Fortescue Races Iron Ore Drop to Cut Debt Cost: Australia Credit

Photographer: Carla Gottgens/Bloomberg

Dump trucks unload waste dirt at Fortescue Metals Group Ltd.'s Cloudbreak operation in the Pilbara region of Western Australia. Close

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Photographer: Carla Gottgens/Bloomberg

Dump trucks unload waste dirt at Fortescue Metals Group Ltd.'s Cloudbreak operation in the Pilbara region of Western Australia.

Fortescue Metals Group Ltd. (FMG) is racing both a forecast drop in iron ore prices and the tapering of U.S. stimulus as it seeks to reduce costs of the biggest debt load among junk-rated miners.

Australia’s third-biggest iron ore exporter wants to shave about 50 basis points from interest payments on a $5 billion loan it borrowed in the U.S. last year after prices for the commodity plunged, said a person familiar with the matter. Fortescue also has $2.64 billion of bonds it can repay immediately, the company highlighted in an Oct. 17 report.

“Paying down debt should be Fortescue’s number one focus,” said Chris Walter, a credit research analyst at Westpac Banking Corp. in Sydney. “They have essentially enjoyed a free kick with stronger-than-anticipated iron ore prices in the last two months. They should utilize that.”

Fortescue wants to cut its $12 billion debt as the volume of loans to junk borrowers in the U.S. approaches a level last seen in 2007, and before a predicted four-year slide in the price of its sole product. A rebound in Chinese demand has driven a 30 percent iron ore recovery since Sept. 17, 2012, the day before Fortescue’s loan deal was agreed. The company’s bonds have returned 16 percent since then, compared with 9 percent for junk mining peers, Bank of America Merrill Lynch indexes show.

Bull Market

Iron ore, Australia’s biggest export by value, entered a bull market in July as China replenished stockpiles that shrank in March to the lowest level since 2009. Prices have rallied 24 percent from this year’s low on May 31 to $136.80 a ton Nov. 5, according to The Steel Index Ltd. Australian goods exports to China, its biggest trading partner, rose to a record during September, according to data released yesterday by the Australian Bureau of Statistics.

“Fortescue has been the riches to rags to riches story of the Australian resources market in 2013,” UBS AG analysts led by Glyn Lawcock said in a Nov. 5 report, upgrading the stock to ‘Buy’ from ‘Neutral’. “We’ve misjudged the iron ore market this year and Fortescue’s ability to deliver on its objectives.”

Still, prices are set to decline to an average of $114 a ton next year, according to analyst estimates compiled by Bloomberg, and are forecast to slide every year until at least 2017 as companies boost supply to meet demand from China. Rio Tinto Group and BHP Billiton Ltd., the world’s second- and third- biggest shippers, last month reported record quarterly production, while BHP raised its annual output forecast.

Covenant-Light

Fortescue said Oct. 30 it was refinancing its $5 billion facility to cut interest payments. The so-called covenant-light loan is being arranged by Credit Suisse Group AG, a person familiar with the matter said Oct. 29. The company is proposing to pay interest at 375 basis points more than the London interbank offered rate, down from 425 basis points on the existing loan, the person said.

Loans to junk-rated companies in the U.S. have exceeded $870 billion since Dec. 31, and this year is poised to be the biggest since before the global financial crisis, according to data compiled by Bloomberg. Fed policies have kept global interest rates near historic lows, spurring a hunt for yield. The central bank will start paring its bond purchases in March, according to a Bloomberg survey of economists on Oct. 17-18.

Syndicated Loan

As well as the loan refinancing, Fortescue in September said it will repay A$140 million ($133 million) of preference shares, its most expensive debt, to cut interest costs.

“We have the flexibility to pay down debt well in advance of maturity dates,” said Yvonne Ball, a spokeswoman for Fortescue. “Our first debt repayment will occur next week with the redemption of our preference shares, and we will consider further repayments in the months ahead.”

Australia & New Zealand Banking Group Ltd. is also syndicating a loan funding the forward purchase of iron ore from Fortescue, which is set to be increased to $300 million from $200 million after high demand, a person familiar with the matter said on Oct. 30.

“Their view is, let’s sell as much iron ore forward as we can, let’s high-grade our bodies to maximize cash flow in a volatile market,” Paul Young, a resources analyst with Deutsche Bank AG in Sydney, said in an interview. “It’s a short-term strategy to get the balance sheet under control.”

The company’s total debt stands at $12 billion, according to data compiled by Bloomberg, giving the company a net debt-to-equity ratio of 199 percent during 2013, according to Deutsche Bank. That compares with gearing of 34 percent for Rio Tinto.

More Impurities

The positive return on Fortescue’s debt comes amid a rout in bond markets which has seen sovereign rates rise globally. The yield on the 10-year U.S. Treasury (USGG10YR) bond climbed to 2.66 percent as of 5 p.m. yesterday in Sydney, up 0.9 of a percentage point since the end of 2012. The 10-year Australian government bond yield was at 4.21 percent, up 93 basis points this year. The Australian dollar has dropped 8.4 percent to 95.17 U.S. cents since the end of 2012.

Fortescue, which cut production costs by 33 percent during the September quarter, is nearing the end of a $9 billion spending program to nearly triple iron ore production capacity at its mine, port and rail operations in Australia’s Pilbara region to 155 million tons. Compared to peers BHP Billiton and Rio Tinto, Fortescue’s iron ore has more impurities and lower grades, and is sold at a discount to benchmark prices.

“Their operating cost performance has been strong and they beat expectations of a lot of people,” said Westpac’s Walter. “They’re in a strong free cashflow position and should be able to pay back $1 billion to $1.5 billion through to the end of their current financial year,” said Walter, with Fortescue’s fiscal year ending on June 30.

To contact the reporter on this story: Elisabeth Behrmann in Sydney at ebehrmann1@bloomberg.net

To contact the editor responsible for this story: Jason Rogers at jrogers73@bloomberg.net

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