ANALYST’S NOTE

Fortescue (FMG) FY18 results came in below market expectations, after FY18 underlying EBITDA of US$3.18bn missed consensus estimates of US$3.25bn by -2.1%. Top line revenue of US$6.89bn missed market estimates of US$7.05bn.

The Company reaffirmed FY19 shipment guidance of 165-173m tons. Compared to the prior corresponding period (pcp); revenue was down -18.5%, underlying EBITDA declined -32.9%, underlying NPAT was down -49.4% and EPS declined -58.1% – the result was owing to negative seasonal impacts from China driving the average iron ore price lower and higher shipping costs.

On a positive note FMG reduced its C1 cost by -4.0% and restructured its debt profile on investment grade terms reducing the financing costs by US$130m. Management noted that some China steel mills are expecting reduced impact from nation’s winter capacity curbs due to improvement in their pollution control, which we think is positive news for FMG.

FMG is responding to the shift to higher quality raw materials by advancing plans to introduce higher quality products of its own, West Pilbara Fines, in 2019 that will have 60% iron content versus current average of 58% (which is lower than benchmark 62%).

• Key FY18 headline numbers. Compared to the prior corresponding period (pcp): 1. Revenue was down -18.5% to US$6,887m due to a drop in average iron ore price to US$44/dmt from US$53/wmt in FY17. 2. Underlying EBITDA declined -32.9% to US$3.2bn. 3. Underlying NPAT was US$1.1bn, down -49.4%. 4. EPS was down -58.1% to US28.2cps. 5. A fully franked final dividend of A12cps was declared bringing the total FY18 dividend to A23cps representing a dividend payout ratio of 62%. 6. 170mt of iron ore was shipped. 7. C1 cost of US$12.36 per wmt, improvement of +4% compared to pcp. 8. Net debt increased +18.2% to US$3.1bn which included US$863m in cash. Revolving credit facility of US$525m remained undrawn, providing US$1.4bn of liquidity. 9. Cash from operations declined -39.7% to US$3bn. 10. Capital expenditure for FY18 was US$890m.
• 60% iron content strategy. FMG will introduce West Pilbara Fines product in FY19 from existing operations will mean higher margin and access to product until the full-scale completion of the Eliwana project. The Company provided little details on expected tonnes from the initial operations. The Eliwana is estimated to have maiden reserve of 213mt at an average of 60.1% iron grade.
• Improvement in costs. On a positive note, C1 operating costs saw improvement to US$12.36/wmt from US$13/wmt in FY17, a reduction of -4.9%. An increase in shipping cost to US$1.15bn from US$929m in FY17 was offset by reduced Government royalties to maintain total delivered costs at US$22/wmt over FY18.
• FY19 guidance. 1. C1 costs of US$12–13/wmt. 2. An average strip ratio of 1.5. 3. Shipments of 165-173mt. 4. Total capex of US$1.2bn allocated to sustaining capital (US$580m), Eliwana project (US$340m), exploration (US$100m), development expenditure (US$100m) and ore carriers and towage (US$80m). 5. D&A of US$7.10/wmt. 6. A dividend pay-out ratio in the range of 50 – 80% of NPAT. 7. West Pilbara Fines (60% iron ore content) to be launched in 2H19.