As expected Fortescue’s FY15 performance is significantly down on the prior year reflecting the deterioration in iron ore prices. However, through continued successful cost reductions the company was able to deliver US$2bn in positive operating cash flows through FY15
Fortescue has delivered a very respectable result in what was an extremely challenging year for iron ore. From a credit perspective, while financial earnings-based leverage has increased significantly, the company continued to generate strong positive operating cash flows over FY15 and its cash position remains at a high US$2.4bn. Further cost reductions are expected into FY16 with the company expecting to generate positive cash flows in the coming year if iron ore prices remain above US$39/tonne (currently ~$US55/tonne). With low levels of capital expenditure forecast into the foreseeable future, we continue to expect that cash flow generation will exceed accounting profits.
Fortescue has also provided an updated ‘cost curve’ in its results presentation. A cost curve ranks each of the iron ore producers from lowest to highest cost on a cumulative production basis. The latest cost curve depicted below shows that Fortescue has overtaken Vale to be currently the third cheapest major producer of iron ore.
Fortescue expects further cost reductions into FY16 from the current position (reflected in the chart above). There has been no change in terms of FY16 cost guidance, with Fortescue continuing to forecast a breakeven iron ore price of $US39/tonne. The FY16 breakeven price is expected to reduce further if the Australia dollar remains in the low US$0.70 range.
In terms of debt repayments and cash position, Fortescue indicated that it will continue to adopt a “conservative position” through the coming FY16 financial year. Our read of this statement is that Fortescue expects to maintain or build up its cash position rather than use excess cash to repay debt in the near term. The conservatism is driven by the continued weakness in iron ore, and the company’s preference to maintain a higher level of liquidity to manage any further downward volatility in commodity prices. Based on the company’s comments, we expect that it is unlikely we will see an early debt repayment in the coming financial year if prices remain at or fall below current levels (~US$55/tonne).
The payment of a dividend is very shareholder-friendly given the weakness in iron ore prices, particularly when comparing to Newcrest which delivered a strong FY15 result but did not pay a dividend. However, we note that total dividends declared in FY15 by Fortescue of 5c per share are well below the 20c per share declared over FY14.
With its competitive cost position, and strong level of liquidity, Fortescue remains better placed to withstand a shorter-term downturn in iron ore prices than most of the other producers in the market. Its heavy exposure to China makes its share and bond prices highly sensitive to movements in iron ore prices as well as the uncertainty associated with broader Chinese economic activity. With its high financial leverage and single commodity exposure to iron ore, Fortescue remains a relatively high credit risk option while iron ore prices remain subdued.
We note that the company also hinted that it would likely look to deal with the US$5.9bn of debt maturing in 2019 before retiring the 2022 debt, which includes the US$1.05bn outstanding of senior unsecured 2019 bonds. For investors comfortable with iron ore exposure, high bond price volatility and positive about the company’s ability to manage its way through the commodity cycle, the 2019 bond is currently priced at levels well below par (closer to $80) and represents an opportunity for an equity-like return on a bond and the possible prospect of early repayment.
Key points on FY15:
- Key financial performance statistics are provided in the figure below – note the material reductions in revenue, EBITDA and net profit due to the significant falls in iron ore prices over FY15. Impressively however, the company was still able to generate US$2bn in operating cash flows over FY15
- Key credit metrics are outlined in the figure below – as expected, the weakness in iron ore prices and associated weaker financial performance has contributed to a significant increase in financial leverage over FY15, with EBITDA / Interest reducing from 6.9 times to 3.8 times and debt / EBITDA increasing from 1.7 times to 3.8 times. Net debt and gearing have remained steady at US$7.5bn and 56% respectively
Please contact your FIIG representative for more information on the Fortescue bonds available to FIIG investors.