Tuesday 15 March 2016 by FIIG Securities cave-light-shines Opinion

Fortescue bonds shine in iron ore rebound, but eye-watering repayments await


Published in The Australian 15 March 2016

Volatility spells risk but it can also spell opportunity. Global commodity markets are in a state of flux, over reacting both up and down to perceived changes in supply and demand, providing some huge potential gains for investors buying at low points and  prepared to take a risk


This potential was realised for some investors last week, when poorly performing shares in iron ore miner Fortescue Metals Group skyrocketed on news of a Vale joint venture as well as better commodity prices.

The bonds, like the shares, reacted positively to the news, with prices up USD5 to USD6 overnight on the Monday, a significant jump for the bond market.

Repayment of the bonds is one of the major risks facing Fortescue. If it can’t get refinance or repay the loans at maturity then it may ‘default’. While Fortescue has some years to manoeuvre around its debt maturity repayments, a sustained low iron ore price and potential negative cashflow over time would build nervousness.

FMG has three USD bonds that sophisticated Australian investors can buy direct. The lowest risk bond matures the earliest, in November 2019, and has a distinct advantage over the other two. Repayment is due in the same year as a colossal USD4.8 billion is due to be repaid to a consortium of banks and other institutional lenders.

Fortescue has been active in reducing the principal outstanding on the 2019 bonds by conducting on market buybacks and bond tenders. In essence they have offered higher prices than where the bonds have traded, but less than the $100 face value of the bond to investors, a win-win for both parties. The interest rate on the bond is a hefty 8.25per cent per annum which we understand is almost double the interest rate it pays on its term loan facilities. So, there is a financial incentive for the company to reduce its interest obligation on the bond and keep the full USD4.8billion on foot in the expectation that the bank group will roll over the facility.

While Fortescue issued USD1.5billion of the 2019 bond, it has reduced its maturing principal obligation on USD576m through the buybacks, making the task of repaying the remainder more manageable. As the principal outstanding on the bond reduces, confidence in the company’s ability to repay the bond increases and we have seen a steady rise in the capital price of the 2019 bonds. This is expected to continue if the company continues to progressively repay principal.

The other two bonds mature post 2019. One issued last year, the March 2022, has a very high coupon or fixed interest commitment of 9.75 per cent per annum and has defined security, making it lower risk than the other which has a slightly longer term to maturity in April 2022 and no security defined.

While share investors have had to consider the possibility of no growth, lower or no dividends and poor returns over the last year and into the future, bond investors have different concerns and are looking for other signs from the company for comfort.

One mechanism available to raise funds at short notice is to issue a high yielding, secured bond, an option Fortescue took to repay bonds maturing in 2017 and 2018 last year. The new senior secured bond paying a high 9.75 per cent per annum was issued at a critical juncture for the company, but it was a lifeline which the company took. The rate was almost 3 per cent higher than the other existing 2022 bond, a significant penalty. Importantly, it showed that market appetite was there for the company at a price.

Another is for the existing bank lenders to roll over their USD4.8 billion debt pile.  No doubt this will probably incur a higher interest rate than when the loans were first issued, but would be a positive outcome for the prospects of the 2022 bonds.

There are a couple of questions to consider when thinking about investing in Fortescue and deciding between the shares and the bonds. How confident are you that the current share price will rise and that dividends will be paid or grow? In terms of the bonds, do yields, which range from 9.5 to 12 per cent per annum reflect the risk, and is Fortescue likely to be able to repay its debts as they come due?