Fortescue bonds have experienced impressive capital price growth since January lows and are now trading at a premium to par, offering significant returns for investors
Fortescue surprised the market yesterday with a 212% increase in net profit after tax of US$985m, up from US$316m. In response to declining iron ore prices, the company has massively reduced costs and increased efficiencies so that it’s EBITDA margin is now at 45% and better than BHP’s at 41%. In depth analysis of financial results can be found at the end of the note.
Both Fortescue bonds have experienced impressive capital price growth since the lows in January and are now trading at a premium to par.
Source: FIIG Securities
If you invested in FMG bonds earlier this year, you would be sitting on significant returns.
FMG USD Senior Unsecured 2022 summary
|Date ||Description ||$ (USD) |
|21/01/2016 ||Purchase || -$5,419.62 |
|01/04/2016 ||Coupon ||$343.75 |
|23/08/2016 ||Sale ||$10,500.00 |
|Net increase in cash ||$5,424.13 |
|Holding period return ||100.08% |
|Annualised holding period return ||169.91% |
FMG USD Senior Unsecured 2022 summary (adjusted for FX at spot rates shown)
|Date ||Description ||AUD/USD || $ (USD) |
|21/01/2016 ||Purchase ||0.7015 ||-$7,725.76 |
|01/04/2016 ||Coupon ||0.767 ||$448.17 |
|23/08/2016 ||Sale ||0.763 ||$13,761.47 |
|Net increase in cash ||$6,483.88 |
|Holding period return ||83.93% |
|Annualised holding period return ||142.48% |
FMG USD Senior Secured 2022 summary
|Date ||Description ||$ (USD) |
|21/01/2016 ||Purchase ||-$8,643.00 |
|01/03/2016 ||Coupon ||$487.50 |
|23/08/2016 ||Sale ||$11,946.30 |
|Net increase in cash || $3,790.80 |
|Holding period return ||43.86% |
|Annualised holding period return ||74.46% |
FMG USD Senior Secured 2022 summary (adjusted for FX at spot rates shown)
Note: Prices accurate as at 23 August 2016 but subject to change.
|Date ||Description ||AUD/USD ||$ (USD) |
|21/01/2016 ||Purchase ||0.7015 || -$12,320.74 |
|01/03/2016 ||Coupon ||0.718 ||$678.97 |
|23/08/2016 ||Sale ||0.763 ||$15,657.01 |
|Net increase in cash ||$4,015.24 |
|Holding period return ||32.59% |
|Annualised holding period return ||55.33% |
With the improving credit profile and further debt reduction targeted, we believe there is a strong chance the bonds will be called at the first opportunity and now may be a good opportunity for holders sitting on capital gains to take profit in what is currently a supportive commodity price environment.
The Fortescue bonds are offered at the following indicative yields to worst (YTW).
- Secured 2022 bond (rated BB+/Ba2): trading in an indicative range of 5.24% to 6.16% per annum (yield to 1 March 2018 call date at a call price of US$109.75), with current prices trading higher than the call price
- Unsecured 2022 bond (rated B+/B2): trading in an indicative range of 5.78% to 6.24% p.a. (yield to 1 April 2020 call date at a call price of US$100), compared to a current price of just under par.
Prices of both the secured March 2022 and unsecured April 2022 bonds are trading close to the call date prices, leaving little further upside. If you are interested in taking profit, some possible US dollar switch targets are:
- AusDrill November 2019 (YTW 7.4% pa.)
- IAMGOLD October 2020 (YTW 6.85% pa.)
- TransAlta November 2022 (YTW 4.41% pa.)
- Virgin November 2019 (YTW 6.62% pa.)
Note: Fortescue’s bond ratings differ to its corporate credit rating (BB negative outlook/Ba3 stable outlook) due to their respective rankings in the capital structure. For each rating agency, the secured bond rating ranks three notches above of the unsecured bond rating, reflecting its stronger position in the capital structure.
Fortescue full year 2016 results
The result is highlighted by a 27% growth in EBITDA despite 17% lower revenues during the year, a reflection of the significant progress the company made on cost reduction. As a comparison, Fortescue’s underlying EBITDA margin of 45% was better than BHP’s margin of 41%.
The company’s significant improvement in rating profile over the past year makes it a candidate for a credit rating upgrade. At the same time, Fortescue bonds have experienced impressive capital price growth in 2016, following the recovery in iron ore prices. With the company moving from a pure focus on debt reduction towards increasing dividends to shareholders, now may present an opportunity for existing holders to take profit.
The table below summarises the full year financial performance: Source: Fortescue
Fortescue delivered healthy cashflow generation across all measures, with the majority of cashflows applied to reduce debt and gearing levels as reflected in the figures below: Source: Fortescue
Net debt reduced by US$2bn over the year to US$5.2bn, and the company is targeting gross gearing levels of less than 40% (currently 45%). Further debt reduction is anticipated but will likely at be a slower rate than recent years. Fortescue’s cash balance at 30 June 2016 was US$1.6bn and the company has targeted liquidity of US$1 to 1.5bn, so up to US$600m is available from existing cash for further debt repayment. That figure excludes future free cashflow generation which is expected from the business.
However, we also note that Fortescue delivered a sixfold increase to the final dividend, from 2c per share at FY15 to 12c per share at FY16, so the company has transitioned from being purely focused on debt reduction to now being a meaningful dividend payer. While increased dividends to shareholders in itself is not credit positive, we believe Fortescue has weathered the resources storm and is now well positioned to manage its future debt maturity profile. We expect it to maintain a healthier balance sheet than previous years, and it is reasonable to expect an improved level of dividends as long as earnings and cashflow generation remain solid.
Being a single commodity producer tied to the production of steel, the continued risk for the business remains a downturn in iron ore prices or a slowing of demand from China for its product. While these are difficult risks to quantify, we note that the company’s cashflow breakeven price of around US$28 per dry metric tonne (dmt) is less than 50% of spot iron ore prices, so Fortescue has created a significant operating buffer to manage any future deterioration in price.
It is also important to note that the rating agencies are using relatively conservative iron ore price assumptions in the determination of their ratings. For example, S&P is currently assuming average benchmark iron ore prices trending to US$40/dmt for the rest of calendar years 2016, US$40/dmt in 2017, and US$45/dmt in 2018, with Moody’s adopting similar forecasts. These assumptions are well below current spot iron ore prices of around US$60 per tonne, and if the rating agencies were to revise their assumptions upward we would likely see an upgrade to Fortescue’s credit rating depending on the extent of the price assumption uplift. If Fortescue were to be upgraded to investment grade, for example, its ability and cost of obtaining new debt finance would improve materially and we would expect the company raise new debt to refinance and call the existing bonds early.
A link to the announcement is available here.
Please contact your FIIG representative for further information on the Fortescue US dollar bonds. Available to wholesale investors at a minimum face value of USD10,000.