAT loss of A$975m as with no production
interest is being capitalised ahead of project start-up. This has downgraded our
irrelevant FY08 estimate, but there is no change to FY09+.
ƒæ Leucedia Royalty ¡X The Leucedia royalty is a 4% revenue royalty on all
production from Cloud Break and Christmas Creek through to 18 August 2019.
The royalty is interest on a US$100m facility that was tied to a A$400m 2006
placement, which was done at a premium to the share price at the time.
ƒæ NPV A$1.83b ¡X Previous revaluation of Leucedia note was by A$304m to
A$401m in FY07. The increase to A$1.83b (~A$1.3b post tax) has been driven
by higher iron ore prices and production expectations (expansion to 110mtpa).
The P&L hit is upfront, but the cash flow impact is over life through to 2019.
ƒæ Our NPV A$1b. ¡X We assume a 50% probability of expansion to 110mtpa, and
a royalty NPV of A$1b in our A$5.70/share FMG NPV. If probability was
increased to 100% this would be A$1.1b (FMG NPV A$6.80/share), less than
accounted for by FMG as we no doubt assume lower iron ore prices.
ƒæ Sell Recommendation ¡X We recently initiated coverage on FMG with a Sell
recommendation driven by combination of stretched price to NPV and risk of
the company delivering against the aggressive ramp-up schedule ¡V please refer
to ¡§Production to Construction Risk¡¨, 4 March 2008.