Debt Concerns For Iron Ore Miners

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

-Anxiety around miner debt grows
-Iron ore prices to remain weak
-Mitigated somewhat by AUD slide
 

By Eva Brocklehurst

Conditions remain tough in iron ore mining. Fortescue Metals ((FMG)) has decided to forgo a refinancing of its debt because it was unable to obtain terms that were favourable enough, despite an investment grade rating for its US$2.5bn senior secured note offer. Hence, the miner’s debt structure is unchanged and the first debt repayment, a US$1bn note, remains due in April 2017. This puts the spotlight back on the sustainability of cash flow and the trajectory of iron ore prices.

Morgan Stanley acknowledges the cancellation of the refinancing has put a damper on sentiment and increases anxiety around the company’s debt levels. The broker maintains that even if refinancing were possible, Fortescue makes only modest free cash flow on spot iron ore prices and this restricts its ability to repay debt if low prices persist. Morgan Stanley calculates that a mid US$70/t iron ore price is required to enable repayment of all its debt.

While the deferral may reflect negatively on Fortescue’s ability to raise additional debt, UBS highlights the fact that the company’s near-term liquidity is sound. From a cost benefit perspective, pursuing a refinance strategy at an interest rate well above the average interest rate on existing facilities must be weighed against the existing maturity profile, in the broker’s opinion. That said, there is a risk, UBS acknowledges, that the company’s ability to refinance favourably may continue to diminish if iron ore prices remain below US$60/t.

The failure to complete the debt refinancing disappointed Macquarie and this is expected to maintain downward pressure on the share price in the near term, particularly if iron or prices fall in line with the broker’s forecasts. Since the debt restructure was announced earlier this month the iron ore price has fallen to US$57/t (and now to 54.50) from US$62/t. In tandem with this development, Macquarie has reviewed its iron ore price forecasts and updated its exchange rate outlook. A weaker Australian dollar has mitigated the impact of falling iron ore prices somewhat. Still, further supply additions from the major miners has combined with cost cutting to flatten the cost curve.

Macquarie has reduced its iron ore price forecasts by 11% and 16% and its AUD/USD rate forecasts by 4% and 13% for FY15 and FY16 respectively. The broker expects iron ore prices will trough below US$50/t in the third quarter of this year and remain in a US$55-60/t trading range for the subsequent 15 months. In Australian dollar terms the decline is likely to be less severe, with prices expected to dip in the next six months but rebound as the currency weakness outpaces a recovery in the iron ore price. Further down the track iron ore prices are expected to recover to US$70/t in 2017 and return to US$80/t by 2020.

Incorporating these changes means the broker forecasts greater losses for the smaller pure iron ore miners – Mount Gibson ((MGX), Atlas Iron ((AGO)) and BC Iron ((BCI)) over FY15 and FY16. Given the relatively short mine lives of all three players the impact beyond FY17 is considered marginal. Grange Resources ((GRR)) is expected to continue to report modest profits as it is benefitting from strong pellet premiums.

The broker maintains that all four iron ore producers will be loss making in the third quarter – when the iron ore price is expected to trough. Downward pressure on the mid cap producers is expected to continue, exacerbated by the commissioning of Rio Tinto‘s ((RIO)) 360mtpa expansion in the next few months. Macquarie downgrades its recommendation on BC Iron to Underperform from Neutral but maintains a Neutral rating for Mount Gibson and Grange Resources, as both are currently trading below their cash backing. The broker already has an Underperform rating for Atlas Iron.
 

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