King of Costs

Fortescue Metals released its June quarter 2017 production report, which Ord Minnett considered to be a mixed result.

 

We note the following key points, firstly, the headline achieved price discount of 40% was higher than expected, although the 27% discount on a weighted average basis (excluding provisional pricing) was broadly as forecast; secondly, cash costs (C1 basis) were a 5% beat, with impressive FY18 cost guidance of US$11–12/tonne; thirdly, FY18 capital expenditure guidance of US$900 million was broadly in line with our estimate, but higher than pre-release consensus of US$740 million; and lastly, net debt of US$2.7 billion also bettered forecasts.

 

Fortescue’s achieved iron ore price of US$38/t was a 40% discount – we had forecast 35% – to the quarterly 62% Fe (iron) average benchmark price. While this was disappointing, the company provided new disclosure on the discount, excluding timing differences related to provisional pricing. This came in at 27% versus our 29% forecast – a marginally positive outcome, in our view. We predict a 23% discount next year with a long-term discount of 17%.

 

Quarterly shipments of 44 million tonnes (Mt) were in line with our forecast, while cash costs of US$12.2/t were a 5% beat. Net debt of US$2.7 billion was down US$100 million quarter-on-quarter and better than our US$3.3 billion estimate, due to the timing of tax paid and working capital releases.

 

Management flagged another step-down in costs to US$11–12/t in FY18, despite the strip ratio rising from 1.0 to 1.4. We find this an extraordinary outcome and testament to the company’s strong operational management.

 

Fortescue continues to screen attractive on valuation, dividend potential, operational reliability, operating earnings margins and now balance sheet, with 21% gearing. We also note the positive momentum in macroeconomic data is a good backdrop for the sector. We maintain our Accumulate recommendation and have raised our target price to $6.50 from $6.30.

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