Fortescue calls the end of easy finance for minersPUBLISHED: 15...

Fortescue calls the end of easy finance for miners


PUBLISHED: 15 hours 29 MINUTES AGO | UPDATE: 5 hours 0 MINUTES AGO

Mathew Stevens

When iron ore’s boldest rider starts welcoming the incipient investment reality check delivered by uncertain commodities prices and scarce credit, then you have to know that the times they have a-changed.

Mind you, the juniors condemned to “a more sensible assessment of future projects” by Fortescue’s Nev Power might prefer to greet this sudden embrace of the harsh new realities of financing the digging and marketing commodities with some scepticism.

Certainly the coincidence of Power’s public recognition of mining’s new normal and the completion of Fortescue’s next keystone funding package might justify some self-reinforcing incredulity.

Interestingly, to some degree, the structure of the mission-critical funding package Fortescue confirmed yesterday identifies some of the peculiar characteristics abroad in capital markets.

To lock in its $US1.5 billion package, Fortescue agreed to what looks like an immediate draw-down of a $US750 million syndicated term loan with the balance sitting in a revolving credit facility.

The underwriter and arranger of the facility is Bank of America Merrill Lynch and it is said to have been keen to trigger interest and fee payments on as much of this facility as possible, as early as possible.

Apparently this is becoming a trend. The banks are keen to lend but they are less thrilled by the uncertainties of big ticket draw-down facilities that require them to sustain liquidity but which the customer, in the end, is not using.

But, to return to our theme here, the fact is that the market would be quite wrong to invest self-interest as the sole motivation for Power’s message. In the end, he is saying nothing that the majors have not already recently observed.

The issue here is not that demand for raw materials is suddenly going to fade away. Fortescue, like its bigger, more established siblings in shovelling up the Pilbara, keeps reassuring us that it is selling everything it can dig up.

Mining margins are being squeezed by cost inflation and price deflation and that has triggered renewed caution across even those corners of the capital markets that have remained relatively open to the cause of minerals investment.

The cost of building projects is increasing incrementally as our skills-short economy struggles to digest the schedule of already committed capital works. At the same time, operational costs have risen by about 10 per cent annually over the past several years.

It should be remembered, of course, that the only reason Fortescue needed this new tranche of debt was that a $US1 billion cost blowout of a growth project that will see its capacity step up from 95 million tonnes a year to 155mtpa by 2013 (given all runs smoothly.)

The addition of $US1.5 billion of relatively short lending (the facility matures in 2013) to Fortescue’s otherwise pretty long profile will see its debt to EBITDA heading to three times by FY13.

Two weeks ago Moody’s assessed that while Fortescue’s credit profile had benefited from solid iron ore prices over the past two years, “the cost overrun will be a credit challenge, not only because of the resulting increase in financial leverage but also because it raises uncertainty about its ability to complete the project within the revised budget”.

But the company has long suggested that, given iron ore prices run within long-term forecasts, it hit a cash-flow inflection point at 95mtpa. All things being equal, at that point Fortescue can start funding its growth from cash flows. Fortescue is within spitting distance of a production run rate that says 95mtpa is achievable and that is why it is so comfortable in adding this 2013 maturity to its $US7 billion worth of US bonds that do not start rolling off until 2015.

Nonetheless, in concluding its observations on Fortescue’s plans to tap the debt markets Moody’s observed: “The cost overrun highlights the execution challenges faced by companies embarking on large-scale expansions and new projects, especially in resource-rich Western Australia and in the liquefied natural gas sector.

“As Australia’s massive pipeline of resources projects ramp up development, we expect the already intense competition for skilled labour, material and equipment to increase, thereby increasing the risk of cost overruns and schedule delays.”

While former South Australian treasurer Kevin Foley might not want to believe it, these are the investment realities that will shape the immediate future of what was supposed to be SA’s umbilical to the boom, the $US30 billion transformation of Olympic Dam from underground to open-cut copper and uranium mine.

Writing in Adelaide’s Sunday Mail, Foley suggested that BHP’s reluctance to pursue a project that seemed certain seven months ago was the result of “greedy” US investors getting “their hands on BHP’s mountain of cash” by forcing it to increase dividends rather than spend it on long-term capital projects.

This is simply not so. BHP is unlikely to lift its dividend this year. BHP is expected to spend $US40?billion on new and existing projects over the next two years. It will pay about $13 billion n dividends over that same period and $US17 billion or so in taxes.

You need to look to the cash-flow lines to understand BHP’s new reality. In 2011 cash flow topped $US31 billion. Deutsche Bank forecasts it will hit $US26 billion this year and drift lower over the next two years. Given the underlying market outlook and the fact that its existing expansion programs extend to 2014 and beyond, finding the resolve to commit to OD has become suddenly much harder.

There is considerable debate presently over whether or not BHP will meet the December deadline for approval required under its agreement with the state.

The indenture is an interesting document in that it does not proscribe the project that is to be built. That task falls to the layers of other approvals BHP requires, most importantly environmental pacts.

So there is a sense that BHP has rather more options than some might imagine. We have, in the past, wondered whether starting smaller and finishing faster, when BHP appears to have more cash flow wiggle room, might not provide a profitable path for negotiation.

Given that ploughing ahead with last year’s plan doesn’t seem to be on the cards, the other options appear to be letting the indenture lapse (triggering a new round of negotiation over things like royalty rates and land access) or seeking an extension of the agreement.

Striking a deal

CSL’s decision to seek precedent-setting Fair Work Australia intervention in strike action that threatened New Zealand’s supply of plasma-based medicines has delivered potent results.

CSL went to FWA last Wednesday seeking orders to end industrial action under section 424 of the act , which aims, among other things, to protect the health of the population.

The twist was that CSL was seeking to defend the health of a population outside Australia because union bans on processing internationally sourced plasma left NZ’s supply of some medicines at risk. The application has proved a productive circuit breaker with FWA conciliation producing a revised pay offer that has apparently been endorsed by the three unions at CSL’s key Broadmeadows fractionation plant. The union has suspended its campaign of work bans and strike action.

CSL gave ground on its pay offer. The addition of 0.25 per cent to each of the three annual rises (4 per cent, the 3.5 per cent for the final two years) compounds to a better than 250 basis points lift in pay over the life of the EA. And the workers will get a $1000 sign-on bonus if they accept the offer. In return CSL has deflected union moves to make issue of the sort of incidental conditions that have become sticking points in a collection of headline disputes around the nation.

One union had sought the opportunity for redundancy if the company altered rosters while others were seeking an extension of entitlement to rostered days off, the increase of super contributions to levels above government mandate and the extension of embedded CSL wage rates to contractors.

The Australian Financial Review