Fitch Affirms Fortescue Metals' LT IDR at 'BB+'; Negative Outlook Maintained
Fitch Ratings-Singapore/Sydney-26 February 2016: Fitch Ratings has affirmed Australia-based iron ore miner, Fortescue Metals Group Limited's Long-Term Issuer Default Rating (LT IDR) at 'BB+' and maintained the Negative Outlook. The agency has also affirmed Fortescue's outstanding issue ratings. A full list of ratings can be found at the end of this commentary.
The affirmation of Fortescue's ratings comes in spite of the decline in market prices for iron ore, and reflects the company's strong progress in cost reductions. Fortescue's cash production costs (or C1 costs) reduced by almost 50% over the 12 months to end-2015, averaging USD16/ton in 1HFY16 (fiscal year ends 30 June). The benchmark price for iron ore, with 62% iron content delivered to China has fallen by around 40% during the same period. The ratings factor in Fitch's view that the benchmark iron ore price will average around USD45/ton in 2016 and 2017, and recover slightly to USD50/ton in 2018 and over the long-term.
The Negative Outlook on Fortescue's LT IDR continues to reflect risks to the company's credit profile should iron ore prices underperform against our current expectations. Fortescue's ability to deleverage remains sensitive to iron ore prices, despite it achieving significant cost reductions. Accordingly, Fitch has amended its negative rating sensitivities to focus on free cash flow generation (FCF, after capex and dividends) as opposed to interest cover. We expect Fortescue's Funds Flow from Operations (FFO) adjusted net leverage to remain below 3x between FY16 and FY18 (fiscal year ends 30 June), and for the company to generate FCF of at least USD750m annually during the same period.
KEY RATING DRIVERS
Cost-Reduction Continues: Fortescue reported average cash production costs (or C1 costs) of USD16/ton in 1HFY16, which is down around 70% over the last three years. While Fortescue expects strip ratios to add USD1/t to C1, Fortescue expects to end FY16 at USD13/ton with additional cost savings from processing (USD0.70/t), mining productivity (USD1.30/t), procurement (USD0.50/t) and inventory and FX (USD0.50/t). The company currently estimates that the benchmark iron ore price needed to break even on its cash costs is around USD29/ton, which is 26% lower than the USD39/ton it reported at FY15.
Costs Sustainable in the Medium Term: We expect Fortescue's cost reductions to be sustainable at least over the next 24 months. Lower costs are due to a combination of product blend and upgrading of ore processing facilities, allowing for lower-grade ore inputs to be used while sustaining output quality. Its newer low-cost Solomon-hub mines have also now fully ramped-up production, which has reduced overall strip ratios. The company has delivered higher efficiencies from its existing port and rail infrastructure and increased its port capacity. Lower crude oil prices have contributed to a reduction in operational and shipping costs, and a weaker local exchange rate has also supported lower costs.
Comfortable Liquidity: At end-2015 Fortescue had USD2.3bn cash on hand, with no significant debt maturities until at least 2019 when its USD4.8bn secured credit facility, and USD577m of senior unsecured notes fall due. Fortescue purchased USD750m of senior unsecured notes via a tender offer in 1HFY16, and a further USD384m of senior unsecured notes off the market. The company appears to be committed to reducing its debt to a targeted gross gearing ratio of 40% (end-1HFY16: 52%, and 42% net of cash), supported by its comfortable free cash flow generation.
KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Fortescue include:
- Benchmark iron ore prices will average USD45/ton in 2016 and 2017, and USD50/ton in 2018
- Fortescue achieves 85% price realisation of the benchmark iron ore price, after discounts for grade, moisture and product quality
- C1 costs of USD15/ton in FY16, USD13.4/ton in FY17, and USD13.2/ton in FY18, broadly in line with management's guidance
- AUD/USD of 71 US cents in FY6 and FY17, and increase to 74 US cents in FY18
- All-in costs will average around USD26/ton in FY17 - FY18
- Fortescue will use materially all of its cash to repay debt
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage exceeding 3x on a sustained basis (1HFY16: 2.3x)
- An inability to generate FCF of at least USD750m annually
Positive: Not meeting the negative sensitivities for an extended period of time will result in the outlook being revised to Stable
The full list of ratings actions is as follows:
Fortescue Metals Group Limited
--Long-Term IDR Affirmed at 'BB+' with a Negative Outlook
--Long-Term Rating on Senior Secured Debt Affirmed at 'BBB-'
--Long-Term Rating on senior unsecured debt affirmed at 'BB'
FMG Resources (August 2006) Pty Ltd
--Senior secured notes due in 2022 affirmed at 'BBB-'
--Senior secured term loan due in 2019 affirmed at 'BBB-'
--Senior unsecured notes due in 2019 and 2022 affirmed at 'BB'
