Fortescue metals making money, still

FMG has had a tough time of late. It’s down 45.7% year-today having been heavily impacted by the collapsing iron ore price, grading discounts and the assumption it will be unable to service its mounting debt.

 

Iron Ore
Source: Bloomberg

Iron ore has started to find some support around US$75 a tonne. However, the expectation coming out of China is for this price to fall further in 2015. This will be largely due to the cooling property market, which will significantly reduce the demand for iron. (It’s also a concern for copper).

This raises two major concerns:

One, cost to income and two, capital risk.

The current fall in the iron ore price has certainly hit cash flow according to UBS and Goldman Sachs. FMG’s estimated all in cash costs are between $70 and $71 a tonne, meaning FMG is still making money at current prices but only just. Further down side in the iron ore price will squeeze this margin even more so. Cash flow risk leads into the next question around debt servicing.

Net debt is approximately US$7.4 billion and explains the concern about its debt burden. However, the nearest maturity is a 6% bond due in 2017, which gives it plenty of time. FMG made a strategic decision to pay out $1.7 billion of debt in January this year, which was due for maturity next year and in 2016, further reducing the capital risk. I see FMG’s ability to refinance and service this debt as relatively stable and it is unlikely to create a capital event in the interim.

Although the short term outlook isn’t all that bright, FMG continues to find support at or just below $3. This level has been a very strong support level for many years and I would suggest it would be an advantageous level to buy at, as the stock is likely to see a short term bounce from this level.

FMG is likely to remain undervalued over the short term. However, I believe the worst of the contraction is now over and it’s likely to be range bound over the coming months.

 

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