Is Fortescue Expansion Timetable (Too) Aggressive?

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This story features FORTESCUE LIMITED.
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The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

– Fortescue site visit highlights accelerated production target
– Management confident in new target
– Brokers see the schedule as challenging
– Majority of analysts see value in Fortescue at current levels

By Chris Shaw

Fortescue Metals ((FMG)) held a site visit for stockbroking analysts last week, the major point of interest being greater detail on how the planned eventual expansion to 355Mt of output will be achieved. 

As well, a more aggressive interim target with respect to production growth was set, with Fortescue now committed to delivering an expansion to 155Mt annually by June 2013. This is a year earlier than previously indicated.

Company management has indicated confidence in the accelerated target, Credit Suisse noting recent visits to major suppliers have confirmed orders and delivery times for critical lead items. As RBS Australia points out, if Fortescue can deliver on this target there is significant upside potential to market earnings and valuations.

Whether this can be achieved remains uncertain, as while 95Mt annually at Chichesters appears doable, Citi's estimates suggest achieving the last 60Mt annually at the Solomon Hub by FY13 will be a challenge. Achieving such a production target allows very little wiggle room for even small disruptions to operations.

Citi's current forecasts call for first production at the Solomon project itself in the June half of 2014 and the broker is comfortable with such a time-frame. Goldman Sachs agrees, seeing FY13 for production of 155Mt annually as a best case outcome, with 126Mt in FY14 and 138Mt in FY15 as more likely.

As part of the update Fortescue has confirmed capex guidance for the expansion of US$84 per tonne. The majority of the budget is now committed, so Fortescue is suggesting only US$800 million of the total US$8.4 billion in capex is at risk of rising. This is because accelerating the expansion schedule reduces the potential risks of any capex blowouts.

RBS Australia has taken a more conservative view and factored in capex of US$100 per tonne, while Credit Suisse continues to see some pressures from the elevated Australian dollar. Regardless, Citi suggests even factoring in more bearish iron ore price assumptions shouldn't make things more difficult in terms of raising the funds required for expansion.

Taking a broad view, Goldman Sachs suggests the expansion to 155Mt annually is well timed and supports a generally positive outlook for Fortescue for the next few years. Longer-term a more cautious view is appropriate however, as Goldman Sachs expects the iron ore market will at some point move into structural oversupply. 

This will cause prices to fall and if this happens when Fortescue is part way through its expansion with high debt levels, the company could struggle. Given the positive medium-term outlook Goldman Sachs retains a Buy rating on Fortescue.

The FNArena database shows a total of five Buys and three Holds for Fortescue, Deutsche Bank arguing the Hold case in suggesting the ability to ramp up production in two hubs to meet a relatively aggressive timetable remains a big ask. This is especially the case given construction risks, some native title issues and risks to shipment rate allocations out of Port Headland.

RBS Australia is more bullish, classing Fortescue as the top pick among Australian large cap miners. This reflects the potential for a significant re-rating as projects continue to progress towards development.

The current share price offers an attractive entry before this theme runs its course according to RBS, the broker setting a price target on Fortescue of $8.95. This is up slightly from $8.89 prior to the site visit.

The FNArena database shows a consensus target for Fortescue of $7.91, with targets ranging from RBS's high mark to Deutsche Bank at $6.20. Goldman Sachs is not in the database but has a target of $9.22.

Shares in Fortescue today are down slightly and as at 1.50pm the stock was 7c lower at $6.39. Over the past year Fortescue has traded in a range of $3.83 to $7.34, the current share price implying upside of around 24% to the consensus price target in the FNArena database.
 

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