As FMG flirts with major support levels today (and in the name of balance), here is a note from JPMorgan arguing upside:
1) Valuation. As we highlighted in our recent note, FMG is trading on a FY14 PE of 3.5x, with around 50% upside to NPV. We acknowledge FY14 is the peak earnings year in our forecasts, but even at long term assumptions beyond FY18 (80c AUD / US$80/t iron ore) FMG is on 5x.
2) Costs trending down. As FMG ramps up the Solomon mining hub with significantly lower strip ratios (2:1 long term), costs should be well supported below US$40/t, particularly with economies of scale benefits.
3) Production ramping up, projects on track. FY14 production guidance of 127-133Mt @ US$38-40/t C1 costs was impressive in our view, causing consensus upgrades to eps, and highlighting projects are on track.
4) Growth capex rolling off. We estimate that FMG will have spent the bulk of its growth capex by the end of Sep 13, coinciding with the 40Mtpa Kings project ramp-up (US$6.3bn in FY13, dropping to US$1.9bn in FY14).
5) Free cash flow improving. On our assumptions, FMG is already free cash flow positive. We estimate ~US$2bn FCF in FY14, which should help reduce net debt of ~US$10.7bn (including leases).
6) TPI sell-down. The sale of a minority stake in FMG’s infrastructure has the potential to provide a cash injection to improve the company’s capital structure. In our view, a deal would be taken positively, with the stock unlikely to react materially to any news about a deal falling though.
7) AUD falling. As the AUD continues to slide down, FMG experiences material cost relief. Every 1c move adds about US$34m (1% ) to FY14 npat.
8) Iron ore prices look to have stabilized. With Chinese iron ore inventories at circa 20 days, we don’t expect further de-stocking, which is supportive of iron ore prices. Further, current prices appear to be supported around the marginal cost of China’s domestic iron ore production.
9) Gearing reduces materially over the next 2 years. FMG does not have any debt repayments due before Nov 2015. Even without the TPI deal, we predict gearing to reduce to 51%/40%/30% in FY14/FY15/FY16, with interest cover a healthy 7.0/7.2/8.3x.
10) Long term EBITDA margin ~30%. At long term prices of 80c AUD and US$80.
My line remains that even with a dollar-assisted margin expansion, all of the major producers want to see FMG go down and will endure short term pain to see it happen.
