Fortescue’s shrinking margins

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Stephen Bartholomeusz has a nice snippet on Fortescue today:

The group’s chief executive, Nev Power, has said Fortescue’s cash break-even point is an iron ore price in the low $US70 a tonne/62 per cent CFR range. Fortescue, with lesser quality ores than its Pilbara competitors Rio Tinto and BHP Billiton, receives lower prices than they can get for their ore with its higher ferrous content.

…While it did lower net debt by more than $3 billion in that half-year, its cash flows for the period included $US712 million of prepayments for iron ore and a further $US500 million of pre-payments of port access fees.

In other words, it had the benefit of payments for future production and services to enable it to reduce its debt. That’s $US712 million of future production and $US500 million worth of port access fees that it won’t get when it ships ore and grants access to its port facilities in future. It also has a $US750 million tax payment due in December.

The low 70s number was before FMG was dumping its contract cargoes at fire sale rates. Adjusted for discounts at 12.5%, UBS sees the break even at $77, implying a $12 margin today. But those discounts are now a little higher. We must remember as well that contract prices lag spot.

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Another way to look at it is to use the low $70 break even figure and apply average realised prices. In Q4 last year, FMG achieved an average price per tonne of $124 based upon a contract price of $135. But by Q1 this year its average price had tumbled to $107 even though the benchmark contract price was unchanged.

Benchmark Q2 contract prices will have fallen to $120 on the basis of the first quarter average. Add grade discounts and that suggests an attained price around $90 for the current quarter.

Benchmark Q3 contract prices will fall to around $100 plus grade discounts which is likely to compress FMG margins to the width of a piece of paper unless either spot or grade discounts improve or the Australian dollar falls a lot.

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About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.