Fortescue: China Breaks the Iron Ore Monster

Fortescue Metals Group (FSUMF.PK), Australia’s third largest producer of Iron ore, is taking enormous measures to grow capacity in an effort to satisfy China’s growth. The Chinese, after being scorned by FMG’s Australian rival Rio Tinto (RTP), is now ready to provide FMG with the cheap long term financing it had waiting for Rio Tinto, $6Billion worth. FMG is a newly formed mining company who has used their extensive rail network to gobble up market share from Aussie junior miners as their infrastructure investment pays off in spades. Now with the backing of the Chinese, FMG is looking to more then double their output in less than 3 years. Ultimately I see the stock trading at approx $5.66 by the end of the year, a 51% increase from today’s share price.

The terms of the financing should be favorable to FMG’s shareholders since the debt will be long term and will be structured as a typical mining loan which includes provisions for infrastructure spending. This will ensure shareholders equity will not be diluted from the closing of the deal. The deal does however include FMG giving the Chinese a nice discount on their iron ore currently being shipped this year in return for the financing. FMG has agreed to sell 20M tones to China in the second half of 2009 at a benchmark in the low $60 range while competitors are selling ore at least $10 higher per tone, while spot prices are nearing the century mark. This discount is included in my analysis and is worth FMG doing in order to obtain the financing. Iron ore pricing is in a long term bull trend, and demand is structurally supportive coming from emerging markets.

Below is my breakdown of their pro forma income stmt out to fiscal 2012.

Using a 10% discount rate, the avg. share price for the end of 2009 is $5.66. The P/E multiple is higher during the period of higher growth and tapers off during a period of normalized growth. The forward P/E ratio on BHP, VALE, and RTP are 26x, 15x, and 11x respectively. The average of these three is how I derived the P/E multiple for the initial year.

FMG shareholders will benefit thru increased production coupled with higher iron ore pricing and margin expansions thru cost efficiencies. This company will become a large pure play on iron ore and ultimately will be tied to Chinese growth.

Disclosure: Long FSUMF Shares (US version of FMG:AUS), Long VALE Shares.

Comments

[epeon]

No doubt that the threat of throwing FMG subordinates in jail helped in the negotiations.

2009 Aug 19 05:11 PM

[Tedi]

The discount is 3 cents cheaper than the price settled by Rio Tinto earlier. And that means FMG compromised an approx $35.4M cut for the 20M tones of Fe59% iron ore. But China has to provide $5.5~6 Billion financing by the end of this Sep. for that deal. What a bargain!!

2009 Aug 19 10:48 PM

[Positroll]

Now I wonder whether FMG will try to buy into Moly Mines (Mol.ax , Mol.to) . Also located in the Pilbara area, they got some high quality iron ore at the surface, and one of the worlds biggest moly resources; only needs financing. And FMGs owner already is a major shareholder of Moly Mines ...
I bought some cheap shars at 0,22 Au$ in March, sold 1/3 at 1,20 Au$ lately, and now I'm waiting how it all plays out ...

2009 Aug 20 06:59 AM

[Rohan C. Pease]

Positroll, thanks for the comments, I usually always learn from my readers. Moly would be a good idea since the other large producer of the steel strengthener is FCX. I believe the metal has good margins when steel pricing picks up.

2009 Aug 20 11:13 AM