Australians Fret About Crash With Fortescue Metals Growth Stock

Iron Ore Operation in the Pilbara
Earth movers drive past tiered piles of waste dirt at Fortescue Metals Group Ltd.'s Cloudbreak iron ore operation in the Pilbara region of Western Australia, on July 25, 2011. Photographer: Carla Gottgens/Bloomberg

Neville Power gazes out the window of a chartered jet at the rust-red, mineral-rich Australian Outback.

Power, 53, is the new chief executive officer of Fortescue Metals Group Ltd., a mining company whose one-time penny stock has soared almost 1,200-fold in value in nine years as a result of China’s insatiable hunger for Australian iron ore. While the world teeters on the brink of financial turmoil, Power talks up his company’s next miracle, Bloomberg Markets magazine reports in its November issue.

Fortescue’s share price surge has at various times lifted the firm into the ranks of the world’s 500 biggest companies -- and among the fastest-growing of this century, according to data compiled by Bloomberg.

Even though the share price plunged 28 percent this year, an investment of A$10,000 ($10,318) in Fortescue stock at its lowest point in November 2002 would be worth nearly A$12 million today. The 31.5 percent stake of Chairman Andrew Forrest, who took control in 2003, is worth A$4.6 billion.

Power says he’s not resting on past successes. He says Fortescue is spending $8.4 billion to triple production to 155 million tons by 2013.

“When we reach that target, we’ll be as big in iron ore as BHP is today,” Power says, referring to BHP Billiton Ltd., the world’s largest mining company.

Profits for Miners

Such lofty ambitions are cutting both ways for Australia, if not for Fortescue. The nation of 22.7 million people sprinkled over a land mass the size of the continental U.S. is in the grip of its biggest mining boom since a mid-19th-century gold rush.

While delivering record profits for miners, surging demand for Australia’s minerals sent the local currency soaring to its highest level in 30 years. It has also forced the government to keep the benchmark interest rate at 4.75 percent, the highest in the developed world.

The combined impact of a rising currency and such high borrowing costs has crippled manufacturers, retailers and other nonmining industries. It has also helped to destabilize Prime Minister Julia Gillard’s 18-month-old government, which clings to power by a single parliamentary seat.

Even for miners, the boom carries risks because of the industry’s potentially dangerous overdependence on a single customer.

Slash China’s Growth

According to Australian government statistics, the country is already the world’s No. 1 exporter of iron ore, coal and alumina. It ranks second in gold, zinc and lead production; fourth in nickel and silver; and sixth in copper.

Now, companies such as Rio Tinto Group, BHP and Fortescue are pouring $174 billion into new projects, according to government estimates. Some 40 percent of those minerals are sold to China.

Chinese steelmakers buy more than 95 percent of Fortescue’s iron ore. A recession in the West could slash China’s growth to 7.3 percent in the first quarter of 2012 from 10.4 percent in 2010, according to Deutsche Bank AG.

Growth may even sink to 5 percent after 2013, Nouriel Roubini, chairman of New York-based Roubini Global Economics LLC, told a conference in Shanghai in July.

“If China’s growth falls by half, the price of nonfood commodities will be seriously affected,” says Michael Pettis, a finance professor at Beijing’s Peking University.

‘Turbo-Charged by Growth’

Gillard rejects such predictions. “We have a resources sector that is turbo-charged by the growth in the region,” she said in an interview with Bloomberg News on Sept. 15. “There’s no advice to me that would cause me concern about Chinese demand collapsing.”

That sort of bullishness was on ample display down under in early August when a record 2,400 mining entrepreneurs and their financial backers flew to the Outback.

Their destination: the Wild West gold-rush-era town of Kalgoorlie. Their purpose: to party and promote their newest discoveries at a beer-fueled annual convention called the Diggers and Dealers Forum.

This was no Davos, the buttoned-down thinkathon for corporate and political elites in the Swiss Alps.

By day, the miners and their bankers convened in a large tent near Australia’s biggest gold mine, a 3-kilometer-long (1.9-mile-long), 1.5-kilometer-wide and 400-meter-deep hole known as the Super Pit.

Scantily Clad

By night, many of them continued their wheeling and dealing at honky-tonk watering holes staffed by female bartenders so scantily clad that they’re known as “skimpies.”

Among those packed 10 deep at the bar amid the fading grandeur of the Palace Hotel one evening in August was David Flanagan, CEO of Atlas Iron Ltd., who has increased his company’s market value by more than 50-fold to A$2.9 billion during the past five years.

“There are so many amazing deposits out there that the opportunities are limitless,” Flanagan, 39, says. Nor is he concerned that Atlas Iron doesn’t have a single customer outside China. “If China suddenly catches the flu, the whole planet’s cactus anyway,” he says.

Gina Rinehart skipped the Diggers party but not the dealing. Rinehart, already one of the world’s richest women with a fortune of at least $10 billion, has teamed up with Rio Tinto in the development of the Hope Downs iron ore mine near Fortescue’s pits and is also developing vast coal deposits in Queensland state on the other side of the country.

Amid the Bonhomie

On Sept. 16, Rinehart set about making herself another $1.26 billion when her Hancock Prospecting Ltd agreed to sell a 79 percent stake in two Queensland coal assets to Indian billionaire G.V. Krishna Reddy’s GVK Power & Infrastructure Ltd.

Amid the Diggers and Dealers bonhomie, Todd Buchholz, a former managing director at Tiger Management LLC hedge fund and a one-time adviser to U.S. President George H.W. Bush, struck a note of caution.

“China’s golden moment will eventually fade,” Buchholz said. “Australia can’t just rely on one narrow part of the world economy.”

Fortescue’s Forrest and Power were the undisputed stars of the convention. Having already made his billions, Forrest passed the CEO baton to Power in July and stepped up to the chairmanship so he could spend more time on his philanthropic work.

Forrest will be a hard act to follow. Fortescue’s profit for the financial year that ended on June 30 jumped 76 percent to A$1.02 billion as China in 2010 exceeded the average 10 percent growth surge it has maintained for more than three decades.

Global Markets Plunge

Lately, China’s red-hot economy has been cooling--even before fears over Europe’s debt crisis deepened and global markets began their plunge in the wake of Standard & Poor’s downgrading the U.S. to an AA+ credit rating.

The slowdown began after Beijing raised interest rates and curbed lending in a bid to lower inflation, which in July hit a three-year high of 6.5 percent, before easing to 6.2 percent in August. Partly as a result, global commodities prices slipped 18 percent from April 8 to Oct. 11 after more than doubling in the previous two years, according to the S&P GSCI Index.

The Australian economy is also not shining on miners such as Fortescue. Unemployment, while rising slightly as a result of the troubles of the economy outside of mining, is still just 5.3 percent -- barely half of what it is in the U.S.

Spiraling Costs

While that may sound like good news, there is such a shortage of skilled labor that average wages in the mining industry have jumped 33 percent in the past five years to A$2,113 a week.

That’s almost twice as much as miners earn in the U.S., according to government statistics in both countries. The state of the Australian dollar doesn’t help, either.

Mining companies are paid in U.S. dollars by their customers, yet they have to pay their employees in the local currency, which soared more than 40 percent in three years to well above parity with its U.S. counterpart before losing some of those gains in September. It was trading at just below parity on Oct 12.

Other costs have spiraled even higher. The giant, 3.5-meter-diameter tires used on dump trucks that haul iron ore and coal have tripled in price to $100,000 each -- roughly the price of a Porsche 911 Carrera S -- on the spot market, according to Leighton Holdings Ltd., a contractor for BHP and other mining companies.

Other Sectors Wilt

In August, Rio Tinto blamed rising costs and currency gains for a profit that came in below analysts’ estimates despite climbing 30 percent to $7.6 billion in the first half of 2011.

Now, the mining companies face the prospect of higher taxes. As other sectors of the economy wilt, Prime Minister Gillard is planning to introduce an additional 30 percent tax on iron ore and coal miners’ profits next year and, in a bid to reduce pollution, charge them $23 a ton on their carbon emissions.

Fortescue’s 28 percent share price decline compares with an 11 percent fall in the benchmark index as of Oct. 12. Still, Power says his faith in Fortescue’s prospects is undiminished.

“All I have to do to allay any concerns is to take another trip back to China,” Power says. “It is such a tremendous country, with a great track record of development.”

Power says he’s not reassured simply by China’s soaring city skylines and massive construction projects that consume the steel made from Australian iron ore, coal and manganese.

‘Even More Dependent’

What strikes him more, Power says, is the Chinese government’s decision to move major steelworks to the coast from inland. Beijing-based Shougang Group has already shifted operations, and Baosteel Group Corp. and Wuhan Iron & Steel Co. plan to follow suit.

“That shows the Chinese intend to become even more dependent on imported iron ore than on their own domestic mines,” Power says.

If something does go wrong in China, Fortescue has a cushion. Power says the company could still be profitable even if iron ore prices plunge to $70 a ton from the average of $169 that Fortescue obtained last year.

Australia’s biggest money manager is also upbeat on China. “People say it’s a bit risky to put all your eggs in the China basket, but China is going to continue to grow,” says Stephen Halmarick, who helps manage A$150 billion at Sydney-based Colonial First State Global Asset Management. “If we don’t sell to China, someone else will.”

‘Massive Projects’

Halmarick says there’s no sign that the recent global turmoil will slow mining investment in Australia. “There are some massive projects in train in Australia, and they will all go ahead,” he says.

Some of Australia’s resources have even at least partially bucked the downward commodities trend. On Sept. 6, gold hit what was then an all-time high of $1,923.70 per ounce before declining to $1,674 on Oct 12.

Iron ore, at $164.40 a ton, was still 11 percent higher on Oct. 11 than a year earlier and supply shortages will likely support an average price of $181 between 2012 and 2014, Standard Chartered Plc said in a September report.

That’s a far cry from the A$28 a ton that iron ore was selling for in November 2002, when shares in a company then known as Allied Mining & Processing Ltd. were trading at the equivalent of just 0.004 Australian cents.

Allied owned what turned out to be one highly valuable asset: rights to mine in the Pilbara, the richest iron ore region in Australia, where BHP and Rio Tinto had been digging ore for 40 years.

Two Mining Giants

In April 2003, Forrest took control of Allied, renamed it Fortescue and began adding adjoining mining leases on flatland that BHP and Rio Tinto had ignored in favor of the mountains of ore in the nearby Hamersley Range that had appeared more iron rich and accessible.

When the two mining giants refused to let the interloper use their railroad lines, Fortescue raised the money to build its own -- one capable of carrying the heaviest loads ever transported by rail.

This year, trains 2.7 kilometers long will carry 55 million metric tons of ore across 300 kilometers of sun-scorched wilderness to China-bound ships waiting at Port Hedland.

Now, Forrest and his board have entrusted Power with overseeing Fortescue’s next great leap forward: the tripling of production by spending $8.4 billion on the construction of new mines, more heavy-haul rail tracks and a new port.

Tripled in Value

Power says Fortescue will raise half of the funds through regular cash flow and may partly finance the rest by selling shares in Hong Kong or bonds in the U.S.

Surveying what Fortescue has already achieved from 30,000 feet just days before the Diggers confab, Power says that Chinese and other foreign investors, rather than investing in their own mines, should be putting their money into Fortescue shares.

Some already have. In 2009, Chinese steelmaker Hunan Valin Iron & Steel Group Co. paid $1.3 billion for a 17 percent stake in Fortescue -- an investment that had almost tripled in value when it sold about 1 percent of its holding in July.

Russian billionaire Victor Rashnikov’s Magnitogorsk Iron & Steel Works bought 5 percent of Fortescue in 2007 for an undisclosed amount. And in 2006, New York-based investment firm Leucadia National Corp. paid $400 million for a 10 percent stake in Fortescue and a 13-year unsecured note that pays a 4 percent royalty on the revenue from some of its mining operations.

‘A Delicious Investment’

Leucadia has since recouped almost $1 billion in share sales and interest and still retains a 5 percent stake valued at an additional A$733 million. It’s involved in a legal dispute with Fortescue over what it claims is an attempt by the company to dilute its royalties by offering other investors similar notes.

Even so, the New York investors are pleased with the returns Fortescue has delivered.

“This is, has and will remain a delicious investment,” Leucadia Chairman Ian Cumming and President Joseph Steinberg said in April in their annual letter to shareholders.

How long it will remain so depends not only on Neville Power’s ability to triple production of iron ore but also on China’s appetite for consuming it.

-- With assistance from Elisabeth Behrmann and Angus Whitley in Sydney, Jason Scott in Perth, Matthew Winkler in Canberra and Helen Yuan in Shanghai. Editors: Stryker McGuire, Michael Serrill

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