Fortescue Credit Rating Cut by Moody's After Iron Ore Slump

  • Miner's credit score lowered to second-highest junk rating
  • Downgrade comes even after cost cuts and debt reduction

Fortescue Metals Group Ltd., the Australian iron ore producer that last week announced an accord with Brazilian counterpart Vale SA, had its debt rating cut by Moody’s Investors Service.

The credit assessor cut its score on the Perth-based miner one level to Ba2, two steps below investment-grade, Moody’s said in a statement Monday. It has a negative outlook on the rating.

The downgrade follows a drop in iron ore of more than 70 percent from its peak in 2011 amid weakening Chinese demand and a ramp up in supply. While Fortescue has reduced operating costs and used free cash flow to cut debt, Moody’s said a “fundamental downward shift in the mining sector” resulted in weaker credit metrics for the company.

“Ratings need to be recalibrated to reflect expected performance over a more protracted challenging operating environment,” Moody’s said. “The slowing economic growth rates in China and reducing steel production rates impact demand for iron ore -- leading to lower prices. Supply imbalances in iron ore, Fortescue’s sole earnings and cash flow driver, will maintain pressure on prices for several years.”

The company’s shares rose 0.8 percent to A$2.60 as of 10:15 a.m. Tuesday in Sydney. They reached A$3.08 on March 7, the highest close in 15 months. The yield premium over U.S. government debt on the firm’s March 2022 dollar bond, its largest outstanding line, widened to 776 basis points on Monday from 768 at the end of last week.

The action follows Moody’s downgrades to other major iron ore producers in the past month including Vale, Rio Tinto Group and BHP Billiton Ltd.

Cost Reductions

While the Fortescue rating cut reflects Moody’s view on the decline in the outlook for iron ore, the credit assessor did make note of the company’s cost reductions and said it expected the miner to better than break even under its base case price assumption.

“It is pleasing that Moody’s has recognized Fortescue’s strong performance, stable production profile and long life, high quality reserves,” Chief Financial Officer Stephen Pearce said in a statement. “Our focus on successfully reducing operating and capital costs continues to offset the impact of lower iron ore prices.”

Fortescue is currently rated BB with a negative outlook by Standard & Poor’s, in line with the new Moody’s score. Its ranking at Fitch Ratings is the equivalent of one level higher.

The price for 62 percent iron ore in China was at $55.55 a ton as of Monday having fallen as low as $38.30 in December, although it remains well below its $191.70 peak from five years ago.

Fortescue has bought back some of its bonds at a discount to their face value, cutting its net debt to $6.1 billion as of Dec. 31, according to company filings. It has also said it’s committed to further reducing its liabilities.

With the recent recovery in iron ore prices having spurred a rally in its bonds and driven down yields, Fortescue has more recently been talking with investors about potentially refinancing some of its debt, people familiar with the matter have said.

The miner, which is controlled by billionaire Andrew Forrest, last week entered into a memorandum of understanding with Vale that will allow for them to sell a blended ore product together. The pact includes plans for joint ventures and the possibility that Vale will take a stake in Fortescue.

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