Fitch Ratings Affirms Fortescue at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) Fitch Ratings-Sydney-August 23: Fitch Ratings has affirmed Australia-based iron ore miner Fortescue Metals Group Limited's Long-Term Issuer Default Rating (IDR) at 'BB+'. The Outlook on the IDR is Stable. At the same time, Fitch has withdrawn Fortescue's senior secured rating following the full repayment of its senior secured bonds in June 2018. A full list of ratings can be found at the end of this commentary. The affirmation reflects Fortescue's substantial mining assets and position as a low-cost producer to Asia (predominantly China). However this is counterbalanced by weaker profit margins. The margins were trimmed in the financial year ended 30 June 2018 (FY18) following a drop in Fortescue's realised price to 64% (FY17: 77%) of the benchmark price (62% Fe Platts CFR Index) - reflecting the lower iron content in its blend compared with the benchmark (58% versus the benchmark 62%). Fitch does not expect Fortescue's realised price to return to historical averages of around 85% in the short term, as demand for high iron ore content amongst Chinese steel mills will remain strong due to environmental controls and wide ongoing profit margins for steel. Nevertheless, we believe that the company's low-cost base will support its ongoing profitability and cash flow generation over this period. Fortescue expects to benefit from improved production flexibility, which also allows it to introduce a new 60% Fe product from 2H19 - West Pilbara Fines - on account of the development of the Eliwana mine in Australia's north-west Pilbara region. Fitch expects that this will help to reduce some of the average discount applied across its portfolio over the longer term, and have a positive effect on margins - with the mine also helping the company retain its status as a low-cost producer over the longer term. Fortescue's leverage credit metrics remain strong for its rating, even including the impact of the Eliwana project which the company expects to cost USD1.3 billion and be funded from operating cash flows. The removal of the last of the secured debt in Fortescue's financial structure in FY18 following the repayment of its US dollar senior secured bonds, is also a positive development for Fortescue's credit profile. KEY RATING DRIVERS Lower Realisation Weakens Profitability: Fortescue's cost of mining and shipping iron ore to its main market in China compares well with other major low-cost iron-ore producers such as Rio Tinto (LON:RIO) Ltd (A/Stable) and BHP Billiton (LON:BLT) Limited (A+/Negative). However, its profitability is not as strong due to its lower price realisation. The company's mines were positioned in the second and lower-third quartile of the iron ore global cost curves in 2017, according to CRU's business cost model, which adjusts for grade and price realisation. Fitch has amended the sensitivities to capture this weaker position on the cost curve, when adjusted for grade and price realisation, relative to peers. Fortescue has historically been able to achieve price realisation of around 85% of the benchmark. However, this declined to 64% in the financial year ended 30 June 2018 (FY18). Fitch expects this figure to improve from FY20 following the planned introduction of a 60% iron-grade product in 2H19. Further Cost Improvements Challenging: Fitch expects the company's C1 costs (which include the cost of mining, processing, port and rail) to average around USD13 per wet metric tonne (wmt) in FY19, which is at the top end of the company's guidance of USD12-13 per wmt. This recognises that factors beyond Fortescue's control can have an impact, such as crude oil prices and the Australian dollar exchange rate. Investment-Grade Credit Metrics: Fortescue's credit metrics are strong for its rating, and we expect FFO adjusted net leverage to remain below 2.5x over the next four years. This includes the impact of the USD1.3 billion Eliwana mine project, which will be financed by operating cash flows, as well as increased shareholder returns following deleveraging since FY13 - where the company repaid USD10.4 billion of debt, including USD500 million in FY18. Flat Iron-Ore Prices: Fitch kept its expectation for benchmark iron ore prices in May 2018 at USD55 per dry metric tonne (dmt) for 2019 and increased our expectation to the same level thereafter. This is based on our expectations that the global iron-ore market is likely to remain well supplied, with new capacity continuing to be added amid weaker demand. This is lower than Fitch's expectation of USD60 per dmt in 2018, as we expect prices to continue to fall in line with market fundamentals over the longer term - and drives our conservative projection of a drop in Fortescue's EBITDA to USD2.5 billion for FY19. DERIVATION SUMMARY Fortescue is amongst the leading low-cost iron ore producers globally, which positions it well against peers. Fortescue has a similar business risk profile to Brazil's Vale S.A. (BBB+/Stable) in that both are highly exposed to a single commodity - iron ore - and have comparable financial risk profiles. However, the rating differential reflects Vale's significantly stronger profitability on account of its high Fe content, despite Fortescue benefitting from its proximity to China and lower sovereign risk than Brazil. Anglo American (LON:AAL) plc's (BBB-/Stable) rating reflects its significant commodity exposure and geographic diversification as one of the world's largest mining companies. This is despite capturing its high exposure to South Africa, which is a challenging environment with an active, unionised workforce and comparatively high wage and electricity cost inflation. Fortescue, like Anglo American, has improved its financial profile as it prioritises balance-sheet strength. However, Fortescue's weaker profitability is reflected in the one-notch difference between the ratings on the two companies, as a result of lower price realisation due to the iron content of its ore being lower than the benchmark. KEY ASSUMPTIONS Fitch's Key Assumptions Within Our Rating Case for the Issuer - Benchmark iron-ore price to average USD60 per dmt for 2018 and USD55 per dmt thereafter - Fortescue's C1 costs to be around USD13 per wmt in FY19 and FY20 - Capex of around USD1.2 billion for FY19, in line with company guidance - Dividend payout ratio to remain at the upper end of Fortescue's guidance of 50%-80% of net profit after tax from FY19 to FY22 RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Maintaining FFO adjusted net leverage at less than 2.5x on a sustained basis (FY18: 1.6x). - Cost position of key operations, adjusted for grade and price realisation, moving to the 2nd quartile on a sustained basis. - Maintaining neutral free cash flow on average on a sustained basis. Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO adjusted net leverage sustained at higher than 3.0x on a sustained basis. LIQUIDITY Comfortable Liquidity, Debt Structure: Fortescue had USD863 million of cash on hand at FYE18 and a USD525 million undrawn revolving credit facility. It has no debt maturities until 2022, when the first tranche of the unsecured notes issued in FY17 of USD750 million falls due, together with the USD1.4 billion term loan. Total debt of USD4.0 billion at FYE18 (including finance leases) does not include financial maintenance covenants. This provides the flexibility to reshape its capital structure, which is supported by its strengthened financial credit profile. FULL LIST OF RATING ACTIONS Fortescue Metals Group Limited - Long-Term Issuer Default Rating: Affirmed at 'BB+'; Outlook at Stable - Long-term rating on senior unsecured debt: Affirmed at 'BB+' - Long-term rating on senior secured debt: Affirmed at 'BBB-' and withdrawn FMG Resources (August 2006) Pty Ltd - Senior unsecured notes due 2022, 2023 and 2024: Affirmed at 'BB+' Contact: Primary Analyst Kelly Amato, CFA Director +61 2 8256 0348 Fitch Australia Pty Ltd Level 15, 77 King Street, Sydney, NSW, 2000 Secondary Analyst Leo Park Associate Director +61 2 8256 0323] Committee Chairperson Vicky Melbourne Senior Director +61 2 8256 0325 For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Media Relations: Leslie Tan, Singapore, Tel: +65 6796 7234 , Email: leslie.tan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10023785 Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10024585 Sector Navigators (pub. 23 Mar 2018) https://www.fitchratings.com/site/re/10023790 Additional Disclosures Dodd-Frank Rating Information Disclosure Form https://www.fitchratings.com/site/dodd-frank-disclosure/10042307 Solicitation Status https://www.fitchratings.com/site/pr/10042307#solicitation Endorsement Policy https://www.fitchratings.com/regulatory ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTPS://WWW.FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. 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