rbs research note

Fortescue (FMG) Site Visit
Gordon Barrett's notes below:

Possibly the best thing that could have happened to Fortescue was the iron ore price falling to US$85 per tonne some 12 months ago. That's the point that FMG had their "titanic" moment and realised that if they didn't take evasive action very quickly the ship could go down. A frantic weekend solidifying its debt position ensured the company's survival. Since then the company has worked tirelessly to position the company as "the best on ground". What they lack in the quality of the underlying resources that BHP or RIO possess they have made up a lot of ground through ensuring that its process chain is as efficient as it can possibly be. FMG have come a long way and still have some way to go. However I suspect that within 12 to 18 months time its break-even point wont be too far away from that of BHP's iron ore division break even point.

They are currently number 3 on the world cost curve.




Facts:

Breakeven cost $70 per tonne, a reduction of $20 per tonne over the past twelve months.
Sept quarter average realised cost US $121 compared to $113 in the prior qtr.
C1 costs $34
Cash balance of $2.8 bil at end of September

Major upcoming events:
March ramp up to 155 MTpa
Debt repayment in 2014 cy of between 4 to 5 billion dollars
blending of high grade high phosphorous ore from Firetail in the Solomon hub with the lower grade, low impurity ores from Christmas creek will allow lower grades to be mined substantial reducing strip rations and substatial reducing ming costs on those operations
once the debt reprogram has been implemented the company will introduce a permanent dividend payout ration level.
introduction of autonomous haulage fleets significantly reducing the cost of their single greatest cost centre, Haulage.
Major longer time frame events
5th berth construction
ramp up production to 175 m/ts
majority of production ramp to be achieved through "sweating" existing assets and hence cost of new production could come in at as low as $60 per tonne.

The main area of differentiation that is obvious to anyone that spends any time on- site with the company is its corporate culture.

The corporate culture relies heavily on a bottom up approach whereby those that are working on a process are encouraged to become part of the efficiency drive and air their ideas to divisional managers. This has created a culture where by everyone in the production chain is focused on margins.

Of course they also benefit from being the most recent entrant of the majors in the market which has enabled them to implement the latest technologies through the process chain including:
the worlds heaviest gauge rail net work
super efficient rail work shops
most efficient ship loading operations
Investment schematics

Various initiatives should see break-even coming down to around US$60 per tonne
Cash flows once full ramp up is achieved based on current prices and currency levels US$7.5 bil per annum, moving to $US8.5 bil per annum, from 2016 once final expansion to 175 mtpa has been achieved.

Expected debt levels by 2114cy end 4 to 5 billion.
(I'm disregarding the companies Magnetite expansion plans as the first stage is fully funded and a move to stage to will be purely a function of whether an acceptable return can be achieved)
Current cap ex cycle is effectively at an end. This is the major point of differentiation between Fortesque and RIO and BHP.
Once current debt payment cycle is complete company has the potential to become a long term high yield play ( dependant of course on the underlying currency and commodity prices)

Based on FMG's own forecast 2014 numbers they are trading on a forward PE of 6 times. That compares with the average market forward PE of 10 times and BHP on 12 times.

One comment that was consistent amongst all those who attended the trip is that the main point of differentiation between FMG and BHP and RIO is that FMG is seen to be ex-capital spend which was seen as a significant positive.