From Fitch:
Fitch Ratings-Sydney-03 September 2013: This is a correction of the rating action commentary published on 1 September which did not include the affirmation of the company’s senior secured ‘BBB-‘ rating. The corrected version is as follows:
Fitch Ratings has revised Australian based Fortescue Metals Group Limited’s (Fortescue) Outlook to Stable from Negative and affirmed its Long-Term Issuer Default Rating (IDR), senior unsecured rating at ‘BB+’ and senior secured rating at ‘BBB-‘. At the same time, Fitch has affirmed Fortescue’s senior unsecured and senior secured debt, issued through FMG Resources (August 2006) Pty Ltd, at ‘BB+’ and ‘BBB-‘ respectively.
The Outlook revision reflects the expectation that debt will decrease and, should iron ore prices remain above USD110/t through to FY14 and the AUD remains at sub parity, the decrease could be accelerated. Fortescue expects to achieve 150m metric tonnes per annum (mtpa) run rate from March 2014. With a permanent reduction in costs, and having passed the inflection point of capex intensity (capex is expected to decrease to USD1.94bn in FY14 from USD6.24bn), free cash generation is expected to be strong, consequently driving debt reduction.
KEY RATING DRIVERS
Deleveraging quickly: Under our base case assumption of USD110/dry metric tonnes (dmt) , 62% Fe and AUD/USD 0.94 in FY14, we expect Fortescue’s FFO adjusted net leverage to be less than 2.50x, down from 3.34x in FY13. Aside from operational improvements including stronger production volume, a reduction in costs, lower capex, prepayments as at August 2013 totalling USD1bn (including USD500m for port access from Formosa) and any asset sales, are also expected to enhance the strong free cash generation in FY14 and FY15.
Fortescue is considering the sale of a minority interest in The Pilbara Infrastructure Pty Ltd (TPI) to reduce gearing (net debt/net debt+equity) from 71% at FY13 to Fortescue’s targeted levels of between 30 and 40% by end FY15. While Fortescue is still considering the sale of TPI, to date it has not received offers that meet its expectations of value and terms. Fitch’s base case does not factor in this potential sale. Should a transaction occur, we would need to review the terms to assess the likely impact on the company’s overall credit profile.
Step change reduction in costs: During FY13, C1 costs peaked at USD50/wet metric tonnes (wmt) in the December 2012 quarter, but these have reduced to USD44/wmt for FY13. The key drivers include cost reduction measures that were put in place in October 2012, lower strip ratios on account of the new mine plan, and the commissioning of the low cost Firetail mine (strip ratio of 1:4 compared to Chichsterster of 3.5:1). The reduction in costs is considered permanent, with the expectation that they will trend lower, and will be helped with the depreciation of the AUD/USD.
Operating efficiencies insulate against lower iron ore price: Falling cash costs and rising production will be key drivers to profit margin. Fitch expects the profit margin to remain stable as the business benefits from increased scale.
Low costs support rating: The ratings reflect Fortescue’s cost advantages due to its close proximity to key Asian markets. Substantial rail and infrastructure assets assist in its cost advantage.
Lack of business diversification: Fortescue has limited business diversification compared with its international peers, current selling one product (being iron ore) into the Chinese market.
RATING SENSITIVITIES
Positive: Future developments that could lead to positive rating actions include:
-Funds from operations (FFO) adjusted gross leverage falling below 2.0x and FFO gross interest cover moving above 5.0x. Prior to such action, elements of the capital structure would need to be more reflective of a ‘BBB’ category.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-FFO adjusted gross leverage exceeding 3.00x and FFO gross interest cover being below 4.0x from FY14.
Good luck to Twiggy. Enjoy it while it lasts!
