Fortescue shows ANZ who the real cash machine is

Fortescue's jump over ANZ in the market cap stakes holds another important lesson for corporate Australia.

Robert GuySenior Writer

Dec 9, 2020 – 5.29pm

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Fortescue Metals Group leapfrogged ANZ to become the seventh-largest company in Australia after a bullish iron ore outlook left investors in no doubt that while it may not be a bank, the miner is a veritable cash machine turning dirt into dollars with every shipload dispatched from the Pilbara.

Despite the hand-wringing about China's appetite for iron ore amid the diplomatic spat between Canberra and Beijing, it was the miner's director of sales and marketing, Danny Goeman, who delivered a lesson in supply-demand arithmetic to cheer the Fortescue faithful and cash-strapped Treasurer Josh Frydenberg: China's strong recovery + Brazil's supply problems = strong prices into 2021.

Fortescue Metals Group CEO Elizabeth Gaines underscored the need for good relations with China. Philip Gostelow

Goeman's intel gathered over the "last few days" suggests ongoing strength in steel demand may lead iron ore inventories at China's ports to fall as low as 100 million tonnes during the first quarter of 2021 as rising demand outside of China collides with lower Brazilian output.

That 100 million tonne prognosis is a headline grabber given it would be the lowest level since 2016.

It was the reference to growing demand outside of China that bodes well not only for Fortescue Metals Group and its rivals BHP and Rio Tinto, but also Australia, given the region is home to our largest trading partners.

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Goeman's observation that South Korea's Posco and Japan's Nippon Steel were restarting blast furnaces underscored the rebound in industrial activity across the region despite the looming spectre of another wave of COVID-19 cases.

That demand across the region has been reflected in robust steel mill spreads.

East Asian blast furnace spreads, which measure the difference between the price of finished steel and raw materials like iron ore, have been above $US240 ($322) a tonne.

While the spike in iron ore prices will crimp some of that margin, it is still juicy enough to keep mills demanding more iron ore as long as the appetite for steel remains strong.

But central to the iron ore story is China. It is the anchor to the region's – and Australia's – growth outlook.

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China's FIFO – first in, first out – recovery from a sharp first quarter contraction, coupled with faltering supply from Brazil's Vale, has stoked a rally in iron ore prices to $US147 a tonne.

Confirmation about the gathering recovery in the world's second largest economy came from November's inflation.

While consumer price inflation dipped for the first time since 2009 as food prices eased, it was the moderation in producer price deflation that provided another indicator that industrial sectors are slowing re-finding their footing.

That's thanks to China's marshalling of fiscal policy into infrastructure investment and the channelling of cheaper funding into small- and medium-sized companies.

While China's recovery has been stronger than many had expected, it must be noted that iron ore imports have dipped over the past two months.

But Fortescue's Goeman isn't fazed. He reckons October's global production figures suggest crude steel output has now almost fully recovered to pre-COVID-19 levels.

He expects steel demand to be "well supported" beyond 2021, with another 170 million tonnes to be added to the 1.8 billion tonnes already produced.

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That's a potentially strong tailwind for the iron ore sector, which looks well positioned to keep feeding that demand given the latest generation of mines being built by BHP (South Flank) and Rio Tinto (Koodaideri) – and, in Fortescue's case, being delivered in the form of the Eliwana mine, which opened on Tuesday.

Fortescue's investor day briefing showcased the compound impact of applying technology and innovation at scale to drive production growth and steer costs lower.

That the miner's C1 costs have dropped from $US48 a tonne in the 2012 financial year to under $US13 a tonne reflects the ability to squeeze more out of its truck fleet and its ore processing facilities.

That it's delivered an average margin of 50 per cent over the last decade and a 23 per cent average return on capital employed explains why it's gone from a concept in 2003 to a $67.1 billion company.

Fortescue's jump over ANZ in the market cap stakes holds another important lesson for corporate Australia: a long-term commitment to the rise of Asia can pay off if you have the stomach for risk and an ability to look over the horizon, not the next half-year results.