Forecast Impact: --Recommendation Impact: Our fair value...

Forecast Impact: --

Recommendation Impact: Our fair value decreases to $1.40 a share. Despite the reduction in our fair value, at $0.82 a share our recommendation remains Buy.

Event Analysis
GBG confirms capex at its Karara iron ore project will increase 30% from $1,975m to $2,570m. Higher material requirements driven by design changes were the main culprit with price inflation also a factor. Joint venture partners GBG and Ansteel expect to fund the $600m shortfall with additional equity. GBG had $240m in cash at the end of March but we expect it needs a further $200m to cover its $300m share of required equity. Details of the imminent capital raising are yet to be announced but we prudently incorporate an estimate at this stage. We factor a $200m rights issue into our financial model assuming an issue price of $0.73 a share, a 10% discount to the current price. Shares on issue increase by 30% to 274m reducing our valuation 23% to $1.47 a share. A higher issue price and/or some kind of debt component will reduce dilution of existing shareholders and may increase the valuation. GBG is yet to complete its cost review but expects operating cash costs to increase from the A$42 a tonne guidance provided in May 2010 to A$65-68 a tonne at production of 10M tonnes a year. Costs should fall to A$55-60 a tonne as production reaches 16M tonnes a year. The increase is largely attributed to higher capital costs associated with the Westnet railway upgrade, charged to GBG as an operating cost. We aren�t completely surprised by the increase. Cost inflation is rampant in Western Australia and early stage forecasts are often optimistic. Our model assumed flat operating costs of $50 a tonne. We increase our short term cost forecast but reduce long term costs in line with forecast iron ore price declines. The net impact is a further 5% decrease in our valuation to $1.40 a share. GBG expects to ship 480,000 tonnes of hematite in CY11 as per its short term agreement with Sinosteel. Hematite shipments to Ansteel will start in January 2012 at a rate of 1Mtpa rising to 2Mtpa by December 2012. Magnetite shipments will start in June 2012 increasing to 8Mtpa by December 2012. GBG is unaffected by Sinosteel�s announcement to mothball its Weld Range project. Sinosteel�s Koolanooka mine remains operational enabling GBG to use its infrastructure and fulfil its contractual obligations. Longer term, the Weld Range decision could scupper the Oakajee port and Rail (OPR) project impacting GBG�s expansion plans beyond 16Mtpa. We cap production in our financial model at 16Mtpa as OPR is increasingly unlikely to be developed. We do not blame GBG alone for the cost increases as many projects are being undermined by cost inflation in Western Australia. GBG�s competitive advantage is it is through the bulk of its capex with more recent cost inflation a bigger barrier to others. Excluding Atlas Iron (AGO), we consider GBG to have the brightest outlook amongst the mid cap iron ore stocks. The strongest of the Midwest producers, it is well positioned for future infrastructure negotiations. Its relationship with Ansteel, China�s second largest steelmaker, gives access to the worlds most important steel market. It should not be compared with peers solely on cost. GBG�s magnetite concentrate will receive the Hamersley fines iron ore price (62% iron ore) plus a grade adjustment for its 68% iron content plus a 10% quality premium. The effect boosts margins to competitive levels verses peers. Although as with lower grade magnetite projects, capital intensity is high and overall returns will be below that for the simpler high grade conventional direct ship iron ore. The mid cap iron ore sector was hard hit over the past six months with many stocks losing over a third of their value. GBG�s cost increases disappoint but competitor projects are likely to suffer the same fate. At current iron ore prices GBG could generate large cash flows. Despite the reduction in our fair value, at $0.82 a share our recommendation remains Buy