Fortescue Metals Group

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1 AUSTRALIA FMG AU Price (at 6:1, 17 Jul 212 GMT) Outperform A$4.54 Volatility index Medium 12month target A$ month TSR % +7.6 Valuation A$ 7.58 DCF (WACC 1.5%, beta 1.6, ERP 5.%, RFR 5.%, TGR 3.%) GICS sector Materials Market cap A$m 14,137 3day avg turnover A$m 83.5 Number shares on issue m 3,114 Investment fundamentals Year end 3 Jun 211A 212E 213E 214E Revenue m 5,377 6,736 1,84 17,8 EBIT m 2,588 2,716 4,735 7,667 Reported profit m 1,23 1,473 2,621 4,377 Adjusted profit m 1,38 1,434 2,634 4,599 Gross cashflow m 1,216 1,712 3,168 5,546 CFPS CFPS growth % PGCFPS x PGCFPS rel x EPS adj EPS adj growth % PER adj x PER rel x Total DPS Total div yield % Franking % ROA % ROE % EV/EBITDA x Net debt/equity % P/BV x FMG AU vs ASX 1, & rec history Note: Recommendation timeline if not a continuous line, then there was no Macquarie coverage at the time or there was an embargo period. Source: FactSet, Macquarie Research, July 212 (all figures in USD unless noted) 18 July 212 Macquarie Securities (Australia) Limited Skipping the 6s, straight into the 7s Event FMG provided its June quarterly production report. Impact Skipping the 6s. FMG reported shipments of 17.8mt or ~71mtpa on an annualised basis (inclusive of thirdparty shipments), 2mt ahead of FMG's guidance of 15.8mt, an increase of 42% qoq. Total FY12 shipments of ~57.5mtpa were ahead of fullyear guidance of 55mtpa. FY13 guidance is now 89mt (previously: 8mt; we model 8mt). Stronger cash flow... Unit costs (in US$/wmt) declined ~12% to ~US$46/t from Mar q levels of US$53/t. FMG achieved US$125/dmt CIF China for the June q (Mar q: US$126/dmt), as average spot price for the quarter was broadly flat qoq. We estimate the volume increase and steady price resulted in quarterly EBITDA of ~US$8m (vs ~US$5m Mar q). Funding position less robust as capex increases. At end June, FMG reported cash of US$2.3bn and undrawn facilities of US$1.9bn (FMG had drawn US$.1bn of revolving credit facility and US$.1bn of its US$1.5bn lease facility). More capex required (US$.6bn), a tighter schedule (~$.9bn more in FY13 than we had previously modelled) and less expansion capex already spent (~$.7bn less than FY12 guidance) means that funding is considerably tighter than we had modelled previously. We believe FMG may require an additional US$12bn depending on iron ore prices over the next 12 months. Iron ore headwinds gather. We believe iron ore remains a strong play on physical Chinese market conditions, which after a seasonal improvement in March and April have eased into May and June. With our expectation that Chinese steel output will drop into July and August, we believe there is a lack of nearterm catalysts that can lead prices to break out of the $1315/t range. While we believe there is potential for upside beyond this range later in the year, this will require a broader Chinese recovery that incorporates construction and machinery volume improvements. Earnings and target price revision FY13EPS reduced to US$.844ps from US$.93ps; no other material changes. Target price reduced to A$7.6ps from A$7.7ps in line with lowered DCF. Price catalyst 12month price target: A$7.6 based on a DCF methodology. Catalyst: Financial results Aug 212; Port Hedland fifth berth approved Action and recommendation Outperform. FMG continues to generate strong cash flow from its current 55mtpa+ production footprint and the step change in quarterly performance supports its increased guidance for 2HCY12 as its expansion to 155mtpa proceeds. However, we flag the risk of lower than planned capex sunk thus far and increased capex to be spent going forward exerting renewed pressure on the balance sheet in the short term. Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website

2 Quarterly performance Skipping the 6s... FMG reported shipments of 17.8mt or ~71mtpa annualised (inclusive of thirdparty shipments), 2mt ahead of FMG's guidance of 15.8mt, an increase of 42% qoq. These shipments were generated by a 4%+ increase in ore mined and ~35% increase in ore processed. Fig 1 Quarterly KPIs Item unit 4Q11 1Q12 2Q12 3Q12 4Q12 QoQ YoY Waste mt % 44% Mined mt % 55% Strip Ratio times % 7% Processed mt % 27% Tonnes Shipped FMG mt % 48% Tonnes Shipped others mt % 569% Total tonnes shipped mt % 53% Unit cost (RHS) US$/t % 14% Exchange US$/A$ % 5% Unit Cost A$/t % 9% Source: FMG, Macquarie Research, July 212 Total FY12 shipments of ~57.5mtpa were ahead of fullyear guidance of 55mtpa. FMG moved almost 35mt of material (ore and waste) in FY12, for 41% increased shipments at a 1% increased unit cost. Fig 2 Financial year KPIs Item unit FY11 FY12 YoY FY13G YoY Waste mt % Mined mt % Strip Ratio times % % Processed mt % Tonnes Shipped FMG mt % Tonnes Shipped others mt % Total tonnes shipped mt % 89 55% Unit cost (RHS) US$/t % 455 ~% Exchange US$/A$ Unit Cost A$/t % ~% Source: FMG, Macquarie Research, July supports increased FY13 guidance. 1H13 guidance is 38mt (~76mtpa), supported by commissioning the second Christmas Creek OPF and the second port inload circuit late in the half (Sep q guidance: 15mt or ~6mtpa). FMG targets a 95mtpa production rate by end 212. FY13 guidance is now 89mt (previous: 8mt); we model 8mt. Fig 3 Forecast rampup mtpa Source: FMG, Macquarie Research, July 212 Cloudbreak Christmas Creek BCI Solomon Ph 1 Macq rampup 18 July 212 2

3 Unit costs (in US$/wmt) declined ~12% to ~US$46/t from Mar q levels of US$53/t. Fig 4 Production and cost mt $/t Q11 1Q12 2Q12 3Q12 4Q12 Total tonnes shipped annualised Unit costs (US$/t, RHS) Unit costs (A$/t, RHS) Source: FMG, Macquarie Research, July 212 Underlying cost escalation. We note the decline in unit cost seems muted in light of the 42% production increase and declining strip ratio. We don t believe that costs are entirely variable and the small decline in unit costs vs other quarters with high quarterly shipments shows evidence of underlying cost escalation, in our view. Fig 5 Unit cost vs wmt shipped A$/w mt Q11 3Q12 1Q Q12 4Q w mt shipped Source: FMG, Macquarie Research, July 212 Stronger cash flow. FMG achieved US$125/dmt CIF China for the June q (Mar q: US$126/dmt), as average spot price for the quarter was broadly flat qoq. Management indicated that this represents a reduced discount as the proportion of lowergrade ore shipped increased qoq. We estimate the volume increase and steady price resulted in quarterly EBITDA of ~US$8m (vs ~US$5m in Mar q). Fig 6 Estimated EBITDA margin US$m 1, US$/w mt Q11 1Q12 2Q12 3Q12 4Q12 EBITDA iron ore US$m US$/dmt CIF (RHS) US$/w mt FOB Unit cost (RHS) US$/t Source: FMG, Macquarie Research, July July 212 3

4 Expansion progress, capex spend back end loaded Capex increases... FMG highlighted a US$.6bn increase in expansion capex to ~US$1.5bn, with US$4.8bn spent so far (all inclusive of mining fleet, exclusive of a fifth berth at Port Hedland, which is yet to be allocated). The bulk of the increase is due to Solomon processing capacity being more expensive than originally scoped by US$.5bn. No capex for the fifth berth is included; management estimates this at US$.2.3bn. We continue to model US$12bn to reach 155mtpa. Fig 7 Original vs revised budget US$m 3,5 3,2 3, 2,5 2,7 2,2 2,3 2,4 2,5 2, 1,5 1, 1,1 1, 5 Chichesters Solomon Rail Port Budget (orig) Budget (revised) Source: FMG, Macquarie Research, July 212 but expansion spend undershoots. Overall, FMG spent US$6.bn in FY12 (guidance: US$5.6bn). FMG had planned to spend US$4.7bn on the T155 expansion, but spent only $4bn of this. The sustaining and optimising capex of US$.8bn plus development capex of US$.1bn originally targeted grew to US$1.6bn. Management indicates that other includes dewatering capex and the Cloudbreak wet front end (planned to be commissioned in the Sep 12 q), as well as ~US$.4bn on studies and development (including Nyidinghu and Anketell). In addition, US$.4bn not originally included in FY12 guidance was spent on mining fleet. Fig 8 FMG capex actuals and guidance (US$bn) Item FY11A FY12G FY12A FY12 Var FY13G T55.39 T Fleet Sustaining *..45** Optimisation *. n/a Development *.3 n/a Other.37..4*.4.35 Total * Note: *Macquarie Estimates US$5/t Source: FMG, Macquarie Research, July 212 Increasing our FY13 forecast. FMG guided to US$6.2bn in FY13, consisting of US$4.2bn on the T155, US$1.2bn of fleet, ~US$.5bn sustaining capital and ~US$.3bn other. We had modelled US$5.3bn, due to a longer T155 build phase (we had modelled US$1.3bn in FY14 vs FMG guidance US$.4bn) and lower sustaining and other capex. Funding position less robust as capex increases. At end June, FMG reported cash of US$2.3bn and undrawn facilities of US$1.9bn (FMG had drawn US$.1bn of revolving credit facility and US$.1bn of its US$1.5bn lease facility). More capex required (US$.6bn), a tighter schedule (~$.9bn more in FY13 than we had previously modelled) and less expansion capex already spent (~$.7bn less than FY12 guidance) means that funding is considerably tighter than we had modelled previously. We believe FMG may require an additional US$12bn depending on iron ore prices over the next 12 months. 18 July 212 4

5 Fig 9 Cash flow forecast US$m H13 2H13 1H14 2H14 1H15 2H15 Investing cash flow Operating cash flow Funding rqd MGL price $14/dmt $13/dmt $12/dmt Note: Macquarie capex (US$12bn) and rampup profile; funding requirement depends on timing of investments. Source: FMG, Macquarie Research, July 212 FMG is currently reviewing additional funding sources management anticipates raising a further US$1bn debt. Debt covenants tight under a bearish scenario. The current unsecured debt (US$7.4bn) has conditionality that beyond US$6.4bn, further unsecured debt is permitted, subject to a minimum consolidated Fixed Charge Coverage Ratio of 2.5:1 (on a twelvemonth trailing basis). In the event that and iron ore prices go to US$12/dmt CIF China from here and stay there and FMG seeks to raise US$1.5bn, we estimate this ratio to be just below 2.5, potentially limiting FMG s ability to raise unsecured debt. Commitments increase again. Capital commitments for the expansion to 155mtpa increased ~15% to US$7.6bn (Mar q: US$6.5bn), 84% of the revised budget. Fig 1 Committed capex vs revised budget US$m 3,5 3, 2,5 2, 1,5 1, 7 7 1, 8 3,2 2,9 2,5 2, 2,3 1,8 1,5 1,3 2,5 2,1 1,9 1,6 5 Chichesters Solomon Rail Port Dec Q 11 Mar Q 12 Jun Q 12 Budget (revised) Source: FMG, Macquarie Research, July July 212 5

6 Market outlook moving (temporarily) away from the Cast Iron scenario? Iron ore headwinds gather. We believe iron ore remains a strong play on physical Chinese market conditions, which after a seasonal improvement in March and April have conspicuously deteriorated into May and June. With our expectation that Chinese steel output will drop into July and August, we believe there is a lack of nearterm catalysts that can lead prices to break out of the $1315/t range. While we believe there is potential for upside beyond this range later in the year, this will require a broader Chinese recovery that incorporates construction and machinery volume improvements. Scenarios Chinese demand growth and seaborne supply additions are key uncertainties driving iron ore price over the medium term see 25 May Essentials Ironed Out? Depending on how these turn out, we had identified four scenarios: Cast Iron future (continued demand growth, delayed supply), Iron Man (subdued demand but delayed supply), Pig Iron (demand continues to grow but there is a rapid supply response) and Ironed Out (demand destruction, supply growth). Fig 11 Iron ore scenarios Iron ore scenarios Chinese demand Grow Pig Iron Cast Iron Future Catch up Seaborne Supply Fall behind Ironed Out Iron Man Competition Contract Source: Macquarie Research, July 212, after C Sunter and C Illbury and flags. We believe flags for demand going from growth to shrinkage are a Chinese steel production going ex growth or declining. On the supply side, the call on Chinese domestic iron ore supply is a key flag in the short term. Both flags have recently been moving away from Cast Iron. Fig 12 Iron ore flags Chinese domestic mine operating rates Chinese steel demand Source: SMM, NBS, Macquarie Research, July 212 FMG best positioned in the Cast Iron scenario. In a Cast Iron scenario, with continued Chinese demand growth and delays in new supply, prices can be expected to firm as supply remains tight. Those with significant current production and nearterm expansions are best positioned and we believe best candidates for a rerating. This scenario favours FMG as it has both these attributes. Different horses for the Iron Man scenario. In the Iron Man scenario, producers with capex behind them, ungeared balance sheets and competitive cost structure are likely to outperform. FMG s balance sheet seems to be moving in the opposite direction. 18 July 212 6

7 211a 212e 213e 214e 215e Chichesters Solomon Corporate & Exploration Net Debt Total 211a 212e 213e 214e 215e 211a 212e 213e 214e 215e 211a 212e 213e 214e 215e Macquarie Private Wealth Financial forecast DCF adjusted marginally downwards. We model increased sustaining capital in FY13 and FY14 and beyond (increase of US$1m and US$35m, respectively, in FY13 and FY14, A$.49ps DCF impact). We have also rolled forward our DCF half a year (which has added A$.38ps). The net impact is to reduce DCF to A$7.58ps from A$7.71ps. Fig 13 Financial forecast (FMG.ASX) Year ending 3 June 7.6 Profit & Loss 211a 212e 213e 214e 215e Total revenue US$m 5,442 6,795 1,84 17,8 19,381 Iron ore FOB US$m 5,36 6,227 1,119 15,87 17,951 CIF component / shipping US$m ,138 1,43 Total cash costs US$m 2,677 3,82 5,535 8,394 9,86 State royalties US$m ,19 1,346 Production US$m 1,879 2,83 4,89 5,988 7,18 CIF component / shipping US$m ,216 1,495 EBITDA US$m 2,765 2,994 5,269 8,614 9,521 Depreciation US$m ,236 Underlying EBIT US$m 2,588 2,716 4,735 7,667 8,285 Abnormal items US$m Reported EBIT US$m 2,484 2,732 4,675 7,397 7,989 Net interest US$m 1, , Pretax profit US$m 1,335 2,95 3,694 6,26 7,1 Income tax expense US$m ,57 1,88 2,45 Reported profit US$m 1,23 1,473 2,621 4,377 4,935 Abnormal items US$m Adjusted profit US$m 1,38 1,434 2,634 4,599 5,183 EPS adjusted Uscps EPS adjusted Acps EPS growth % 31.5% 32.8% 74.8% 75.8% 13.6% DPS (ex preference share) Acps Payout ratio % 2% 18% 18% 17% 71% Average diluted shares m 3,122 3,122 3,122 3,122 3,123 Cashflow 211a 212e 213e 214e 215e Net cash inflow from operating activities US$m 2,778 2,823 5,269 8,614 9,521 Net interest US$m , Tax paid US$m ,687 1,927 Other US$m Net operating cashflow US$m 2,336 2,284 2,684 4,642 6,312 Development Capex US$m 1,136 4,923 5, SIB Capex US$m Exploration & development US$m Proceeds from sale of PP&E US$m 1 35 Net cashflow from investing US$m 1,684 5,971 6,21 1, Debt drawdown/(repayment) US$m 631 3,595 2, ,784 Dividends paid (includes preference shares US$m ,947 Share capital US$m Net financing cashflow US$m 537 3,326 2, ,731 Net cashflow US$m 1, , Free cashflow US$m 652 3,687 3,518 3,121 5,335 FCFPS Acps Balance sheet 211a 212e 213e 214e 215e Cash US$m 2,663 2,33 1,336 3,684 3,288 Other current assets US$m ,817 2,392 2,642 P,P & E US$m 4,951 1,269 15,782 16,197 15,776 Other noncurrent assets US$m Total assets US$m 8,626 14,1 19,599 23,95 22,691 Current liabilities US$m 1,118 1,568 1,788 1,46 1,555 Total liabilities US$m 6,192 1,441 13,576 13,322 9,929 Shareholder equity US$m 2,434 3,658 6,23 9,773 12,761 Total debt US$m 4,855 8,596 11,436 11,559 7,893 Net debt US$m 2,192 6,266 1,1 7,875 4,65 Sales & Key Assumptions 211a 212e 213e 214e 215e Chichesters mt Solomon mt Total sales mt Fines t CIF China Fines (Chichesters) US$/wmt Fines (Solomon) US$/wmt Cash costs excl royalties (blended) US$/wmt Cash costs excl royalties (Chichesters) US$/wmt Cash costs excl royalties (Solomon) US$/wmt A$/US$ exchange rate US$/A$ Share price: $4.54 ps blank values Net Present Value US$m US$ps A$ps spot values Chichesters 16, Chicheste. 6.5 Solomon 7, Solomontimes Key Ratios G & A 1, Corporate Glacier Valley Net Debt Exploration tenements Total Deferred tax assets Net debt (adjusted for Leucadia note) 5, FMG NPV 18, Long term AUD/USD to convert NPV ST AUD/USD Premium to NPV 4% Key investment ratios 211a 212e 213e 214e 215e Adjusted PER x GCFPS A$c (RHS) PGCF x EV / EBITDA (fwd) x EV / EBITDA (today's debt) x USc/mtu mt $m 1, 9, 8, 7, 6, 5, 4, 3, 2, 1, A$ps Fines 6 74 A$:US$ Solomon Chichesters Cash costs excl royalties (Solomon) Cash costs excl royalties (Chichesters) US$/wmt EBITDA US$m EPS adjusted Acps 2.9 NPV Components Adjusted PER x EV / EBITDA (fwd) x US$/t Acps Adjusted profit US$m cps PGCF x GCFPS A$c Source: Macquarie Research, July July 212 7

8 Important disclosures: Recommendation definitions Macquarie Australia/New Zealand Outperform return >3% in excess of benchmark return Neutral return within 3% of benchmark return Underperform return >3% below benchmark return Benchmark return is determined by long term nominal GDP growth plus 12 month forward market dividend yield Macquarie Asia/Europe Outperform expected return >+1% Neutral expected return from 1% to +1% Underperform expected return <1% Macquarie First South South Africa Outperform expected return >+1% Neutral expected return from 1% to +1% Underperform expected return <1% Macquarie Canada Outperform return >5% in excess of benchmark return Neutral return within 5% of benchmark return Underperform return >5% below benchmark return Macquarie USA Outperform (Buy) return >5% in excess of Russell 3 index return Neutral (Hold) return within 5% of Russell 3 index return Underperform (Sell) return >5% below Russell 3 index return Volatility index definition* This is calculated from the volatility of historical price movements. Very high highest risk Stock should be expected to move up or down 6 1% in a year investors should be aware this stock is highly speculative. High stock should be expected to move up or down at least 4 6% in a year investors should be aware this stock could be speculative. Medium stock should be expected to move up or down at least 3 4% in a year. Low medium stock should be expected to move up or down at least 25 3% in a year. Low stock should be expected to move up or down at least 15 25% in a year. * Applicable to Australian/NZ/Canada stocks only Recommendations 12 months Note: Quant recommendations may differ from Fundamental Analyst recommendations Financial definitions All "Adjusted" data items have had the following adjustments made: Added back: goodwill amortisation, provision for catastrophe reserves, IFRS derivatives & hedging, IFRS impairments & IFRS interest expense Excluded: non recurring items, asset revals, property revals, appraisal value uplift, preference dividends & minority interests EPS = adjusted net profit / efpowa* ROA = adjusted ebit / average total assets ROA Banks/Insurance = adjusted net profit /average total assets ROE = adjusted net profit / average shareholders funds Gross cashflow = adjusted net profit + depreciation *equivalent fully paid ordinary weighted average number of shares All Reported numbers for Australian/NZ listed stocks are modelled under IFRS (International Financial Reporting Standards). Recommendation proportions For quarter ending 3 June 212 AU/NZ Asia RSA USA CA EUR Outperform 55.67% 61.% 53.43% 42.58% 69.23% 46.6% (for US coverage by MCUSA, 9.5% of stocks followed are investment banking clients) Neutral 3.5% 22.11% 36.99% 52.41% 28.2% 33.69% (for US coverage by MCUSA, 8.14% of stocks followed are investment banking clients) Underperform 13.83% 16.89% 9.59% 5.1% 2.75% 19.71% (for US coverage by MCUSA,.45% of stocks covered are investment banking clients) Company Specific Disclosures: Macquarie Bank Limited makes a market in the securities in respect of Limited. Important disclosure information regarding the subject companies covered in this report is available at Analyst Certification: The views expressed in this research reflect the personal views of the analyst(s) about the subject securities or issuers and no part of the compensation of the analyst(s) was, is, or will be directly or indirectly related to the inclusion of specific recommendations or views in this research. The analyst principally responsible for the preparation of this research receives compensation based on overall revenues of Macquarie Group Ltd (ABN , AFSL No ) ( MGL ) and its related entities (the Macquarie Group ) and has taken reasonable care to achieve and maintain independence and objectivity in making any recommendations. General Disclosure: This research has been issued by Macquarie Securities (Australia) Limited (ABN , AFSL No ) a Participant of the Australian Securities Exchange (ASX) and ChiX Australia Pty Limited. This research is distributed in Australia by Macquarie Equities Limited (ABN , AFSL No ) ("MEL"), a Participant of the ASX, and in New Zealand by Macquarie Equities New Zealand Limited ( MENZ ) an NZX Firm. Macquarie Private Wealth s services in New Zealand are provided by MENZ. Macquarie Bank Limited (ABN , AFSL No ) ( MBL ) is a company incorporated in Australia and authorised under the Banking Act 1959 (Australia) to conduct banking business in Australia. None of MBL, MGL or MENZ is registered as a bank in New Zealand by the Reserve Bank of New Zealand under the Reserve Bank of New Zealand Act Any MGL subsidiary noted in this research, apart from MBL, is not an authorised deposittaking institution for the purposes of the Banking Act 1959 (Australia) and that subsidiary s obligations do not represent deposits or other liabilities of MBL. MBL does not guarantee or otherwise provide assurance in respect of the obligations of that subsidiary, unless noted otherwise. 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The Macquarie Group, its officers and employees may have conflicting roles in the financial products referred to in this research and, as such, may effect transactions which are not consistent with the recommendations (if any) in this research. The Macquarie Group may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case. The Macquarie Group s employees or officers may provide oral or written opinions to its clients which are contrary to the opinions expressed in this research. Important disclosure information regarding the subject companies covered in this report is available at 18 July 212 8