Fortescue’s Iron Bridge To Underpin Blend

This story features FORTESCUE LIMITED. For more info SHARE ANALYSIS: FMG

The Iron Bridge magnetite project has strong economics, brokers acknowledge, but this depends heavily on Fortescue Metals obtaining a significant premium to benchmark pricing.

-Far more compelling than existing WA magnetite projects
-Expected to raise overall product quality for Fortescue Metals
-Yet incremental shareholder value more difficult to ascertain
 

By Eva Brocklehurst

Blending opportunities are to the fore as Fortescue Metals ((FMG)) and partners move forward with the 20mtpa Iron Bridge magnetite project. Iron Bridge is located south of Port Hedland in Western Australia and has a large resource located in four deposits. The project has strong economics, brokers accept, although this depends heavily on the ability to sustain a significant premium to 62% iron benchmark pricing.

Macquarie incorporates the development scenario into its estimates for the first time and envisages potential for the higher grade material to blend with lower-grade products over time and improve overall realised prices.

The company's price realisations have been steadily improving. Macquarie notes realisations for the lowest-quality product, Super Special Fines, have spiked in recent weeks and are now at similar levels to the better-quality products. Fortescue Blend has also experienced a step up in realisations since mid February.

The broker calculates Iron Bridge magnetite is likely to receive a price of over US$100/dmt at current benchmark prices. The anticipated production rate is higher than the broker expected, while capital costs are lower.

On Credit Suisse's calculations, the project requires realised pricing of around US$80/t in order to generate positive net present value (NPV). As a caveat, the broker acknowledges NPV estimates may be the wrong metric to use to analyse Iron Bridge, given the large endowment, time to first production and inability to effectively quantify the blending opportunity.

The main question, therefore, is whether the lower-than-expected capital intensity can achieve expected recoveries, at the stated costs, when scaled up from the current pilot plant.

FMG Iron Bridge (88% Fortescue Metals, 12% Baosteel) owns 69% of the project in partnership with Formosa, which has 31%. Fortescue Metals will be operator and control marketing rights.

The company will fund its US$1.85bn share through a combination of specific project debt as well as operating cash flow. The partners have already spent $500m on a full-scale module demonstration plant. Morgan Stanley believes the debt is manageable and Fortescue Metals can comfortably fund its project share from the balance sheet.

Returns

Citi finds the internal rate of return (IRR) of 10.4%, modelled using a long-term iron ore price of US$55/t and 67% concentrate price of US$65/t, is modest and the company will need to achieve better than this to generate an acceptable return.

Still, the broader blending opportunities are notable. The company considers it relatively straightforward to blend the full 20mtpa into its products at Port Hedland and asserts, if it chooses to blend the concentrate into its current product mix, this would lift average grades for more than 50% of production to over 60% iron.

Credit Suisse acknowledges being impressed with the numbers being crunched, assessing Iron Bridge is far more compelling than existing magnetite projects in Western Australia. That said, the broker's medium-term view on pricing is also more subdued and the payback and returns are, therefore, more modest.

Timeframe

The decision to proceed will allow growth of higher-grade production. First production at Iron Bridge is expected in 2022 with a full ramp up in 12 months. All-in sustainable costs (AISC) are flagged at US$45-55/dmt and the mine life is assessed at over 20 years. Capital cost is envisaged at US$2.6bn.

Credit Suisse highlights the company's track record in delivery, although notes the mid range of AISC does not allow for additional capital that may be required for new power generation sources, nor any contingency. Fortescue Metals is confident that third-party sources can fulfill power requirements and, if they cannot, the company and partners would build additional power at additional project expenditure.

Deutsche Bank has upgraded Fortescue Metals to Hold, after further news on iron ore supply disruptions from Cyclone Veronica in WA, pointing out there are not many businesses where value is added by producing less.

Iron ore prices have continued to head higher, supporting the dividend potential and the company's bottom line. The broker observes the downside has been limited, as the market again adjusts to changing supply-side circumstances.

Macquarie assesses the rapid rise in iron ore prices has resulted in a spot price valuation materially above its base case. The broker estimates the share price is currently factoring in a long-term realised price of less than US$45/dmt, although this assumption benefits from current weakness in the Australian dollar and low shipping rates.

There are two Buy ratings, four Hold and two Sell on FNArena's database. The consensus target is $6.84, suggesting -12.3% downside to the last share price. Targets range from $5.50 (Morgans, yet to comment on the update) to $8.30 (Macquarie). The dividend yield on FY19 and FY20 forecasts at present FX values is 10.8% and 9.2% respectively.

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