Fortescue Metals: On the way to $100?

  1. 36

    Started this calender year around $13.60

    On 1st May was about $22.30

    This morning hit a high of $32.77, currently on $32.14(+$2.92 since Friday)

    It's having an amazing run, although trading volumes have not been massive.

    Not sure if this article was posted on T$ before, but here it is for those who are interested. Taken from Eureka Report May 4th, it certainly paints a much brighter picture for FMG than most..........

    I for one have been accumulating since this article, so far so great :)

    Fortescue: Blue Sky Miner

    By Charlie Aitken

    There is no large-cap stock in Australia that generates more polarising views than Fortescue Metals Group (FMG).

    When I wrote recently that I would be joining a Fortescue site visit, some investors wondered why I would bother. The simple answer is because this is a company that is capitalised at $6 billion and is included in the benchmark ASX 200 index, yet only one mainstream broker writes research on it and no mainstream Australian institutional investor owns any stock.

    Fortescue, led by chief executive Andrew Forrest, is building the most significant new resource project in Australia, yet nobody in the Australian investment community takes it seriously. Only last week, a major US broker upgraded all its iron ore price assumptions, upgraded its recommendations on BHP Billiton and Rio Tinto, and also recommended small caps Mount Gibson Iron Ore (MGX) and Murchison Metals (MMX).

    It made no mention of Fortescue, which demonstrates the discrimination against the stock that has the greatest pure leverage to the brokers theme.

    The investment community has made the mistake of playing the "man" and not the "ball". My view is that clearly it is time to play the "ball", particularly given it seems a "misinformation" campaign has been run about Fortescue by vested interests in the iron ore industry.

    Getting to the Fortescue site meant taking an early flight from Perth to Port Hedland. The first thing I noticed was that there were no Australian institutional investors on the trip. Those brokers that did bother did not send senior resource sector analysts, which reaffirmed my theory about the cynical attitude most brokers have towards Fortescue.

    During the flight I sat next to Graham Rowley, executive director of FMG Operations. Graham is a former Rio Tinto operative who held senior positions at Hamersley Iron and Argyle Diamonds. He was previously a director of the Dampier Port Authority and has extensive experience in operational management of both iron ore shiploading facilities and heavy haul railways.

    To me, talking to Graham was the first positive surprise of the trip. Like everyone else, I had previously thought of Fortescue as the "Andrew Forrest show", but when you delve a little deeper you realise Forrest has assembled a world-class management and operational team. The way I see it, Andrew is the financier and largest shareholder in the group. He is the chief executive, chief enthusiast, and strategist as such, while below him is a highly experienced team of hardened operational iron ore men, most of who are ex Rio Tinto or BHP Billiton.

    Management depth

    The depth and quality of Fortescue's operational team is not widely known, so I will spend a little time running through that team and their credentials. I have already mentioned Graham Rowley; the other executive director is Russell Scrimshaw, formerly of the Commonwealth Bank.

    Chief finance officer Chris Catlow is ex-Iluka Resources (ILU). The chief finance officer of Pilbara Infrastructure (100% owned by FMG), Peter Thomas, is ex-Lehman Brothers. The chief operating officer of Pilbara Infrastructure, Alan Watling, has had 25 years in heavy haul management positions with Hamersley Iron (RIO), and was responsible for major new projects at Marandoo, Yandicoogina, and Brockman.

    The head of resource strategy is Dr John Clout, who is ex-CSIRO, and has previously advised companies such as Rio Tinto, BlueScope Steel, OneSteel, Robe River, Hancock Prospecting, and Hope Downs. The head of mining, John Blanning, has more than 22 years experience in open-cut mining operations. His previous job was as general manager of BMA Blackwater Mine (BHP), the largest open-cut black coal mine in Australia.

    This management team is serious, credentialled, and experienced in large-scale mining, financing, and heavy-haul logistics.

    Fortescue has employed blue-chip contractors for the project. Laing O'Rourke is doing the rail construction; Roche Mining is doing the outsourced mining operations; BGC the rail earthworks; General Electric the locomotives; McConnell Dowell the marine structures; and Thyssen Krupp the design of iron ore stackers, reclaimers, and ship loaders. They are all incentivised to deliver the project on time and on budget. Infrastructure is key to any bulk mining business.

    The topography at Cloud Break, the key iron ore site for Fortescue, is much flatter than the other existing iron ore mines we saw. This is an interesting point because the topography and positioning of the ore body close to the surface should reduce mining costs and increase sustainable margins.

    Some of the other existing iron ore mines we saw are so deep it takes the trucks 40 minutes to reach the top, and one can only guess how many hundreds of litres of diesel fuel that takes. Fortescues trucks should only take five minutes across flat country to reach the crushing and screening plants. That is a big sustainable advantage in fuel costs, as is the continuous mining strategy that Fortescue is employing.

    The nature and structure of the ore body make continuous mining necessary. The market has huge doubts about continuous mining of iron ore, yet the technology is widely used around the world in the coal industry. Fortescue has ordered 16 continuous miners from Germany's Wirtgen, and has people on site at the manufacturing plant making sure the technical specifications are met.

    Fortescue mined its test pit with a single, 17 year-old continuous miner, and that worked well. The new models have significantly better operating features, and are dramatically more efficient in terms of operating costs. The market will only believe that continuous mining of iron ore works when they see the first train loaded with ore from the mining technique, but after seeing the test pit with my own eyes I would be certain that continuous mining works on an iron ore body of this style and that will keep Fortescue right down the cost curve.

    This is a key point, and should ensure that Fortescue's lower iron content ore is offset by lower mining costs, seeing margins similar to existing operators. The other factor that should increase operating margins is Fortescue's project "rocket", which is designed to increase the average iron content of shipments and should eliminate the discount Fortescue receives for its product.

    Volume x margin

    Iron ore is basically a logistics business. It's all about moving as much high iron content volume as possible, doing it 24/7, and doing it for the lowest possible cash cost. Fortescue's initial target is to move 45mtpa of iron ore. That annualised rate will be achieved in the second half of 2008.

    However, the limited broker research doesn't see 45 million tonnes per annum until 2009-10 at the earliest and, as I mentioned earlier, they see cash costs closer to $25 a tonne and selling prices heavily discounted to Rio Tinto and BHP Billiton. Even with these very pessimistic assumptions, the company generates forecast revenue of $2 billion-plus a year, net profit of $700 million, and earnings per share of about $2.40. Even on very pessimistic assumptions, Fortescue is trading on 9.5 times 2009-10 earnings.

    That's the worst-case scenario. Lets look at some more realistic "back of the envelope" earnings scenarios for the years beyond 2009-10.

    Lets assume Fortescue decides to go straight to production of 120 million tonnes a year. That decision needs to be made by August this year. That would require bond holder approval, which I suspect would occur. Fortescue keeps all the contractors on site, and they go for it. The 120mtpa scenario sees four berths, three shiploaders, 10 million tonnes of stockpiles at the port, a double train loop with 1x2 car unloader, and 1x4 car unloader. It's all additions to what will be existing infrastructure, and I think it's unrealistic to consider Fortescue producing 45 million tonnes a year. Under the expanded production scenario, it would be producing 120 million tonnes in 2011-12.

    At a margin of $40 a tonne, 120mtpa means EBIT of $4.8 billion a year. Interest costs will be about $300 million assuming stage two is debt-funded. Deducting corporate tax of 30% leaves NPAT of $3.15 billion, earnings per share on the current capital base (264 million shares) of $11.90 a share.

    No, that is not a typo. The scenario above sees Fortescue with 2011-12 earnings per share of $11.90, which puts the stock on a prospective 2011-12 price/earnings multiple today of 1.87 times. The stock will have a tonne of free cashflow, and should be able to maintain a 50% payout ratio. The dividend yield is potentially extremely attractive.

    Lets just say Fortescue does generate earnings per share of $11.90 in 2011-12. The world will pay 1012 times earnings for that annuity stream, which gives you a 2011-12 price target of $119.00 to $142.00. The 2011-12 market capitalisation could be $3137 billion, placing Fortescue among Australias top 10 stocks. This could all happen in the next four financial years.

    Who dares wins

    No analyst will ever dare write what I speculate about above, but this is how you make money in companies that nobody believes in. You have to take a view, and run "what if" scenarios. Even if the scenario is half-right, Fortescue will have earnings per share of $6 in 2011-12. Put that on a price/earnings multiple of 10 times and you still get a share price target of $60.

    The point I am making is that even rough back-of-the-envelope mathematics that this company, with a current market capitalisation of $6 billion, could easily prove to be a tremendous bargain. Yes, we are a long way from Fortescue shipping 120 million tonnes a year at a $40 margin, but we are closer than the market believes. I think you can justify the current Fortescue share price on a worst-case scenario, because I believe the mining and logistics process will work, and the initial 45 million tonne target will be met.

    Yet, when you do "what if" scenarios you can see the leverage in this stock is potentially enormous. There is no way of buying such pure, large scale, leverage to the sustainability of iron ore contract prices. If I am right about my stated view on the sustainability of iron ore prices, and if I am right about Fortescue's production growth and selling price assumptions, then in medium-term (three to five years), it could easily be a $100 stock and have a significant weighting in the ASX 200 index.

    I am one of only a handful of Australians outside of Fortescue's employment who has visited their project. Unlike the vast bulk of east coast cynics who have never been to site, I believe this project of national significance will work, and work to a scale both operationally and financially that nobody currently believes possible. The biggest risk is that this project is a genuine success, not the genuine failure that most people expect. On that basis, the real investing risk in Fortescue is low, and the potential upside leverage high.

  2. 884

    Funny how NOBODY was interest when I was buying, at 66c! Sold of course, for $1.05. Not enough margin for error any more. Too many cyclones coming.

  3. 749

    Hi Gregoire,

    i wonder if the same could happen to arh that have 1/2 the iron ore reserves comapred to fmg.

    Nobody wants arh at the moment, but it could turn out to be another fmg...


  4. 36

    ...from Mining News today........

    FORTESCUE Metals Group's share price has overtaken that of arch rival BHP Billiton for the first time, with the ambitious iron ore play adding another 12.2% to its runaway price this morning.

    Opening at $29.22 this morning, FMG peaked at $32.77 a share before retreating slightly to $31.98. In comparison, BHP was changing hands at $31.46.

    While share prices are worthless as a means of comparing value between companies (Fortescue's market capitalisation of $8.46 billion is only a tiny fraction of BHP's), Fortescue may see the latest improvement as a psychological win over the world's largest miner.

    Fortescue and BHP have been at loggerheads for several years over the former's attempts to win access to BHP's Pilbara rail network.

    Fortescue director of operations Graeme Rowley told he was "enormously satisified and very excited" about the latest share price move.

    Fortescue has now added almost $10 a share over the past fortnight, with the company's shares starting May at $22.25.

    This morning's move has further improved the paper value of chief executive Andrew Forrest's personal stake.

    Forrest's 38% holding was worth an eye-popping $3.27 billion at $31.98 a share.

    Today's closing price: $32.38 (+$3.16 or 10.81% for the day)

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