From Credit Suisse

Oct 29, 2014

Site visit points to “bankable” 171mt in FY17: Last week’s FMG site visit highlighted a no-capex pathway to a potential 180mtpa output. Rail and port capacity will be at this level by mid CY15. We have assumed 171mt production in FY17 post the start-up of the Solomon detritals plant plus 5mtpa of additional DSO at Chichesters. We stick with our US$30-$31/t cash costs to be conservative but note FMG is targeting cash costs in the mid $20s/tonne range. Higher volume assumptions see our FY15 EPS revised up 4% and FY16-17 EPS up 10%.

■ Valuation metrics compelling: In FY16 we use $80/t China fines pricing and FMG can still generate $1bn off our $30/t cash costs. And with capex at$1.2bn, debt can still be reduced by ~$700m. Even at this earnings and FE price low, FMG trades on FY16 PE of 8.6x, price/cash earnings of 3.9x and FCF yield of ~11% at an EBIT margin of $11/t. Our DCF SOTP is A$6.5/sh.

■ Stress test also supportive: Running $85/t in perpetuity through our models with no change in costs gets a DCF in line with the share price for a steady state EBIT margin of $13/t. At $5/t lower costs, the share price solves for $80/t iron ore. The good news is that at $13/t margin, FMG can still reduce debt and is trading on prospective P/Es at 6-7x and cash P/Es at ~3.5x. At the lower costs, the EBIT break-even Fe price is $72/tonne. Every $4/t increase in the assumed Fe price adds A$1/sh to the DCF.

■ Maintain OUTPERFORM and target price of $5.00. FMG’s shares are down 24% in the last three months, underperforming iron ore peer Rio Tinto by 16%. On a 12-month view, FMG has underperformed Rio by a hefty 28%. Value is apparent and we think our stress-testing points to an attractive risk-reward opportunity.