we are all doomed says big mac

Fortescue Metals Group

One small step or a giant leap?

Event

•
We visited Fortescue’s (FMG) Pilbara iron ore project.
Impact

•
Storming towards project completion. We came away from site visit
suitably impressed with the progress FMG has made since our last visit in
December 2007. The operation is progressing well and on the way to the next
major milestone: ‘project completion’. Management indicated that it expects to
reach ‘project completion’ around the second week in July; currently
operations have been tracking the ‘2mt over four weeks’ rate for ~15 days.
•
Expansions plans front and square. FMG management discussed its
intention to push forward with an aggressive expansion of its eastern Pilbara
iron ore project following project completion. The target rate is 160mt by the
end of 2009. While we have not made material changes to our short-term
production profile, we have tweaked our expansion assumptions and
increased our DCF valuation to $6.96. We have increased the capacity of the
expansion to 135mtpa (120mtpa) coming online in 1Q11 (2Q10) and added
an extra 1bt to the eastern Pilbara resource base in order to reflect the
investment decision to expand the infrastructure.
•
Iron ore price settlement. Rio Tinto and Baosteel have settled the
Hamersley benchmark for JY08 for fines at 144c/mtu (+80%) and lump at
201.7c/mtu (+96%). On an iron adjusted basis we have calculated that the
settlement has narrowed the freight differential between the Brazilian and
Australian products by ~US$7/t, a long way short of the current US$50/t
freight differential. The settlement is a positive for all Australian producers;
however, we note FMG has the lowest lump to fines ratio (16%) of the major
Australian producers.
Earnings revision

•
FY09 EPS increased 10% due to iron ore price increase, FY10 EPS cut 18%
due to push back in expansion tonnage to FY11, offsetting the price increase.
Price catalyst

•
12-month price target: A$6.96 based on a DCF methodology.
•
Catalyst: Forecast iron ore surplus in 2H08 is the most likely catalyst of
underperformance.
Action and recommendation

•
We have increased our DCF and price target to $6.96ps and are sticking with
our Underperform recommendation. We can appreciate the positive sentiment
towards FMG post the site visit and Rio Tinto’s JY09 price settlement.
However, on our current set of pricing assumptions and fundamental analysis
we cannot move into upgrade territory and remain attracted to the relative
valuations of the global diversified miners.
•
We maintain our positive thematic for bulk commodities and urge investors to
seek exposure through our preferred picks (Mount Gibson, A$3.47,
Outperform, $3.50ps price target and Northern Iron, A$3.88, Outperform,
$3.93 price target) which we believe offer better value at current levels.