Fortescue has solved its debt problem with - wait for it - more debt and, equally worrying, it's iron ore price expectations for next year are now out of kilter with those of the federal government.
Fortescue's thumping $US4.5 billion refinancing deal was well received yesterday and the company's shares were up again this morning, rising another 17¢ or 4.9 per cent to $3.67 by about 11.30am.
CBA analyst Matthew Hodge wrote that Fortescue had "dodged a large bullet with a miraculous line of new debt". The new secured facility was fully underwritten by Credit Suisse and JP Morgan, replaced all bank debt and finance leases, and provided extra headroom to continue the expansion to 155 million tonnes in fiscal 2014, he wrote.
But the increase in Fortescue's borrowing capacity carries plenty of risk. As at June 30, Fortescue had total debts of $US10.4 billion, of which $US1.8 billion was undrawn. In August it added $US1.5 billion in debt, provided by Merrill Lynch, and drew that loan down fully, lifting its total borrowing capacity to to $US11.9 billion. Yesterday the company raised that borrowing capacity again, adding another $US900 million to take the total to $US12.8 billion. The next quarterly update will tell us how much Fortescue has drawn down its borrowings.
Last night Deutsche Bank's analysts estimated Fortescue now had available funds of $US6.7 billion after the refinancing but cautioned that its profit margins remained weak at current iron ore spot prices, which are still low at around $US105 a tonne.
"When including royalties, shipping and corporate costs, we calculate an all-in cost of US$65 a tonne for Fortescue," the bank's analysts wrote. "Given Fortescue's high leverage, we believe it is prudent to include interest expense of circa US$8 a tonne. At spot [prices] after adjusting for moisture, grade and impurities, we estimate Fortescue achieves a circa US$12 a tonne margin."
If capital expenditure was included - say, $US20 a tonne - Fortescue was cash flow negative, Deutsche wrote.
That may be manageable in an expansion phase if you think the iron ore price is headed back over $US120 a tonne, as Fortescue chief executive Nev Power said yesterday.
But as BusinessDay reported this morning, the federal government's own Bureau of Resources and Energy Economics doesn't agree. It expects the iron ore price to drop 20 per cent from an average of $US126 a tonne this year, to $US101 in 2013, remembering Australian production has more than doubled since 2002-03 and supply is catching up with demand. The relevant chart is on page 33 of the BREE quarterly at http://www.bree.gov.au/documents/publications/req/BREE-REQ-Sept2012.pdf.
BREE expects iron ore contract prices in the first half of next year will reflect the same low spot prices that are expected for the rest of 2012. It's not until the second half of 2013 that BREE tips contract prices for iron ore will increase, based on Chinese stimulus spending generating an increase in steel-related consumption demand.
Until that rebound kicks in, it's going to be a nervous wait for Fortescue.