##{"id":65030,"date":"2015-04-20T12:42:44","date_gmt":"2015-04-20T02:42:44","guid":{"rendered":"http:\/\/www.fnarena.com\/index.php\/2015\/04\/20\/challenges-keep-mounting-for-fortescue\/"},"modified":"2015-04-20T12:42:44","modified_gmt":"2015-04-20T02:42:44","slug":"challenges-keep-mounting-for-fortescue","status":"publish","type":"post","link":"https:\/\/staging.fnarena.com\/index.php\/2015\/04\/20\/challenges-keep-mounting-for-fortescue\/","title":{"rendered":"Challenges Keep Mounting For Fortescue"},"content":{"rendered":"

-Liquidity issues still arise
\n-Maybe some breathing space
\n-Substantial impact on Orica<\/strong>
\n <\/p>\n

By Eva Brocklehurst<\/p>\n

As the iron ore price descends into the pits, Fortescue Metals ((FMG)) has made a concerted effort to preserve its cash flow by slashing costs, consolidating labour, limiting procurement and chasing near-surface deposits.<\/p>\n

The company is pulling out all stops, drawing on inventory to reduce working capital. Even so, Citi still envisages liquidity issues could arise, given an iron ore price forecast of US$40\/tonne until the end of FY18. The company expects to achieve break even at US$39\/dmt CFR, by improved mine and labour productivity, switching the Solomon hub to gas and, squeezing contractors. Even after recognising the full benefit of lower costs and capex, Citi is not confident. The broker believes the debt refinancing opportunity has all but closed and Fortescue will need to increase prepayments or sell infrastructure\/operating assets to fund repayments after 2017, and an asset sale is not out of the question.<\/p>\n

During the March quarter Fortescue shipped 40.4mt at a C1 cost of US$25.90\/wmt. The average price received was US$48\/dmt CFR. This was weaker than UBS expected, attributed to a higher-than-forecast impurity discount and provisional pricing impact. Incorporating the update, the broker decreases FY15 earnings estimates. Cost assumptions have been cut for FY16, which leads UBS to raise earnings estimates from FY16 onwards.<\/p>\n

Credit Suisse observes there was not much cash being generated on each tonne sold in the quarter. The company has indicated total capex in FY16 would be less than $400m and could remain that low for some years if necessary. The broker maintains forecasts for FY15 but reduces the loss estimated for FY16 by 31%. Credit Suisse also assumes dividend payments will be suspended for some time.<\/p>\n

In Deutsche Bank's description, Fortescue is "pulling the waste lever perhaps for the last time". The broker perceives the change to the Chichester hub mine plans is likely to be value destructive as it will shorten mine life and affect product quality. Cloudbreak will be high-graded. Through reduced waste stripping the company will lower costs to US$18\/t. Deutsche Bank believes this will be sustainable for just 1-2 years but should allow Fortescue to pay back its next US$1bn in debt in 2017, although only as far down as a 62% iron ore price of US$45\/t.<\/p>\n

With no maintenance covenants around secured debt and the option to raise additional unsecured notes, pursue asset sales or raise equity, Bell Potter is of the view that the company has a number of funding sources available before maturities fall due in 2017 and 2019. While acknowledging iron ore spot prices remain a significant risk to cash flows, the broker now classifies Fortescue as a speculative investment and upgrades to Buy Speculative from Hold.<\/p>\n

Less than a month ago, Morgan Stanley envisaged the prospect of negative free cash flow would lead to cash depletion and an unresolvable debt issue. Now, provided iron ore prices do not collapse, this broker, too, senses Fortescue has a few years to work out a debt solution. Based on past performance, Morgan Stanley is prepared to bring the benefit of mine plan, roster change, contractor consolidation and gas conversion into its base case. If peers match Fortescue, lower iron ore prices could occur. This keeps the broker from becoming more positive at this time but the rating is upgraded to Equal-weight from Underweight.<\/p>\n

Fortescue's overburden (waste) volumes fell a further 28% in the March quarter after declining 14% in the December quarter. Morgan Stanley observes this reverses a long period where overburden volumes had consistently grown. On this subject the fall-out for a suppliers such Orica ((ORI)) is significant. These overburden volumes are the best proxy for ammonium nitrate (AN) demand. Fortescue is one of Orica's largest customers on Australia's west coast for this product and Morgan Stanley expects the additional efforts to further reduce strip ratios could equate to an extra 15-30,000t reduction to Orica's AN volumes.<\/p>\n

Morgan Stanley, like Deutsche Bank, does not consider the reduced stripping ratio is sustainable. Still, the outlook is unlikely to change any time soon in the face of weak iron ore prices. Mine closures by other west coast customers add to the challenge. Subsequently, Orica's AN capacity may need to be rationalised and Morgan Stanley believes the utilisation challenge facing the company's 300,000t Burrup AN plant that comes on line later this year is growing exponentially. Indirectly, the broker also surmises that this could spill over to Orica's Bontang plant in Indonesia, from which the company currently supplements its Pilbara customers.<\/p>\n

FNArena's database shows seven Hold ratings and one Sell for Fortescue. The consensus target has fallen to $1.89 from $2.12 ahead of the production update and suggests 1.1% upside to the last share price.<\/p>\n

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)<\/a>" – Warning this story contains unashamedly positive feedback on the service provided.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"