By Elisabeth Behrmann - Apr 30, 2012
BLOOMBERG
With Fortescue Metals Group Ltd. (FMG)’s earnings poised to almost triple, companies looking for a gateway to ship iron ore to China can still acquire the Australian producer at half the valuation it fetched a year ago.
Fortescue, already the world’s fifth-largest iron ore supplier, is adding mines, railways and port capacity to almost triple annual output to 155 million tons by June 2013. While analysts project its profit will surge nearly threefold to $2.8 billion in the 2014 fiscal year from current levels, Fortescue is still trading at 12.2 times earnings, 50 percent less than a year ago, according to data compiled by Bloomberg.
The $18 billion company, which sells almost all of its iron ore to China, would appeal to Anglo American Plc (AAL), the Glencore International Plc-Xstrata (XTA) Plc combination and Teck Resources Ltd., according to RBC Capital Markets, with steel production on the mainland forecast to increase more than 50 percent by 2025. While any suitor would need to win the backing of founder and biggest shareholder Andrew Forrest, they could offer a 43 percent premium and still pay only the median earnings multiple of mining takeovers in the last five years for the Perth-based company, data compiled by Bloomberg show.
“If you’re serious about getting into iron ore, this is probably the best way that you can do it,” said Chris Drew, a Sydney-based analyst at RBC. “You’ve got an appealing growth profile lined up straight ahead in front of you. There’s a substantial asset base, a reasonable cost base, all the infrastructure you need. It’s pretty compelling.”
Fortescue rose 1.6 percent to A$5.72 a share as of 2:20 p.m. in Sydney today. Australia’s benchmark S&P/ASX 200 Index was up 0.7 percent.
‘Like Gold’
Yvonne Ball, a spokeswoman for Fortescue, declined to comment on a possible sale of the company.
Founded in 2003 with a mine called Cloudbreak in Western Australia’s Pilbara region, Fortescue made its first iron ore shipment in May 2008, and reported revenue of $139 million for the twelve months that ended in June of that year. With the company targeting production of 55 million tons of iron ore this year, analysts estimate revenue will reach $6.7 billion, a 48- fold increase since 2008, data compiled by Bloomberg show.
Now the third-largest iron-ore miner in Australia after BHP Billiton Ltd. (BHP) and Rio Tinto Group (RIO), Fortescue generated 97 percent of its revenue from customers in China last year, according to its annual report. The company has its own railroad and about a quarter of the shipping capacity at Port Hedland, the world’s biggest terminal for iron ore shipments.
“That port capacity at Port Hedland is like gold,” said Peter Chilton, an investment analyst at Constellation Capital Management Ltd. in Sydney. “Plus there’s the potential for another port and more rail line.”
Doubling Capacity
Fortescue is spending $8.4 billion, including on rail and port infrastructure, to raise annual output to 155 million tons a year by 2013. The company, which last November set a record for the largest iron-ore shipment to leave Port Hedland, plans to more than double capacity at the port and is expanding its rail network with an 81 mile rail spur to its Solomon mine.
“There’s no shortage of iron ore around the world,” said Peter Strachan, who heads Perth-based independent advisory firm StockAnalysis. “What there is is a shortage of iron ore which is linked to a railway line and a port.”
Fortescue, whose $18 billion market value means that a takeover would be the largest acquisition of an Australian mining company ever, could be a target for London-based Anglo or the merged combination of Glencore (GLEN) and Xstrata, said Prasad Patkar, who helps manage about A$1 billion ($1 billion) at Platypus Asset Management Ltd. in Sydney, citing its port and rail assets.
‘Diversity of Geography’
“They’re all underweight iron ore in their portfolios and they have expressed a desire in the past,” to add iron ore, Patkar said in a telephone interview. For Anglo, which already mines iron ore in Brazil and South Africa, a purchase of Fortescue would add “diversity of geography,” he said.
Spokesmen at Anglo, Glencore, Xstrata and Teck Resources all declined to comment on possible interest in Fortescue.
Anglo, which held almost $12 billion in cash at the end of December, continues “to examine M&A opportunities as one of our strategic priorities,” Chairman John Parker wrote to investors in the company’s annual report in March. The company, which plans to raise iron ore production to 80 million tons by 2014, is struggling with budget overruns and delays at its Minas Gerais iron-ore project in Brazil. In December, Anglo raised its cost projection on that project for at least the fourth time to as much as $5.8 billion, more than double an initial estimate.
A combination of Glencore and Xstrata, who agreed in February to a merger that will create a commodities trading and mining giant, is likely to prompt other global mining companies to seek acquisitions to boost sales to BRIC economies, Bank of America Corp. analyst Oscar Cabrera wrote in a research note this month, referring to Brazil, Russia, India and China.
‘One Fell Swoop’
Zug, Switzerland-based Xstrata bought iron ore deposits in Mauritania for $516 million last year and co-owns the $6 billion Zanaga project in the Republic of Congo. Baar, Switzerland-based Glencore has an iron ore sales accord with a producer in Sierra Leone, and a holds a stake in a project in Republic of Congo. The company is studying acquiring iron ore mines, Chief Executive Officer Ivan Glasenberg said last year.
“Xstrata’s buying small-scale assets and building their own presence,” said RBC’s Drew. “They could look at doing it in one fell swoop and buy Fortescue.”
Canada’s Teck Resources (TCK/B), with $4.3 billion in cash, has also said owning iron ore mines would be beneficial, given that the company already produces coking coal, the other key raw material for steel making. Teck Resources may have bought a 2.89 percent stake in Fortescue, the Australian Financial Review reported in February, without identifying its sources.
‘Our Plate’
“Iron ore would be a good fit with our portfolio,” Chief Executive Officer Don Lindsay told analysts Feb. 28. “We’ve said we don’t want to get into the iron ore business by project development, because as you can see we have quite a number of projects on our plate right now.”
While the Vancouver-based company has expressed an interest in adding iron ore mines, it has had a hard time finding attractively valued assets close to China and already in production, Lindsay said.
That may have changed with the drop in Fortescue shares, according to Bank of America’s Cabrera.
“A combined Teck Resources and Fortescue mining entity would be in the sweet-spot of BRIC economies’ demand,” the Toronto-based analyst wrote in an April 9 note.
Opportunity for Buyers
Analysts predict Fortescue’s net income will climb to $2.8 billion by the year ending June 2014, from the $1 billion reported last year, estimates compiled by Bloomberg show.
Even with Fortescue projected to post record profit and sales in each of the next three years, the company’s shares are trading at 12.2 times earnings, down from 24.3 times 12 months ago, according to data compiled by Bloomberg. Fortescue retreated 35 percent last year as concern that Europe’s sovereign debt crisis and a possible slowdown in China would curb demand sent iron-ore prices to a 22-month low of $116.90 per ton in October.
The company’s shares have rebounded as China’s steel mills increased output to a record 61.58 million metric tons in March. New yuan loans that month surged to the most in a year and money-supply grew unexpectedly after Premier Wen Jiabao moved to bolster the economy by cutting banks’ required reserves and helping small companies get funding.
Fortescue’s valuation has created an opportunity for “longer-term bulls on iron ore,” said RBC’s Drew.
Third Richest
With Fortescue producing iron ore for less than $50 a ton on average, Morgan Stanley forecast in March that average iron ore prices will stay above $120 until at least 2017 as production fails to keep up with demand. Steel output in China will grow to as much as 1.1 billion tons by 2025, from about 700 million tons currently, BHP said last month.
Any buyer would need to win support of Fortescue chairman Forrest, who told journalists in 2008 that he would load his first shipment onto a train with a shovel if he had to. He founded the company in 2003, after his previous major mining venture -- a nickel company called Anaconda Nickel Ltd. -- left some U.S. bondholders with only 26 cents for each dollar they had invested.
A 32 percent stake in Fortescue has made Forrest Australia’s third-richest person with an estimated fortune of $5.3 billion, according to Forbes magazine. Still, he may be tempted to move on to the next venture, according to Alex Passmore, an analyst at Patersons Securities Ltd.
‘The Right Price’
“If you offered him the right price, he could deliver you control of the company,” Perth-based Passmore, who has a 12- month price estimate of A$7.40 on the stock, said. Forrest’s other business interests include nickel and gold, chairing Poseidon Nickel Ltd. (POS) and buying a 19.9 percent stake in Australian gold producer Apex Minerals NL (AXMDA) on April 24.
Forrest may agree to a merger paid for in shares of the buyer, so that his fortune is less dependent on a single product and a single consumer, according to Matthew Whittall, a resources analyst at Renaissance Capital Ltd. in Hong Kong.
“There’s an argument that the company could look to diversify,” he said in a phone interview. “Andrew Forrest is hugely exposed to iron ore and the future of iron ore.”
A drop in iron ore prices to $100 per ton or less would push Fortescue’s stock price “materially lower,” Jim Chanos said at a New York conference this month hosted by Grant’s Interest Rate Observer, according to an April 20 note from Grant’s. Chanos, founder of the hedge fund Kynikos Associates LP, was one of the first investors to bet against Enron Corp.
‘Highly Profitable’
Fortescue would remain highly profitable even at prices of $90 or $100 a ton, the Australian newspaper said today, citing Forrest’s response to Chanos’ comments.
At current levels, a buyer could pay 43 percent more than Fortescue’s price of A$5.63 a share at the end of last week and still offer just the median multiple, of 17.4 times earnings, paid in 29 takeovers of mining companies larger than $1 billion, over the last five years, according to data compiled by Bloomberg.
Analyst forecasts for accelerating earnings growth mean that a buyer paying A$12 a share next year, or more than double the current stock price, will still be offering less than the median valuation, the data show.
Fortescue’s margin on earnings before interest, taxes, depreciation and amortization will remain at about 50 percent for the “medium term,” Bank of America’s Cabrera wrote earlier this month.
“Fortescue is eminently takeover-able,” Strachan at StockAnalysis said. “They’re in production, they’re cash-flow positive, they’ve got long-life reserves. They have infrastructure, and that’s key.”
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