Australia | Sep 05 2012
– Weaker iron ore prices force Fortescue to delay expansion plans
– Move lowers capex requirements for FY13, FY14 still a question
– Brokers adjust earnings forecasts and valuations
– RBS and UBS downgrade to Hold ratings given uncertain iron ore price outlook
By Chris Shaw
A sharp fall in iron ore prices over the past several weeks has forced action from Australian producer Fortescue Metals ((FMG)), the company yesterday announcing the deferral of some significant production expansion plans.
Having previously set a target of lifting production to 155mtpa, Fortescue will now complete an expansion to capacity of 115mtpa via completing both the Chichester Hub and 20mtpa of the Solomon Hub. This compares to expected production in FY13 of around 84mt.
As Goldman Sachs notes, one implication of the change in plans is Fortescue will lower its capex requirements for FY13 by US$1.6 billion and cut operating costs by around US$300 million for the year.
Given cash available and facilities totalling US$5.66 billion as at June 30, Goldman Sachs suggests Fortescue has enough funding to complete the expansion to 115mtpa in total production. Additional cost savings will help preserve cash flows, while BA-ML sees scope for asset sales if needed.
But RBS Australia points out the US$1.6 billion in capex now not required in FY13 has simply been deferred to FY14, assuming the full expansion is eventually pursued. This means Fortescue will still need to rely on sufficient operating cash flows to finance the expansion as there is also US$1.5 billion in debt maturing at the end of 2013 and this will need to be repaid.
One issue for Deutsche Bank is the delays announced at the Kings mine at Solomon imply higher total capex for the eventual expansion to 155mtpa of as much as US$200 million. On the iron ore price forecasts of Deutsche and factoring in a delayed start-up at Kings, the project's net present value has been cut by around US$1 billion.
On the back of Fortescue's revised plans, equity brokers have been quick to adjust earnings estimates, valuations and price targets. As an example, Deutsche has lowered its net present value for Fortescue by 10% to $4.32. This would fall to $3.46 if spot prices persist through FY13. Deutsche has cut its price target for Fortescue to $4.30 from $4.80 to account for the changes to its model.
RBS went even further, moving to a target of $3.71 from $6.72. This reflects changes to earnings estimates stemming from the view iron ore prices are unlikely to re-rate significantly in the shorter-term and the fact expansion plans and Fortescue's funding structure remain dependent on what are now uncertain operating cash flows.
The changes to its model were enough for RBS to downgrade its rating on Fortescue to Hold from Buy, a move matched by UBS to account for a lower valuation and iron ore price risk. UBS's price target has been cut to $3.80 from $5.60.
Morgan Stanley, which is not in the FNArena database, already had an Equal-weight rating on Fortescue within an In-Line industry view. On base case iron ore price forecasts Morgan Stanley sees no cash shortfall for Fortescue, but on spot prices there could be a hole of as much of US$2.4 billion in FY14. For Morgan Stanley this is enough to justify a cautious stance on Fortescue, at least until iron ore prices find some support and begin to recover.
Others remain more positive, largely given the view the current weakness in iron ore prices will prove to be temporary. As well, Credit Suisse points out the deferral of expansion plans announced by Fortescue should put to rest market fears of an equity raising, something the broker suggests has been weighing on the share price.
JP Morgan counters this by suggesting an equity raising to fund the expansion plans would have been a better option, as moving to production of 155Mtpa as planned would have allowed Fortescue to dilute its fixed costs and interest payments over higher tonnage sooner.
Despite this, JP Morgan retains an Overweight rating but with the caveat iron ore prices need to improve for any share price re-rating to play out. BA Merrill Lynch also has a Buy rating on Fortescue, as using spot iron ore pricing the broker's net present value for Fortescue would still be $4.69, which remains solidly above the current share price. Assuming long-term iron ore price forecasts, BA-ML's net present value for Fortescue would be $6.33.
Overall, the FNArena database shows Fortescue is rated as Buy five times and Hold three times, with a consensus price target of $5.21, down from $6.00 previously. Goldman Sachs is also not in the database but rates Fortescue a Buy with a target of $5.95.
In a weaker overall market shares in Fortescue today are lower, trading down 32.5c or nearly 10% at $3.085 as at 11.50am. This compares to a range over the past year of $3.06 to $6.27, the current share price implying upside of around 66% relative to the consensus price target in the FNArena database.
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