Australia | Aug 01 2007
By Greg Peel
A casual observer of the stock market could be forgiven for thinking that Fortescue Metals Group (FMG) was a leading Australian producer of iron ore, having, as it does, a 52-week share price range of $7.85 to $41.75. That’s a mere 432% rise. But the truth is, Fortescue has not yet shipped one tonne of highly sought after iron ore, and won’t until at least May next year.
A similar observer might have made the same mistake about Summit Resources (SMM), which itself has a 345% 52-week range while never having produced a pound of uranium, and not looking like doing so for some time. Fortescue has become the “uranium stock” in the iron ore space.
Unlike the Summit case, however, there is nothing stopping Fortescue from pulling all its ore reserves out of the ground and selling it to China, other than time and money. Time is clearly of the essence, as while we might be in a super-cycle no one would suggest the iron ore price couldn’t suffer some sort of pull back in the future. Fortescue has to make hay while the sun shines, and do it very, very quickly.
The company is racing to to complete the initial stage of its Western Australian mining project, one which should produce 45Mt of ore. It has already raised a further $504m in July to expand that figure to 55Mt. All of that 45Mt has already been effectively sold, under take-off agreements, and so it has about a further 50Mt. In order to fast track the initial project, Fortescue has assembled team of engineers and managers, dubbed Team 45. As JP Morgan points out, Fortescue cannot allow this crack squad to ride off into the sunset once 45Mt is reached, as it would be be too costly and time consuming to assemble another such group. Team 45 has to become Team 55, and then Team Watch This Space.
(Team 45 is actually an alliance between Fortescue and professional services provider WorleyParsons (WOR). The team is named just for the 45Mt, but for its original address of 45 Georges Terrace in Perth. The group will stay on as it would indeed be difficult to assemble a new team, according to a posting by a team member and FNArena subscriber this morning.)
JP Morgan notes the expansion to 55Mt will cost less than $600m, equating to $60/t (versus a current price of about US$100/t for lump iron ore, which may soon rise to US$120/t or more). The 45-55Mt expansion will include the immediate construction of a full lump circuit, crushing and screening capacity, a loading berth at Port Headland and more rail cars. The target for annualised production of 55Mt of lump is the March quarter 2009.
But that is not all, oh no that is not all.
JP Morgan believes 55Mt production will be just a whistle stop. Without actually including such in their valuation, the analysts believe Fortescue could push expansion out to 100Mt with the development of Christmas Creek. With port and rail expansion costs, this would require another $3 billion in funding. But then there’s also Fortescue’s western tenements, and this could take that figure to 200Mt.
But back in the present, JP Morgan notes the 45Mt project is already 14% over budget. Therein lies one of the biggest problems facing global miners trying to take expedient advantage of the commodity boom – spiralling costs. JPM fears that Fortescue may need to dip into expansion funds just to reach Stage One. However, under its debt covenants, the company would need to be very up front about such an incursion.
JP Morgan is the only broker in the FNArena database to cover Fortescue. Until today, it had been sitting on a Neutral rating with a mere $17 target – small beans compared to where the share price has been trading. Under any other scenario, JPM should have had a big Sell on the stock, but the analysts wanted to delve further into the possibilities first, and this is what they came up with.
They had previously assumed 60Mt capacity by 2012 with cash costs 15% above guidance and ramp-up 6 months behind guidance as conservative measures. A capital cost of 12% was used.
Now they are assuming 100Mt by 2012 and a 5% higher iron ore price. This jump is not included in the analysts’ valuation, which stands at $21, but were it to be included valuation would be $38. It’s all academic however, for this is exactly where JPM has moved the price target to – a jump of 123%.
With the stock trading at around $31.60 today, one might expect a rating upgrade to be forthcoming but no, JPM is happy with Neutral. Mind you, Neutral means cap-weight this stock in your portfolio.