Friday 20 March 2015 by Opinion

Fortescue - where to from here

With Fortescue withdrawing its new secured bond issue, and cancelling the bond buyback, the question becomes what is the most likely path for the company from here.

No doubt the withdrawal of Fortescue’s new secured bond issue has disappointed the investor market.

Ultimately, the company could not achieve the pricing that it wanted on the new debt raising, given the continued fall in iron ore prices and a number of mining issuers looking to tap the US high yield market at the same time. it’s unfortunate for the company that it has all played out so dramatically in the media. It would be an exaggeration, however, to suggest the company cannot raise debt financing.  

So what will the company do from here? Fortescue has indicated that its debt facilities do not have maintenance covenants: however there are secured debt incurrence covenants in place which place a ceiling on the amount of secured debt they can raise. Fortescue’s ability to raise additional secured debt is limited to a maximum of 2 times the last twelve months (LTM) of EBITDA.

Its existing secured debt of US$4.9bn implies it needs an LTM EBITDA in excess of US$2.5bn to raise more secured debt. The current Bloomberg consensus estimate for FY15 EBITDA is currently US$2.584bn. On these numbers, Fortescue will not be able to raise further secured debt if it waits to refinance post FY15 results. 

In the absence of a debt refinancing and a recovery in iron ore, Fortescue could either look to asset sales or raising equity. We do not expect Fortescue will raise additional equity given the low share price, and the prospect for a partial asset sale is less likely given; 

a) Paying away infrastructure charges will increase Fortescue’s production cost.

b) The sale price will be subdued given the current iron ore environment.  

Neither option seems attractive or likely for the business. Unsecured bonds would also be too expensive to consider in the current environment and additional prepayments, while generating liquidity, may not be economic at the current low iron price. 

Therefore, we consider the most likely scenario from here would be another tilt at a secured debt raising pre FY15 reporting (mid-late August). Given the lack of success in the US loan and bank markets, we expect Fortescue could turn the Asian loan market for funding. Taking no action is also a possibility, given its next maturing debt is in 2017 and its strong liquidity position, holding US$1.6bn in cash. 

We expect that FMG will allow the negative sentiment to dissipate before considering a relaunch. The likelihood of a successful debt raise will completely depend on the price of the new debt. The Fed’s continued caution on a US rate rise will mean that FMG will now have more time than was previously thought to launch in a relatively low interest rate environment. 

Following on from our previous commentary, this still places the shorter end of the FMG curve (2017, ‘18 and possibly the ‘19’s) in play for a re-tender process prior to the FY15 reporting season. The 2019’s have been hit particularly hard by the negative sentiment, pricing almost $10 below where the company was prepared to buy them back prior to the tender being cancelled. 

Fortescue’s bond prices have come off significantly since the tender offer was cancelled, particularly in the longer dated 2019’s and 2022’s. The question is whether the market has overreacted to the news, or whether being in iron ore warrants a higher risk premium. The continued fall in iron price has generated a heightened anxiety in Fortescue, and we expect Fortescue will remain volatile until a true bottoming in the iron ore price is reached.  

Iron ore prices will dictate the company’s rating. The rating agencies are very likely to downgrade Fortescue if prices remain below US$60 per tonne – they are using US$65 per tonne as a base short term price in setting the current rating. It would seem a rating downgrade is on its way. 

From a credit perspective, we note the following mitigating factors. Fortescue had US$1.6bn in cash available as at 1H15 (enough to pay out the 2017 and 2018 bonds in full), and its next maturing debt is in two years. After allowing for cash backing, the next maturing debt is in 2019. 

When the market refers to a cash breakeven price of $53 to $55 per tonne, please note that this is the free cash flow breakeven price. In other words, Fortescue can still service all of its interest costs and sustaining capital expenditure at current prices as at the time of writing, albeit at a very thin margin. We explain the concepts around iron ore pricing and cost in the following article - Fortescue – explaining the various cost and price metrics.

You can also read the article Fortescue announces withdrawal of senior secured bond offering for more information, contact your FIIG Representative.