Fortescue under scrutiny as Australian crisis deepens



Debt laden Fortescue Metals Group, the world’s fourth largest iron ore miner by production volume, is coming under growing market scrutiny amid slowing economic growth in China, the biggest importer of the commodity.

Iron ore prices fell by more than half last year, from $134 in January to a low of $65.70 in December, forcing the collapse of small miners such as Western Desert Resources and Pluton Resources. IMX Resources shut its Cairn Hill mine in Australia.

Others – including Atlas Iron, BC Iron, Gindalbie Metals, Mount Gibson Iron and Grange Resources – have cut staff and slashed operating and capital costs. Asset write-downs of at least 2.3 billion Australian dollars ($1.91 billion) are likely during the corporate reporting season starting in late January, according to company statements to the Australian Securities Exchange.

“Our basic view is that we need a period of painful pricing to bring about industry closures [and] re-establish supply-demand balance,” analysts at Credit Suisse, a Swiss investment bank, said on Dec. 15. “We estimate that Australian mining sector earnings …… will be moving to a trend low.”

FMG’s share price has moved in tandem with iron ore, falling from a peak of A$6.22 last February to A$2.31 in December. FMG shares saw a brief New Year’s rally as the iron ore price moved back above $70.

More recently, iron ore prices have been sinking. On Wednesday, the benchmark price for iron ore lost 0.1%, to $67.80. On Thursday, FMG shares dropped to A$2.27, having lost more than 10% in two days and reaching a nearly six-year low.

FMG’s annualized iron ore output of about 170 million tons is about three times that of Anglo American of the U.K., the fifth biggest producer by volume, according to a briefing for the market by CEO Nev Power on Dec. 1. However, analysts said the key issue for FMG would be its cash position when it unveils its latest production report.

FMG is alone among the global top five iron ore producers in depending entirely on a single commodity. Anglo American and the three biggest iron ore producers — Brazil’s Vale, Australia’s BHP Billiton and the U.K.’s Rio Tinto — are all broadly diversified.

“We see the major diversified miners as the most preferred in the space, given their ability to manage margins and cash flow,” analysts at UBS, a Swiss investment bank, said on Dec. 8, reflecting a broadly held view in financial markets.

More pertinently, the big three are all cashed up, with low levels of debt on their balance sheets. FMG is laden with debt, having been forced to borrow an additional A$4 billion in September, after the iron ore price went into free-fall in mid-2012.

FMG also faces increasing competition. Roy Hill Holdings, majority owned by the iron ore heiress Gina Rinehart, is due to begin production this year with lower break even costs than FMG, according to a UBS analysis. In October, Anglo American delivered the first ore shipment from its huge Minas-Rio project in Brazil.

FMG has taken decisive action to cut costs and shore up margins, most recently halving its planned capital spending of $1.3 billion for the financial year ending in June 2015. The group also signalled that it was looking for buyers for its $275 million fleet of newly ordered ships.

“We are towards the lower end of the curve for delivered costs into Asia and we continue moving down the cost curve as we drive our world-class assets to maximize productivity from our existing infrastructure at the lowest cost,” Power told the Nikkei Asian Review in a prepared statement.

Power said that recent falls in the Australian dollar and the oil price “are also improving our cost position.” However, he noted, “A lot of new supply has entered the iron ore market to address a previous shortage, but the current price is not healthy for the industry.”

Macquarie, an Australian bank, estimates that FMG’s total break-even cost for producing and shipping iron ore is $59 per ton, giving it very little room to manoeuvre at current prices. Analysts at Citigroup, a U.S. bank, say the average price of iron ore in 2015 and 2016 will be $60 per ton.

In a Jan. 12 client note, UBS said that “demand growth looks likely to remain anaemic …… [and] outstripped by supply growth from the three majors, Minas-Rio and Roy Hill. So we expect a subdued prices outlook for 2015.” The Australian government reset its budget in December on the basis of an iron ore price of $63 per ton this year.

As iron ore prices ebb, so do FMG’s market fortunes. Analysts have slashed their forecasts for the stock, with some, such as the China specialist J Capital Research, placing valuations as low as A$1.68 on the company’s shares. Macquarie said FMG stock could fall to A$2 unless iron ore prices rose.

Founded in 2003 by Andrew Forrest — the group’s largest shareholder with 33.3% of the company — FMG rode a wave of surging Chinese demand for iron ore, making Forrest one of Australia’s richest men. On paper, he remains a billionaire.

However, his company’s fate lies largely with the Chinese economy — and the latest data are not encouraging. Gross domestic product expanded by 7.3% year on year in the third quarter of 2014 — a five year low. In October, the World Bank cut its growth forecast for 2014 to 7.4% from 7.6%.

The Chinese government forecasts that steel demand will rise 1.4% this year, but some independent analysts say demand is more likely to fall because of the weak property market, which consumes about 50% of steel produced in China. Tim Murray, managing director of J Capital Research, said steel demand was likely to fall by between 5% and 20%.

“In 2014 housing starts were down 14%, according to official figures, and will fall between 20% and 30% this year as developers are squeezed for credit,” Murray said.