Fortescue Metals FMG AU S
November 29, 2015 - 10:35pm EST by
xanadu972
2015 2016
Price: 2.05 EPS 0 0
Shares Out. (in M): 3,100 P/E 0 0
Market Cap (in $M): 6,500 P/FCF 0 0
Net Debt (in $M): 6,000 EBIT 0 0
TEV ($): 12,500 TEV/EBIT 0 0
Borrow Cost: Tight 15-50% cost

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  • Commodity exposure

Description

I will keep this short since much of what I would mention has been discussed in prior commodity threads.  Admittedly, this is probably notthe best spot to short the stock (you could probably wait for ~AUD2.5 or so).  But, I believe FMG AU will ultimately prove to be a terminal short.

Valuation

At current prices, one is paying ~$US55 per tonne of annual production capacity at FMG whereas Rio is able to add brownfield capacity at sites with lower costs and higher sales price realizations at capex costs below $US10 mtpa in some cases (http://www.riotinto.com/ar2014/pdfs/iron-ore.pdf). The big 3’s IRRs are in the teens on many of their project even down into the low $US30s

 Supply

FMG is misguided in its portrayal of the global iron cost curve and its position thereon.  First, everyone is improving costs and much capacity is being added.  Second, FMG, and much of the sellside, touts C1 cash costs (I will admit FMG’s improvement in this area has been impressive).  What if your inferior ore sells for $US5-10 mpta less than competitors?  Touting a $US15-20 mpta C1 cash cost, comparable to competitors, seems to become not quite an apples to apples comparison.

FMG itself, in trying to brag about its movement in rank on the cost curve (which is valid and impressive), makes the perfect case that globally the cost curve continues to move down (everyone is lowering costs) and extend further to the right (more supply is being brought on at these lower levels).

http://fmgl.com.au/media/2669/151111_2015-agm-presentation.pdf

Additionally, FMG’s tired discussion of Chinese iron ore producers losing money (the pain of waiting for Godot, when massive amounts of Chinese production gets shuttered, never seems to come) is pretty inconsequential.   Chinese domestic iron ore market share is now sub-20%.  http://www.riotinto.com/documents/201504_RT_Chartbook.pdf

Lastly, as we have discussed at length on VIC, all of the big three are adding and continue to add capacity, admittedly with some hiccups.

Demand

I don’t believe that demand is a certain leg of the stool on which to hang a short thesis.  However, I will point out that demand out of China continues to disappoint relative to sellside expectations and the guidance of most management teams.  CISA continues to report negative steel demand with the latest report through October of down 6% while most of the sellside has expected flat demand.

Management

 

The press portrays Twiggy Forrest, FMG’s “storied” founder, as one of Australia’s most celebrated entrepreneurs.  His background, however, is marred by episodes of questionable judgment.  He founded FMG when he took control of Allied Mining, a floundering miner.  With an earlier entrepreneurial quest, Anaconda Nickel, Forrest embarked on an ambitious quest “to be the world's largest and most profitable producer of nickel and cobalt.”  This expansion was debt financed and ended with a distressed sale of Anaconda that left bondholders with only a 25% recovery.  Becoming “one of the biggest” sounds awfully similar to FMG’s game plan.

 

Risks:  

Well trafficked thesis.

Borrow costs weren't the cheapest last I checked.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise do not hold a material investment in the issuer's securities.

Catalyst

Continued capacity adds.

Further weakness in China or in the global economy.

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