Fortescue Metals Group (FMG)

Transcription

1 30 October 2015 Analyst David Coates Authorisation John Hester Recommendation Buy (Hold) Price $2.09 Target (12 months) $2.40 (unchanged) Expected Return Capital growth 14.8% Dividend yield 1.9% Total expected return 16.7% Company Data & Ratios Enterprise value Market cap $15,869m $6,570m Issued capital 3,114m Free float 52% Avg. daily val. (52wk) $67.3m 12 month price range $1.58-$3.50 GICS sector Price Performance Materials (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) Fortescue Metals Group (FMG) Fighting fit: ready for a bout with the iron ore price Site visit covers the bases FMG this week hosted an analyst and investor site visit to its Port Hedland, Solomon Hub and Christmas Creek operations. At Port Hedland the tour covered rail and shipping activities and infrastructure at the Herb Elliott Port. At the Solomon Hub the focus was on mining and ore processing at the Kings and Firetail operations where we saw the fully autonomous truck haulage fleet in action at the Kings mine. At Christmas Creek we visited the CC1 mining operations where the more expensive Surface Miner fleet is being superseded by truck and excavator fleets. We also toured Ore Processing Facilities 1 and 2 where performance improvements are key to enabling lower strip ratios at the mines, driving material cost savings. Cost out on target, ready for a fight We came away from the visit impressed with the assets, the people and their professionalism. In our view these factors will see the cost reduction outperformance achieved in 1QFY16 continue over the balance of FY16. However, FMG still has to contend with the iron ore price and we believe the company is well positioned to meet the challenges of a lower price environment. To test FMG s lower costs, we flex our model with flat US$45/t iron ore prices and find that while earnings are heavily cut and include some years of loss, this is largely due to depreciation charges, implying that write-downs would be required. Free cash flows however remain strong. We estimate ~US$4.4 billion generated to the start of FY19, sufficient to service debt and repay the bulk of the US$5.7 billion due in CY2019, with the balance likely rolled over. Investment thesis Buy (from Hold), TP$2.40 (unchanged) We make no changes to our formal earnings forecasts and valuation following the site visit. Company guidance also remains unchanged. We are however increasingly confident in FMG s assets and management. As a result we are of the view that while the near-term outlook for the iron ore price is shaky, FMG is well placed to weather a long-term, low-price environment should it eventuate. We upgrade to a Buy rating. Absolute Price $7.0 $6.0 $5.0 $4.0 $3.0 $2.0 $1.0 $0.0 Oct 13 SOURCE: IRESS Jan Apr Jul Oct FMG Jan Apr Jul S&P 300 Rebased Earnings Forecast Year end 30 June 2015a 2016e 2017e 2018e Sales (A$m) 8,574 7,140 7,673 8,143 EBITDA (A$m) 2,454 2,569 2,878 2,586 NPAT (adjusted) (A$m) EPS (adjusted) ( ps) EPS growth (%) -88% 88% 55% -16% PER (x) FCF Yield (%) EV/EBITDA (x) Dividend ( ps) Yield (%) 2% 2% 3% 5% Franking (%) 100% 100% 100% 100% ROE (%) 4% 7% 10% 8% SECURITIES ESTIMATES BELL POTTER SECURITIES LIMITED ACN AFSL DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 10 THAT FORM PART OF IT. Page 1

2 FMG site visit: fighting fit We came away from the visit impressed with the assets, the people and their professionalism. In our view these factors will see the cost reduction outperformance achieved in 1QFY16 continue over the balance of FY16. However, FMG still has to contend with the iron ore price and we believe the company is well positioned to meet the challenges of a lower price environment. To test FMG s lower costs, we flex our model with flat US$45/t iron ore prices over the lifeof-mine and C1 cash costs of US$15-US$16/t. We make allowances for an increased sustaining capital spend of A$5.00/t (up from our assumption of A$2.50/t currently) from FY19 and use AUD:USD of We find that while earnings are heavily cut and include some years of loss, this is largely due to depreciation charges, implying that write-downs would be required in a sustained low price environment. Free cash flows however remain strong. We estimate ~US$4.4 billion generated to the start of FY19, sufficient to service debt and repay the bulk of the US$5.7 billion due in CY2019, with the balance likely rolled over. This is a bearish case that we would not expect to endure over the life of the FMG assets, but it gives us confidence that FMG s operating and cost performance has placed them in a strong position to cope with such a scenario. Rail and port This week s investor site visit to FMG s Port Hedland, Solomon Hub and Christmas Creek operations covered the key aspects of their operations. At Port Hedland the tour covered rail and shipping activities and infrastructure at the Herb Elliott Port. Cost improvement opportunities here remain the ongoing optimisation of the three train unloaders (TUL s), reduction of cycle times and improving overall utilisation. Capacity of up to 185Mtpa is available across the three TUL s. Optimisations to date include increasing rail car axle loadings and load weight distribution. Combined with re-canting parts of the rail network, this has enabled FMG to achieve the world s heaviest haul of a 140t payload per car, average speed from mine to port of ~65km/h and estimated costs of 0.6c/tkm. Figure 1 Train Unloader in action at Herb Elliott Port On the shipping front, the larger capacity VLOC ships are due for delivery from November These will maximise FMG s tidal shipping capacity at Port Hedland. Increased capacity ships (260kt up from average 200kt) and more efficient loading capability will Page 2

3 enable sailing on every second tide. Funding will be off balance sheet but payment via shipping rates will still be cheaper than current costs. Figure 2 Shiploader at port. VLOC s will have fewer hatches, enabling faster loading Solomon Hub and Christmas Creek mining At the Solomon Hub the focus was on mining and ore processing at the Kings and Firetail operations. At the Kings mine we saw the fully autonomous truck haulage fleet (AHS) in action. Figure 3 The wide open spaces of the Kings Mine are ideal for autonomous trucks To date FMG has achieved efficiency gains of 13% over their manned trucking fleet. In capital terms this implies that 13 fewer trucks need to be purchased for every 100 trucks otherwise required. At $4.5m each, that equates to a $58.5m capital saving before operating and maintenance costs are considered. At Christmas Creek we visited the CC1 mining operations where the more expensive Surface Miner fleet is being superseded by truck and excavator fleets. Initially, doubling of productivity enabled the number of Surface Miners to be reduced from 26 machines to 13 machines. Now, as cut-off grades are being reduced and less selective mining is required, truck and excavator fleets will account for ~80% of the mining at these operations. Truck and excavator methods are $1.40/t cheaper than the Surface Miners. Page 3

4 Figure 4 The fleet of active Surface Miners at CC1 has been reduced from 26 to 4 Christmas Creek Ore Processing Facilities (OPFs) We also toured Ore Processing Facilities 1 and 2 where performance improvements are key to enabling lower strip ratios at the mines, driving material cost savings. The key to lower cut-off-grades at the mining operations is not only the ability to upgrade the Fe grade of the final product through the OPFs but also reduction of the impurities silica and alumina as these penalty minerals also drive mine cut-offs. OPF upgrade performance can be optimised at all points in the circuit and this ranges from trialling various fluid densities, feed pressures and stream cuts in the cyclones to achieving fine control of material flows through the circuit to achieve plant stability a key in any processing plant. On the cost side, reducing maintenance costs through ensuring fit-for-purpose equipment and consumables to maximise wear and shutdown intervals, as well as improved planning for more efficient shuts are all contributing to lower costs. Combined, FMG is achieving the same spec product, for the same costs, from lower quality feed. Figure 5 Cloudbreak grade-tonnage curve showing OPF upgrade impacts SOURCE: COMPANY REPORTS Page 4

5 This enables the lowering of the cut-off-grades in the pits. Due to the flat grade-tonnage curves of the deposits, this in turn results in significantly reduced strip ratios and total material movements. Figure 6 Illustrative pit cross-section showing mining inventory additions SOURCE: COMPANY REPORTS Mining costs represent >60% of C1 costs for FMG and hence are the focus of cost reduction efforts. But these operations are a fully integrated supply chain and the role of the OPFs strongly illustrates that. Figure 7 OPF2 at the Christmas Creek Operations Page 5

6 And finally, what trip to mine site is complete without a big yellow truck? This Komatsu 930E is one of the biggest you ll find anywhere and didn t everyone love it. With a 300t payload and weighing in at a hefty 540t fully loaded, it makes for some of the lowest cost dirt moving in the industry. Teamed with a Liebherr 9800 (800t class excavator) which can load this sucker in three passes, you can move a lot of dirt in not a lot of time. FMG has nine of these running around shifting the overburden at Christmas Creek. Figure 8 Big yellow truck = kids in a candy store Page 6

7 Fortescue Metals Group Ltd (FMG) Company description: Iron ore major in the Pilbara, WA FMG is an independent iron ore producer in the Pilbara region of Western Australia. The company recently reached its targeted Mtpa production rate, following several years of expansion. There is potential for expansions beyond Mtpa rates, through optimising existing assets. The company s prime focus however has shifted to reducing its debt and achieving gearing levels of ~40%. Investment thesis Buy (from Hold), TP$2.40 (unchanged) We make no changes to our formal earnings forecasts and valuation following the site visit. Company guidance also remains unchanged. We are however increasingly confident in FMG s assets and management. As a result we are of the view that while the near-term outlook for the iron ore price is shaky, FMG is well placed to weather a long-term, low-price environment should it eventuate. We upgrade to a Buy rating. Valuation Our FMG valuation incorporates DCF models of FMG s Chichester and Solomon production hubs, a multiple valuation estimate of the Nyidinghu deposit, an estimate of exploration/expansion upside and an estimate of corporate overhead costs. Risks Risks to resources sector equities include, but are not limited to: - Commodity price and exchange rate fluctuations. The future earnings and valuations of exploration, development and operating resources companies are subject to fluctuations in underlying commodity prices and foreign currency exchange rates. - Infrastructure access. Bulk commodity producers are particularly reliant upon access to transport infrastructure. Access to infrastructure is often subject to contractual agreements, permits, and capacity allocations. Agreements are typically long-term in nature (+10 years). Infrastructure can be subject to outages as a result of weather events or the actions of third party providers. - Operating and capital cost fluctuations. Markets for exploration, development and mining inputs can fluctuate widely and cause significant differences between planned and actual operating and capital costs. Key operating costs are linked to energy and labour costs. - Resource growth and mine life extensions. Future earnings forecasts and valuations may rely upon resource and reserve growth to extend mine lives. - Sovereign risks. Mining companies assets can be located in countries other than Australia and are subject to the sovereign risks of that country. - Regulatory changes risks. Changes to the regulation of infrastructure and taxation (among other things) can impact the earnings and valuation of mining companies. - Operating and development risks. Mining companies assets are subject to risks associated with their operation and development. Risks for each company can be heightened depending on method of operation (e.g. underground versus open pit mining) or whether it is a single operation company. Development assets can be Page 7

8 subject to approvals timelines or weather events, causing delays to commissioning and commercial production. - Funding and capital management risks. Funding and capital management risks can include access to debt and equity finance, maintaining covenants on debt finance, managing dividend payments, and managing debt repayments. - Corporate/M&A risks. Risks associated with M&A activity including differences between the entity s and the market s perception of value associated with completed transactions. Page 8

9 Fortescue Metals Group as at 30 October 2015 Recommendation Buy Price $2.09 Target (12 months) $2.40 Fortescue Metals Group (FMG) 30 October 2015 Table 1 - Financial summary PROFIT AND LOSS FINANCIAL RATIOS Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e Revenue US$m 11,753 8,574 7,140 7,673 8,143 VALUATION Expense US$m (6,117) (6,120) (4,571) (4,795) (5,556) NPAT (adjusted) US$m 2, EBITDA US$m 5,636 2,454 2,569 2,878 2,586 Adjusted EPS USc/sh Depreciation US$m (1,003) (1,405) (1,371) (1,286) (1,286) EPS growth % -88% 88% 55% -16% EBIT US$m 4,633 1,049 1,198 1,593 1,301 Adjusted EPS Ac/sh Net interest expense US$m (720) (629) (315) (241) (175) EPS growth % -87% 117% 61% -18% PBT US$m 3, ,352 1,126 PER x 2.2x 17.4x 8.0x 5.0x 6.1x Tax expense US$m (1,173) (104) (287) (429) (355) DPS Ac/sh NPAT (reported) US$m 2, Franking % 100% 100% 100% 100% 100% Abnormal items US$m Yield % 9% 2% 2% 3% 5% NPAT (adjusted) US$m 2, FCF/share USc/sh FCF/share Ac/sh PROFIT AND LOSS (INTERIM) FCF yield % 67% 13% 33% 24% 38% Half year ending Unit Dec-14a Jun-15a Dec-15e Jun-16e Dec-16e EV/EBITDA x 2.5x 5.7x 5.4x 4.9x 5.4x Revenue US$m 4,935 3,639 3,508 3,631 3,726 EBITDA margin % 48% 29% 36% 38% 32% Expense US$m (3,495) (2,625) (2,317) (2,253) (2,405) EBIT margin % 39% 12% 17% 21% 16% EBITDA US$m 1,440 1,014 1,191 1,378 1,321 Return on assets % 12% 1% 3% 4% 4% Depreciation US$m (694) (711) (687) (684) (648) Return on equity % 37% 4% 7% 10% 8% EBIT US$m LIQUIDITY & LEVERAGE Net interest expense US$m (306) (323) (161) (154) (135) Net debt (cash) $m 7,159 7,188 5,718 4,709 3,033 PBT US$m 440 (20) ND / E % 94% 95% 71% 53% 32% Tax expense US$m (109) 5 (110) (177) (173) ND / (ND + E) % 49% 49% 42% 35% 24% NPAT (reported) US$m 331 (15) ND / EBITDA x 1.3x 2.9x 2.2x 1.6x 1.2x Abnormal items US$m EBITDA/Interest x NPAT (adjusted) US$m 331 (15) ASSUMPTIONS - Prices CASH FLOW Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e Iron ore (Fines) 62% Fe US$/dmt OPERATING CASHFLOW AUD/USD US$/A$ Receipts US$m 12,618 8,537 6,913 7,115 8,138 Long term (real) assumptions: IO (fines) 62% US$85/t, AUS/USD US$0.85/A$ Payments US$m (6,220) (5,971) (4,408) (4,979) (5,432) Tax US$m (150) (529) (287) (429) (355) ASSUMPTIONS - Production Net interest US$m (853) (605) (315) (241) (175) Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e Other US$m Sales (FMG equity) Mwt Operating cash flow US$m 5,395 1,432 1,902 1,465 2,177 Third party Mwt INVESTING CASHFLOW Sales (total) Mwt Capex & exploration US$m (1,995) (849) (351) (378) (378) 62% Fe index price US$/dt Other US$m FMG realised price CFR US$/dt Investing cash flow US$m (1,392) (726) (351) (378) (378) Realised price discount % -14% -18% -15% -17% -15% FINANCING CASHFLOW Costs C1 (excl. royalty) US$/wt Net equity proceeds US$m Shipping US$/wt Debt proceeds US$m - 2, Royalties US$/wt Debt repayments US$m (3,092) (2,367) (539) (764) (260) Other US$/wt Dividends US$m (581) (343) (81) (78) (122) Cost of sales US$/wt Other US$m (99) (126) Interest US$/wt Financing cash flow US$m (3,772) (630) (620) (842) (382) Capex (sustaining from FY15) US$/wt Change in cash US$m ,416 Total all-in cost US$/wt Total all-in cost (@ 8% moist) US$/dt BALANCE SHEET Total all-in cost (62% Fe equiv) US$/dt Year ending 30 Jun Unit 2014a 2015a 2016e 2017e 2018e ASSETS VALUATION Cash & short term investments US$m 2,398 2,381 3,312 3,557 4,973 Issued capital Accounts receivable US$m Shares on issue m 3,114 Inventory US$m 1, Options (in the money) m 11 Property, plant & equipment US$m 13,363 12,979 11,959 11,051 10,144 Total m 3,125 Exploration & evaluation US$m 4,705 4,750 4,750 4,750 4,750 Jun-16 Jun-17 Jun-18 Other US$m Sum of parts valuation A$m $/sh A$m $/sh A$m $/sh Total assets US$m 22,694 21,360 21,198 20,593 21,106 Iron ore operations (DCF) 17, , , LIABILITIES Exploration (estimate) Accounts payable US$m 1, Corporate (DCF) (1,125) (0.36) (1,109) (0.35) (1,072) (0.34) Borrowings US$m 9,557 9,569 9,030 8,266 8,006 Total enterprise value 16, , , Other US$m 4,216 3,515 3,215 2,715 2,715 Total liabilities US$m 15,111 13,823 13,146 11,697 11,562 Net debt/(cash) 9, , , SHAREHOLDER'S EQUITY Equity value 7, , , Share capital US$m 1,289 1,294 1,294 1,294 1,294 Reserves US$m MAJOR SHAREHOLDERS Retained earnings US$m 6,211 6,184 6,698 7,543 8,192 Minderoo Group Pty Ltd 33% Non-controlling interest US$m Hunan Valin Iron & Steel Group 15% Total equity US$m 7,583 7,537 8,051 8,896 9,545 Other 52% Net debt US$m 7,159 7,188 5,718 4,709 3,033 Weighted average shares m 3,114 3,114 3,114 3,114 3,114 SECURITIES ESTIMATES Page 9

10 Recommendation structure Buy: Expect >15% total return on a 12 month view. For stocks regarded as Speculative a return of >30% is expected. Research Team Staff Member TS Lim Sam Haddad John O Shea Title/Sector Head of Research Phone tslim shaddad joshea Hold: Expect total return between -5% Chris Savage csavage and 15% on a 12 month view Jonathan Snape jsnape Sell: Expect <-5% total return on a 12 month view Sam Byrnes John Hester Tanushree Jain Healthcare Healthcare/Biotech sbyrnes jhester tnjain Speculative Investments are either start-up enterprises with nil or only prospective operations or recently commenced operations with only forecast cash flows, or companies that have commenced operations or have been in operation for some time but have only forecast cash flows and/or a stressed balance sheet. Such investments may carry an Financials TS Lim Lafitani Sotiriou Resources Peter Arden David Coates Associates Hamish Murray Tim Piper Banks/Regionals Diversified Resources Resources Associate Analyst Associate Analyst tslim lsotiriou parden dcoates hmurray tpiper exceptionally high level of capital risk and volatility of returns. Bell Potter Securities Limited ACN Level 38, Aurora Place 88 Phillip Street, Sydney 2000 Telephone The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. In the USA and the UK this research is only for institutional investors. It is not for release, publication or distribution in whole or in part to any persons in the two specified countries. In Hong Kong this research is being distributed by Bell Potter Securities (HK) Limited which is licensed and regulated by the Securities and Futures Commission, Hong Kong. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arraignment with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Securities Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. ANALYST CERTIFICATION Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers and were prepared in an independent manner and (2) no part of his or her compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by that research analyst in the research report. Page 10