Iron Bridge Costs Up But Fortescue Is Forgiven

This story features FORTESCUE LIMITED. For more info SHARE ANALYSIS: FMG

Stellar iron ore prices are supplying plenty of cash flow for Fortescue Metals so a modest lift in project costs has not induced panic

-Increase in costs reported across the WA mining jurisdiction
-Spot prices generating a sharply higher earnings outlook for Fortescue Metals
-Will low-grade discounts increase significantly?
 

By Eva Brocklehurst

As long as the iron ore price stays at heady heights Fortescue Metals ((FMG)) is forgiven for raising its assessment of the capital expenditure costs required at the Iron Bridge development.

Fortescue Metals has revised up capital expenditure at Iron Bridge to US$3.3-3.5bn from US$3bn, of which its share is now US$2.5-2.7bn. The revised budget is subject to approval by the joint venture and, in the event others choose not to contribute, this may create an opportunity for the company to increase its effective stake.

To date US$1.5bn in expenditure has been incurred and, while the increase in overall expenditure was largely anticipated, the 20% uplift to unit costs and sustaining capex (to US$5-7/t) surprised and disappointed Credit Suisse, given there is no change of scale in the project.

Nevertheless, the broker considers this can be justified because other mining companies in Western Australia have also reported wage inflation. Macquarie equally concludes the increase in capital expenditure reflects project-specific, end-market factors affecting materials and installation costs.

First production has been slightly delayed to a start in December 2021, yet the broker speeds up its forecasts for the ramping up of the project, offsetting the increase in life-of-mine cash costs.

Project planners have reverted back to the original 135km slurry pipeline having abandoned the option of railing magnetite to a port. New capital expenditure guidance includes constructing an offload facility at Lumsden Point, designed to ease logistics constraints.

Iron Bridge is expected to produce 22mtpa of high-grade 67% iron at a life-of-mine C1 cash cost of US$33-38/wmt, lifting the average product grade for Fortescue Metals.

Stellar Prices

The outcome for Credit Suisse is a moderating of the valuation of Fortescue Metal's 61% ownership of Iron Bridge, equating to around -$0.20 a share. Yet the iron ore price continues to hold up and the broker forecasts an iron ore price of US$170/t for the June quarter, noting spot prices have been averaging around US$190/t since the beginning of April.

Macquarie agrees the company is benefiting from buoyant prices, largely offsetting the increase in cost assumptions, and a current spot price scenario generates 8% higher earnings for FY21 and 104% in FY22.

Ord Minnett is also disappointed about the deteriorating metrics, reducing its value estimate for Fortescue Metals by -2%. Still, the project makes sense from a growth and product quality point of view, the broker adds.

Morgan Stanley is much more negative, believing the increases in both operating and sustaining capital will have further negative impact on the project valuation. The broker retains an Underweight rating, envisaging the risk to low-grade discounts increases significantly.

Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, has a Sell rating too, with a target of $18.20. The broker expects a strong June quarter result in terms of production and a record final dividend in August.

Yet the Sell rating is based on relative valuation and the widening of low-grade 58% product realisations along with the uncertainty surrounding the diversification into Fortescue Future Industries.

Goldman Sachs anticipates the iron ore market will move into balance by year's end on increased supply from Brazil along with steel curtailments in China, and this makes higher grade iron ore more favourable on a value-in-use basis.

Blending options and volumes will be based on market conditions and/or customer appetite when production starts. Fortescue Metals has full marketing rights and can sell Iron Bridge concentrate as a stand-alone product or blend to improve quality.

Ord Minnett highlights the dividend yield, strong market and the 25% potential upside to its discounted cash flow valuation, calculating Iron Bridge should generate almost US$600m in operating earnings (EBITDA) when ramped up.

The database has three Buy ratings, three Hold and one Sell (Morgan Stanley). The consensus target is $21.62, signalling -2.3% downside to the last share price. Targets range from $17.45 (Morgan Stanley) to $28.00 (Ord Minnett). The dividend yield at current FX values for FY21 and FY22 forecasts is 15.9% and 11.2%, respectively.

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