majors confident spotted iron ore's bottom

Majors confident they've spotted iron ore's bottomFont Size: Decrease Increase Print Page: Print Matthew Stevens | January 31, 2009
Article from: The Australian
IF yesterday's news from Pilbara sparring partners Fortescue Metals and Rio Tinto is anything to go by, then iron ore will still be a pretty good business to be in for quite a while yet.

Rio Tinto has made an absolute motza from the sale of a high-cost, relatively small but very high-quality iron ore mine in the Brazilian jungle while Fortescue, in delivering a somewhat illusory debut interim profit, has speculated that the iron ore market reached a bottom late last year and that demand has shown renewed momentum in the past month.

The observations of Fortescue executive director Graeme Rowley reflect incipient confidence within Fortescue's major iron ore cousins, Rio Tinto and BHP Billiton, that the spot market is again on the move. "The bottom of this slowdown has been reached and we are starting to see a comeback in prices," Rowley said yesterday.

"Our order book's full into March."

It has, of course, been widely speculated that iron ore prices could fall by as much as 40 per cent this year. But there is a view coalescing in the iron ore business that spot prices will be much closer to equilibrium with the current contract price.

In its guidance on pricing yesterday, Fortescue said:

"The current spot price for customer fines ore with similar specifications as Fortescue's product ranges between $US65 and $US70 per tonne free-on-board, an approximate 20-25 per cent reduction on the 2008-09 original benchmark price.

"However, the spot price has risen somewhat in the last month or so," it finished optimistically.

Meanwhile, Fortescue's $1 billion December-half interim profit looks very encouraging indeed when you consider that its costs of production are a good 40 per cent higher than the company has routinely foreshadowed, that it had a two-week suspension of shipments during December and it was forced to indulge in some price discounting through the second quarter to prevent shipment deferrals.

But before we all get carried away, the salient point here is that Fortescue is still starkly cash-flow negative, having burned another $484 million over the half as it continued to invest against its ambition to mine and deliver 45 million tonnes of ore by as early as the end of calendar 2009.

According to the numbers presented yesterday, Fortescue has $440 million in its cash account and about $160 million of that is locked up in the interest repayment reserve. Which leaves Fortescue with $279 million of free cash going into the third quarter. Which explains why Fortescue, like everyone else in the mining business, has postponed capital-intensive expansion plans in an attempt to retain cash and optimise return on investments already made.

Which raises the big question of when will Fortescue be cash-flow positive?

Well, it might not be too generous to suggest that, with just a little bit of luck, that day might well come as soon as the March quarter. Fortescue plans less capital spend, and to get more product out of the ground and on boats to China.

As well, Fortescue says it is shipping all it can produce, that demand is strong, and that investment over the December quarter in a de-sanding process will drive production growth.

Rowley was refreshingly blunt in his assessment of Fortescue's current performance. He admitted it was well short of the 45 million tonnes a year target but expressed confidence that it would be producing 3.6 million tonnes a month by June and that is the run rate needed to hit that target.

The thing about more volume is that it reduces the average cost per tonne. And at some point in that ramp-up, Fortescue expects to be cash-flow positive given it will be sitting on its hands in terms of capex.

What's more, Rowley said he expected Fortescue would hit 4.6 million tonnes a month by the end of 09, which implied an annual rate of 55 million tonnes.

Oh, of course, it wouldn't be a Fortescue day without some sort of hiccup. So, for anyone wanting to know why Fortescue was forced to call for a two-hour delay of its media and analysts briefings yesterday, it was because it stuffed up its first attempt to file its results with the ASX.

Fortescue failed to send the 4D appendix, which is a summary of financial position that is required under the listing rules, with its first filing. To Fortescue's credit, it realised the error and quickly postponed its planned briefings.

Rio debt dent deep

THE other big deal in iron ore yesterday was Vale's decision to pay $US750 million for Rio Tinto's Corumba project.

This deal is a real vote of confidence in the medium-term future of iron ore. Vale has paid more than 20 times expected 2008 earnings for a mine that delivers only 2 million tonnes a year, sits way up Brazil's Paraguay River and relies on river barges just to get the product to port.

Interestingly for the geologists out there, they say Corumba ore is very similar to the high-grade stuff at Rio Tinto Simandou project in Guinea. The feeling is the two started life as one but were separated by subsequent continental drift.

Corumba was not the only bit of future growth Rio Tinto surrendered to Vale's Roger Agnelli yesterday. The Brazilian giant also picked up Rio Tinto's two potash projects for a cool $US850 million.

Overall then, this week Rio Tinto has raised $1.7 billion or so selling seriously non-core assets in its drive to make a dent on Tom Albanese's promise to retire $US10 billion of his $US38 billion Alcan debt by year's end.