Vol m Mining Australia Equity research October 30, 2015 HOLD (no change) Current price: Target price: Previous target: A$2.20 A$2.16 A$2.16 Up/downside: -1.8% Reuters: Bloomberg: Market cap: Average daily turnover: FMG.AX FMG AU US$4,854m A$6,850m US$38.29m A$53.13m Current shares o/s 3,114m Free float: 66.8% Key changes in this note 3.90 3.40 2.90 2.40 1.90 1.40 100 80 60 40 20 Sprint capacity to 180Mtpa could be achieved in the medium term Our outlook on sustained low costs is achievable in the medium term Price Close Relative to S&P/ASX 200 (RHS) Oct-14 Jan-15 May-15 Aug-15 Source: Bloomberg Price performance 1M 3M 12M Absolute (%) 31.7 17.0-36.2 Relative (%) 24.6 23.4-32.9 James WILSON T (61) 8 6160 8707 E james.wilson@morgans.com.au Adrian PRENDERGAST T (61) 3 9947 4134 E adrian.prendergast@morgans.com.au 106.0 92.0 78.0 64.0 50.0 36.0 Fortescue Metals Group Site visit affirms a positive FY16 view We attended the visit to FMG s Christmas Creek and Solomon operations this week. It became clear that the reduction in costs is becoming real and sustainable in the medium term thanks to innovative low cost business optimizations and the addition of driverless truck technology. We came away with a positive view and we expect further enhancements to production costs during FY16. The pinch-point remains in the ore processing facilities and further optimization work hopes to improve the product yield and as well as an increase in output to achieve sprint capacity to +180Mtpa. Optimizations across the board It s clear that management are driving innovation and optimization processes across the business. From the mine to rail and processing there are continual operational improvement programs. TV screens at each mine show live production versus forecast targets. It s a shift in mindset that operations need to be leaner. Innovation in a low iron ore price environment FMG is following in the footsteps of its peers with automation. A fleet of 41 driverless trucks at Solomon has increased efficiency by 13% according to management. Further roll outs are scheduled and FMG hasn t ruled out driverless trains down the track with the current infrastructure already set up to support driverless technology. Just add water and jiggle it, just a little bit A key area of focus was the Christmas Creek operations where FMG has lowered the cut-off grade to increase throughput in the Ore Processing Facilities (OPF). The process is still being optimized, but the use of cyclones and a jig plant increases yield on the lower grade material whilst upgrading product quality. It s a process that s basically adding more water to lower the product density to improve recoveries and shaking the material on the jig plant to remove additional silica and upgrade product quality. Simple and innovative techniques continue to provide low cost value upgrades to production. Sprint capacity to 180Mtpa, but the focus is on efficiency FMG has infrastructure in place to support a sprint capacity. Port infrastructure can handle up to 205Mtpa and rail could handle sprint capacity up to 180Mtpa with minor improvements to infrastructure. The pinch-point is the ore processing facilities and the significant advances in processing optimization initiatives suggests to us that once this is refined, management will start looking at expansion beyond 165Mtpa. Investment view are we there yet, almost? FMG s share price has held up reasonably well despite ongoing depressed sector fundamentals leaving FMG close to fair value versus our $2.16ps target price. We are more confident of lower sustainable operating costs but note that FMG is still in the process of improving business efficiencies. We came away impressed with the business strategy and see further improvements in FY16 as well as the potential to upgrade output via sprint capacity. The largest risk to our Hold call remains the potential for protracted weakness in commodity prices. Financial Summary Jun-13A Jun-14A Jun-15A Jun-16F Jun-17F Revenue (US$m) 5,711 11,753 8,574 7,513 7,151 Operating EBITDA (US$m) 867 4,877 1,147 2,702 2,269 Net Profit (US$m) -664 3,913 316 552 281 Normalised EPS (US$) -0.26 1.26 0.10 0.18 0.09 Normalised EPS Growth (156%) NA (92%) 75% (49%) FD Normalised P/E (x) NA 1.24 15.36 8.79 17.25 DPS (US$) 0.100 0.100 0.022 0.043 0.044 Dividend Yield 6.41% 6.41% 1.39% 2.74% 2.79% EV/EBITDA (x) 17.76 2.47 10.51 3.59 3.76 P/FCFE (x) NA 1.77 NA 4.13 4.88 Net Gearing 199% 95% 95% 61% 45% P/BV (x) 0.92 0.64 0.65 0.61 0.60 ROE (17.9%) 60.9% 4.2% 7.1% 3.5% Normalised EPS/consensus EPS (x) 1.67 1.53, COMPANY REPORTS IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN 49 010 669 726) AFSL 235410 - A PARTICIPANT OF ASX GROUP 1 Powered by EFA
FMG Financial Data Capital profile Key financials - June y/e 2014A 2015F 2016F 2017F Number of shares (m) 3,114 NPAT Reported (US$m) 2,740 316 552 281 Market capitalisation (A$m) 6,757 NPAT Normalised (US$m) 3,913 316 552 281 Enterprise value (A$m) 11,995 EPS (US ) 125.7 10.1 17.7 9.0 Enterprise value (US$m) 8,877 FCFPS (US ) 141.0 21.3 37.7 41.6 DPS (US ) 10.0 2.2 4.3 4.4 Valuation A$m A$ps Chichester 7,444 2.39 Solomon 4,435 1.42 Western Hub 0 0.00 Nullagine 37 0.01 Total Operations 11,916 3.83 Corporate (912) (0.29) Assumptions and margins 2014A 2015F 2016F 2017F Cash 3,562 1.14 AUD/USD 0.92 0.82 0.71 0.73 Debt (8,800) (2.83) IO fines (US$/dmt) 62% Fe, CFR China 123 68 56 53 Other 0 0.00 Realised price - 58% Fe, CFR China, 9% 99 51 47 44 Other Resources 963 0.31 FMG Freight - Hedland - Qingdao 10 7 8 10 Total Valuation 6,729 2.16 Iron ore fines (US$/wmt; 58% FOB Aus) 89 44 39 35 P/NPV (FMG.AX) FOB cash costs + royalty (US$/wmt) 40 32 22 20 Target price 2.16 Operating margin (US$/wmt) 49 12 18 15 TP methodology: NPV Sales 2014A 2015F 2016F 2017F Chichesters (mt) 79 89 92 92 FMG NPV operational split Solomon (mt) 40 69 70 70 Western Hub 0% Nullagine 0% Nullagine (mt) 5 6 6 6 Total sales (mt) - 100% 124 165 168 168 Total sales (Mt) - equity share 120 165 163 164 Solomon 37% Chichester 63% Cash costs 2014A 2015F 2016F 2017F Chichester FOB cash costs ex royalty (U 34.1 28.5 19.3 19.5 Solomon FOB cash costs ex royalty (US$ 32.6 28.6 18.6 18.3 Group FOB cash costs (US$/t) 33.6 27.0 18.8 17.6 Group CFR cash cost (US$/t) 50.4 39.1 29.2 29.7 Average CFR cash cost (A$/t) 54.9 47.6 41.0 40.9 Profit and Loss (US$m) 2014A 2015F 2016F 2017F Revenue 11,879 8,574 7,564 7,204 Costs (7,002) (7,427) (4,862) (4,935) EBITDA 4,877 1,147 2,702 2,269 Depreciation & amortisation (964) (727) (1,385) (1,385) EBIT 3,913 420 1,317 884 Sensitivity NPV 2015F 2016F Net interest 0 0 (496) (450) Base case NPV / EPS 2.16 10.1 17.7 Other finance charges 0 0 (32) (32) Iron ore 10% increase 6.53 42.7 53.3 MRRT 0 0 0 0 % change 202% 320% 200% Pre tax profit 3,913 420 789 402 Iron ore 10% decrease 0.70 19.9 8.6 Tax expense (benefit) 0 (104) (237) (121) % change -68% 96% -52% NPAT - underlying 3,913 316 552 281 AUD 10% increase 1.88 26.6 23.1 Significant items (1,173) 0 0 0 % change -13% 162% 30% NPAT - reported 2,740 316 552 281 AUD 10% decrease 5.63 36.0 38.6 % change 161% 255% 117% Profitability analysis 2014A 2015F 2016F 2017F EBIT margin 33% 5% 17% 12% Production and costs EBITDA margin 41% 13% 36% 32% Effective tax rate 0% -25% -30% -30% 180 70 ROA - EBIT / (total assets - cash) 19% 2% 8% 5% 160 60 ROE - NPAT / equity 52% 4% 7% 3% 140 50 Cashflow (US$m) 2014A 2015F 2016F 2017F 120 EBITDA 4,877 1,147 2,702 2,269 100 40 Operating cashflow 4,691 1,002 1,906 1,647 80 30 Capex (301) (104) (343) (351) 60 Free cashflow 4,390 898 1,563 1,295 20 40 Other investing cashflow 0 (234) (389) 0 20 10 Financing cashflow 0 (80) (134) (433) Net Change in cash 4,390 584 1,040 862 0 0 2011A 2012A 2013A 2014F 2015F 2016F Balance Sheet analysis (US$m) 2014A 2015F 2016F 2017F Total sales (Mt) - equity share Group CFR cash cost (US$/t) Gross debt 9,567 9,569 9,569 9,269 Equity 7,583 7,537 7,955 8,103 Assets 22,694 21,360 22,216 22,044 Resources Cash 2,398 2,381 4,738 5,600 Iron ore resources (Mt) 9,958 Net debt 7,169 7,188 4,831 3,669 Iron ore reserve (Mt) 2,211 Gearing - net debt/equity 94.5% 95.4% 60.7% 45.3% Gearing - net debt/ (net debt + equity) 48.6% 48.8% 37.8% 31.2% Net debt / EBITDA 1.5 6.3 1.8 1.6 EBIT / net interest 0.0 0.0 (2.7) (2.0) EBITDA / net interest 0.0 0.0 (5.4) (5.0) 2
Investment View: RESEARCH, COMPANY FMG s share price has held up well despite ongoing depressed sector fundamentals leaving FMG close to fair value versus our $2.16ps target price. We came away impressed with the operations. We are more confident of lower sustainable operating costs but note that FMG is still in the process of improving business efficiencies. We expect a significant number of additional improvements in FY16 at the Christmas Creek and Solomon operations. Of particular interest is the processing route options which have further enhancements in the pipeline. We think that once FMG has bedded down the process optimisations that attention will then turn to sprint capacity to potentially move production up to 180Mtpa in FY17. The largest risk to our Hold call remains the potential for protracted weakness in commodity prices. We make no changes to our forecasts and our NPV based target price remains at A$2.16ps. Our valuation is derived using a DCF methodology and equates to our target price. Price tension in currency and iron ore markets offers the strongest chance for FMG to re-rate. Upside and downside risks are also linked to fluctuations in commodity and currency prices, operating performance and the ability to control costs. Site visit highlights Rail and port optimizations Port infrastructure can already support +200Mtpa: The current infrastructure at Port Hedland has significant upside capacity to support moves up to 205Mtpa. The configuration of three stacker and 3 reclaimers and three rail car dumpers which has unload / load capacity of +200Mtpa. Rail Maintenance: Automation in the services area for FMG s 13 trains is completed by a team of just 6 personnel which is significantly automated with robotic assistance further improving efficiencies and reducing costs. Rail speed & Weight: It s not that easy to speed up a train that weight 35,000t, but FMG has been making incremental improvements to its rail design and axle capacity. In our view the likely optimizations will come in the form of increased rail speed and modifications to the rail design (straighter rail lines, increased camber on turns). Figure 1: Twin rail car unloader with 70Mtpa capacity Figure 2: Ship loading underway at Port Hedland 3
Solomon Operations FMG has installed 41 driverless 225 tonne trucks at Solomon (originally planned for 54 trucks). We were impressed by the overall efficiency of the operations with management suggesting that at this stage they were already seeing a 13% improvement in productivity. Plans to roll out additional driverless infrastructure was planned with the aim of increasing to around 20% additional efficiency. Management are still assessing the actual dollar per tonne value of the autonomous systems, but it s clearly a value add in the long term with reduced maintenance, wear and overall productivity. Fire-tail costs in the single digit dollar per tonne range : Management outlined that costs at Fire-tail were cheap and that the C1 cost was in the range of in dollar terms its in single digits and it s a reason why FMG can achieve such low costs in FY16. By blending Fire-tail with Christmas Creek ores we believe the projected FY16 costs are sustainable, at least for the medium term based on Firetail s 7 year projected mine life. Beyond that we believe that exploration discoveries will be required to maintain the current low cost structure. Figure 3: Fire-tail ore processing facility Figure 4: Valley of Kings deposit SOURCE: COMPANY Process plant optimization is a key focus at the Kings OPF. It s a 44Mtpa wetprocessing plant that operates about 10% above its nameplate design of 40Mtpa. Improvements to product yield has been a key area of improvement with yields of around ~90% being achieved according to management. Christmas Creek operations Business optimisation Christmas Creek ( CC ) is by far the most important operation as far as optimisation is concerned. Our visit focussed on the following areas: Contract consolidation: The consolidation of mining services at CC into a single contract commenced in April 2015 and was awarded to Downer EDI (Downer). Management implied that the use of a single contractor had cost savings of around A$4/t on current cost. A large proportion of FMG s costs have moved away from contractors to in-house expertise. Owner operator at Christmas Creek: FMG assumed ownership of the OPF facilities at Christmas Creek in January 2014. Since that time a significant uplift in efficiency and maintenance improvement has resulted in further cost savings. 4
Maintenance focus to ensure availability stays high: Maintenance schedules have been altered to 6 weeks (previously 13 weeks) to ensure availability of ore processing remains high. Figure 5: Christmas Creek OPF infrastructure Figure 6: Business efficiencies Monitors are positioned throughout FMG s operations advising workers of production status updates aimed at having output and performance in front of mind for employees (Figure 5). Christmas creek process plant optimisation: A key area of focus is the output from the OPF which allows FMG to process lower cut-off grade ore whilst maintaining product quality and output. A number of areas contribute to this: Lower the density of the ore to improve yield: By adding additional water to the ores, the process engineers have worked out they can achieve better recoveries with a lower density feed stock and maintaining constant pressure. Increasing processing via cyclones to achieve increased throughput: The use of spiral cyclones isn t anything new, but by lowering the density of the ore, the process plant can increase throughput to the cyclones and achieve higher yields. Process engineers are working on plans to run cyclone feeds up to 700 tonnes per hour versus traditional feed rates of ~500tph which is then fed into the de-sanding circuit. Increased use of the Jigging circuit: The jigging plant isn t anything new, it s a vibrating table that effectively removes additional silica and alumina. FMG processes about 13% of total material through jigging. The upshot of this is a larger proportion of material can be fed through the OPF to extract more Fe and improve cut-off grades. 5
Queensland New South Wales Victoria Western Australia Brisbane +61 7 3334 4888 Sydney +61 2 9043 7900 Melbourne +61 3 9947 4111 West Perth +61 8 6160 8700 Stockbroking, Corporate Advice, Wealth Management Stockbroking, Corporate Advice, Wealth Management Stockbroking, Corporate Advice, Wealth Management Stockbroking, Corporate Advice, Wealth Management Brisbane: Edward St +61 7 3121 5677 Armidale +61 2 6770 3300 Brighton +61 3 9519 3555 Perth +61 8 6462 1999 Brisbane: Tynan Partners +61 7 3152 0600 Ballina +61 2 6686 4144 Camberwell +61 3 9813 2945 South Australia Bundaberg +61 7 4153 1050 Balmain +61 2 8755 3333 Carlton +61 3 9066 3200 Adelaide +61 8 8464 5000 Cairns +61 7 4222 0555 Bowral +61 2 4851 5515 Farrer House +61 3 8644 5488 Norwood +61 8 8461 2800 Caloundra +61 7 5491 5422 Chatswood +61 2 8116 1700 Geelong +61 3 5222 5128 Emerald +61 7 4988 2777 Coffs Harbour +61 2 6651 5700 Richmond +61 3 9916 4000 Gladstone +61 7 4972 8000 Gosford +61 2 4325 0884 South Yarra +61 3 8762 1400 Gold Coast +61 7 5581 5777 Hurstville +61 2 9570 5755 Southbank +61 3 9037 9444 Ipswich/Springfield +61 7 3202 3995 Merimbula +61 2 6495 2869 Traralgon +61 3 5176 6055 Kedron +61 7 3350 9000 Neutral Bay +61 2 8969 7500 Warrnambool +61 3 5559 1500 Mackay +61 7 4957 3033 Newcastle +61 2 4926 4044 Milton +61 7 3114 8600 Newport +61 2 9998 4200 Australian Capital Territory Mt Gravatt +61 7 3245 5466 Orange +61 2 6361 9166 Canberra +61 2 6232 4999 Noosa +61 7 5449 9511 Port Macquarie +61 2 6583 1735 Redcliffe +61 7 3897 3999 Scone +61 2 6544 3144 Northern Territory Rockhampton +61 7 4922 5855 Sydney: Level 7 Currency House +61 2 8216 5111 Darwin +61 8 8981 9555 Spring Hill +61 7 3833 9333 Sydney: Level 9 +61 2 8215 5000 Tasmania Sunshine Coast +61 7 5479 2757 Sydney: Hunter St +61 2 9125 1788 Hobart +61 3 6236 9000 Toowoomba +61 7 4639 1277 +61 2 9615 4500 Townsville +61 7 4725 5787 Sydney: Reynolds Equities +61 2 9373 4452 Yeppoon +61 7 4939 3021 Wollongong +61 2 4227 3022 Disclaimer The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual s relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents ( Morgans ) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so. Those acting upon such information without advice do so entirely at their own risk. This report was prepared as private communication to clients of Morgans and is not intended for public circulation, publication or for use by any third party. The contents of this report may not be reproduced in whole or in part without the prior written consent of Morgans. While this report is based on information from sources which Morgans believes are reliable, its accuracy and completeness cannot be guaranteed. Any opinions expressed reflect Morgans judgement at this date and are subject to change. Morgans is under no obligation to provide revised assessments in the event of changed circumstances. This report does not constitute an offer or invitation to purchase any securities and should not be relied upon in connection with any contract or commitment whatsoever Disclosure of interest Morgans may from time to time hold an interest in any security referred to in this report and may, as principal or agent, sell such interests. Morgans may previously have acted as manager or co-manager of a public offering of any such securities. Morgans affiliates may provide or have provided banking services or corporate finance to the companies referred to in the report. The knowledge of affiliates concerning such services may not be reflected in this report. Morgans advises that it may earn brokerage, commissions, fees or other benefits and advantages, direct or indirect, in connection with the making of a recommendation or a dealing by a client in these securities. Some or all of Morgans Authorised Representatives may be remunerated wholly or partly by way of commission. Regulatory disclosures None Recommendation structure For a full explanation of the recommendation structure, refer to our website at https://www.morgans.com.au/research_disclaimer Research team For analyst qualifications and experience, refer to our website at https://www.morgans.com.au/research-and-markets/our-research-team Stocks under coverage For a full list of stocks under coverage, refer to our website at http://www.morgans.com.au/research-and-markets/company-analysis/asx100-companies-undercoverage and http://www.morgans.com.au/research-and-markets/company-analysis/ex-100-companies-under-coverage Stock selection process For an overview on the stock selection process, refer to our website at http://www.morgans.com.au/research-and-markets/company-analysis www.morgans.com.au If you no longer wish to receive Morgans publications please contact your local Morgans branch or write to GPO Box 202 Brisbane QLD 4001 and include your account details. 30.09.15 6