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05-04-2015, 12:21 PM
Iron fist to fore
1781 words
2 Apr 2015
The Australian Financial Review
AFNR
English
Copyright 2015. Fairfax Media Management Pty Limited.
Resources
In an exclusive interview with AFR Weekend, Andrew Forrest dismisses the doubters but concedes his mistake in using the word 'cap' during the present imbroglio, writes Jennifer Hewett.
Note to the market. The irrepressible Andrew Forrest has lost none of his trademark confidence in Fortescue, nor his enthusiasm for China's continued growth and economic potential.
Now, as always, Forrest is convinced the doubters are wrong and will be proven so. Fortescue's future, he tells AFR Weekend, is assured. The company is on a relentless and successful race to drive down costs, so far keeping just ahead of the equally relentless decline in the price for iron ore.
"Any analyst without a vested interest will tell you Fortescue is still doing well right now and, as every day goes past, is becoming more competitive," Forrest says with typical fervour.
During a frenetic trip to China, he was constantly in and out of meetings with senior Chinese political and business leaders in Beijing and Shanghai and at the annual Boao forum held in China's south.
The recent company board meeting was held in China and the FMG signs at Boao were almost as ubiquitous as Forrest's bouncing presence. He was one of only four people asked to give a speech to President Xi Jinping at Boao at a meeting of global business - where Forrest invited Xi to visit his company. Their firm handshake was covered on Chinese television. Forrest knew Xi long before he became President.
The leader's office has asked Forrest's senior business leaders group to become a semi-official think tank between China and Australia. And rather than China being alarmed at his comments about curbing production to drive up the iron ore price, Forrest says he is repeatedly asked what the fuss in Australia is all about.
Yet, Forrest also knows the fuss in Australia won't die down while the price is so low - and likely to keep falling. The real questions are how low it will go and for how long. Plenty of analysts are marking down Fortescue's ability to survive the carnage, as they did repeatedly while Forrest built the company from an idea into the world's fourth-largest iron ore miner in super quick time.
Despite the risks, an innovative Forrest has always outsmarted doomsayers - able to keep building a massive empire while being told by "experts" why Fortescue would fail.
Yet Forrest's conviction he can keep doing so doesn't lessen his fury and frustration at what he argues is a catastrophically counter-productive strategy from Rio Tinto and BHP Billiton. He believes their determination to flood the market with supply - and to keep on expanding, no matter the impact on the price - is a desperate race to the bottom where no one wins.
Apart from being so damaging to Fortescue's bottom line and share price, he insists it devastates our national interest and "incinerates tens of billions of dollars worth of value" for BHP and Rio shareholders, too.
"Rio is competing with BHP to smash global investment returns for their shareholders, as well as tax and royalty receipts for the federal and state governments," he says. "Their statements that they will expand at any price drives down that price in their endeavour to drive everyone else out of business.
"When has market share strategy over shareholder returns ever helped a company? What BHP and Rio are doing is buying, at massive cost, expansion capacity even when the higher commodity price justification for such investment has evaporated. It's as though they are stuck in a time warp, unable to move with the changed circumstances. Over time, it will be seen for what it is - egos before commonsense."
Right now, though, market commonsense sees it as making Fortescue vulnerable. That's mainly due to its still higher cost of overall production for a product that gets about a 15 per cent discount due to lower quality. Combine that with the company having $US9 billion ($11.8 billion) of debt and the semi-permanent market presence of big "shorters" of the stock, and it helps explain why the FMG share price has fallen more than 60 per cent since last year.
Fortescue's total all-in costs are around $US43.50 a tonne, for example. The target is to get that down further to between $US35 and $US37 a tonne this year. And FMG always prides itself on its ability to consistently exceed its targets. "That will make Fortescue's cash costs at least as competitive as BHP and Rio, so you have to ask what their strategy is, because it's not about making adequate profits," Forrest fumes.
But when Fortescue is receiving only about $US43-$US44 a tonne for its ore at today's low prices, Forrest knows there's no margin for error. That's even tougher when Fortescue expects the price fall to continue, thanks to its competitors' views on increasing production. It obviously affects sentiment, especially given heavy trading in a relatively new Chinese iron ore futures market. It is a vicious price loop for the world's four major producers, including Brazil's Vale, not to mention the rest of the industry.
Such commercial devastation is compounded by what Forrest calls the Chinese economy "taking a breather" as the economy slows and new environmental restrictions and Xi's crackdown on corruption work their way through the system. That is even though demand for steel, Forrest insists, will stay strong long term.
This still requires staying alive in the short term.
Some analysts and investors in BHP and Rio are effectively calling this a Darwinian process of natural selection where only the fittest can and should survive. But others are being persuaded that Forrest's logic is right - that there can be only losers, most particularly Australia. It's not as if BHP Billiton and Rio Tinto have not made major strategic errors of judgment in the past.
Essentially, the BHP and Rio national interest argument is that if they don't increase tonnage from Australia, other countries will. And, in commercial terms, that the world's two lowest-cost producers still make money for shareholders on every tonne, no matter how low the price sinks. Forrest scoffs at such logic. His most polite term is that it's "sadly fallacious".
"When they are saying other people will do it if we don't, they are actually talking about themselves," he says.
He argues no other company in the world could now invest to build production unless the capital had already been committed at boom time price - as with Gina Rinehart's Roy Hill Mine in the Pilbara and Vale's new mine in Brazil. According to Forrest, it is overall returns that matter, rather than considering only the profit on each extra tonne. Rio and BHP are destroying those with their expansion plans, he says, as well as everyone else's.
"No one would contemplate investing to expand in collapsing commodity price markets, apart from those who have no interest in shareholder wealth or are engaged in market-share-at-all-cost pricing," he says. "All the new projects were financed when prices were higher. Commercial capital would now be too expensive.
"So no one else will replace those tonnes. You need a price of at least $US100 a tonne to expand, and the global banking sector is so disillusioned with the lack of leadership and the return on all capital, rather than just incremental capital, that there is a flight of capital from the resources sector."
That market pressure will only intensify, especially if the iron ore price has further to fall. It was Forrest's disgust at his competitors' strategy that led to an off-the-cuff response at a Shanghai dinner that the majors should agree to "cap" production.
He now concedes it was a mistake to use the word "cap" because of potential anti-competition implications. But Fortescue was stunned at the instant over-reaction of Rod Sims at the Australian Competition and Consumer Commission, suggesting this could mean illegal collusion or attempts to form a cartel.
Rio's Sam Walsh dismissed Forrest's comments as "hare-brained". But Rio and BHP could only have enjoyed the furore. There was never the slightest possibility either would take the advice to stop plans to lift production to 360 million tonnes and 290 million tonnes respectively.
After an early flurry of confected concern by Treasurer Joe Hockey, the federal government is also keen to stay silent, saying it's for the market to sort out.
This sort-out is happening - but at enormous and growing cost to government budgets and Australian taxpayers. And for what reason, exactly? Forrest describes this as the "Walsh effect" - simply driving down returns. West Australian Premier Colin Barnett is as vehemently contemptuous as Forrest of Rio and BHP's tactics.
To Forrest's critics, of course, FMG can't escape responsibility for oversupply by ramping up production to 165 million tonnes per annum, with the potential to lift to 180 million tonnes. Forrest justifies this by describing it as past investment when it's the future investment in expansion that's the problem.
But it's now Fortescue's problem that's most acute. So, as well as savagely pruning costs, Forrest has received interest from some large Asian companies about the possibility of taking a modest stake in FMG assets in return for a large capital injection. Fortescue already has a strategic Chinese investor in Hunan Valin, which has 15 per cent, compared with Forrest's holding of
33 per cent.
Nor is Fortescue alone in believing the company represents a buying opportunity, given it has completed construction of its new mines, rail and port network. US-based Capital Group, one of the world's biggest long-term investors managing $US1.3 trillion, recently bought 6 per cent. It has just raised that to 7 per cent, even as the ore price continues its decline.
Fortescue has also received strong interest from US capital markets about a possible return. This was after it pulled a planned $US2.5 billion refinancing effort last month when it failed to get money as cheaply as it wanted. FMG continues to insist there's no rush as the next scheduled debt repayment of $1 billion is not due until 2017 and that there is considerable interest from the banking community to refinance that. Fortescue, says Forrest firmly, will always be strong. A nervous market is yet to be convinced.
Jennifer Hewett attended the Boao Forum as a guest of FMG.
1781 words
2 Apr 2015
The Australian Financial Review
AFNR
English
Copyright 2015. Fairfax Media Management Pty Limited.
Resources
In an exclusive interview with AFR Weekend, Andrew Forrest dismisses the doubters but concedes his mistake in using the word 'cap' during the present imbroglio, writes Jennifer Hewett.
Note to the market. The irrepressible Andrew Forrest has lost none of his trademark confidence in Fortescue, nor his enthusiasm for China's continued growth and economic potential.
Now, as always, Forrest is convinced the doubters are wrong and will be proven so. Fortescue's future, he tells AFR Weekend, is assured. The company is on a relentless and successful race to drive down costs, so far keeping just ahead of the equally relentless decline in the price for iron ore.
"Any analyst without a vested interest will tell you Fortescue is still doing well right now and, as every day goes past, is becoming more competitive," Forrest says with typical fervour.
During a frenetic trip to China, he was constantly in and out of meetings with senior Chinese political and business leaders in Beijing and Shanghai and at the annual Boao forum held in China's south.
The recent company board meeting was held in China and the FMG signs at Boao were almost as ubiquitous as Forrest's bouncing presence. He was one of only four people asked to give a speech to President Xi Jinping at Boao at a meeting of global business - where Forrest invited Xi to visit his company. Their firm handshake was covered on Chinese television. Forrest knew Xi long before he became President.
The leader's office has asked Forrest's senior business leaders group to become a semi-official think tank between China and Australia. And rather than China being alarmed at his comments about curbing production to drive up the iron ore price, Forrest says he is repeatedly asked what the fuss in Australia is all about.
Yet, Forrest also knows the fuss in Australia won't die down while the price is so low - and likely to keep falling. The real questions are how low it will go and for how long. Plenty of analysts are marking down Fortescue's ability to survive the carnage, as they did repeatedly while Forrest built the company from an idea into the world's fourth-largest iron ore miner in super quick time.
Despite the risks, an innovative Forrest has always outsmarted doomsayers - able to keep building a massive empire while being told by "experts" why Fortescue would fail.
Yet Forrest's conviction he can keep doing so doesn't lessen his fury and frustration at what he argues is a catastrophically counter-productive strategy from Rio Tinto and BHP Billiton. He believes their determination to flood the market with supply - and to keep on expanding, no matter the impact on the price - is a desperate race to the bottom where no one wins.
Apart from being so damaging to Fortescue's bottom line and share price, he insists it devastates our national interest and "incinerates tens of billions of dollars worth of value" for BHP and Rio shareholders, too.
"Rio is competing with BHP to smash global investment returns for their shareholders, as well as tax and royalty receipts for the federal and state governments," he says. "Their statements that they will expand at any price drives down that price in their endeavour to drive everyone else out of business.
"When has market share strategy over shareholder returns ever helped a company? What BHP and Rio are doing is buying, at massive cost, expansion capacity even when the higher commodity price justification for such investment has evaporated. It's as though they are stuck in a time warp, unable to move with the changed circumstances. Over time, it will be seen for what it is - egos before commonsense."
Right now, though, market commonsense sees it as making Fortescue vulnerable. That's mainly due to its still higher cost of overall production for a product that gets about a 15 per cent discount due to lower quality. Combine that with the company having $US9 billion ($11.8 billion) of debt and the semi-permanent market presence of big "shorters" of the stock, and it helps explain why the FMG share price has fallen more than 60 per cent since last year.
Fortescue's total all-in costs are around $US43.50 a tonne, for example. The target is to get that down further to between $US35 and $US37 a tonne this year. And FMG always prides itself on its ability to consistently exceed its targets. "That will make Fortescue's cash costs at least as competitive as BHP and Rio, so you have to ask what their strategy is, because it's not about making adequate profits," Forrest fumes.
But when Fortescue is receiving only about $US43-$US44 a tonne for its ore at today's low prices, Forrest knows there's no margin for error. That's even tougher when Fortescue expects the price fall to continue, thanks to its competitors' views on increasing production. It obviously affects sentiment, especially given heavy trading in a relatively new Chinese iron ore futures market. It is a vicious price loop for the world's four major producers, including Brazil's Vale, not to mention the rest of the industry.
Such commercial devastation is compounded by what Forrest calls the Chinese economy "taking a breather" as the economy slows and new environmental restrictions and Xi's crackdown on corruption work their way through the system. That is even though demand for steel, Forrest insists, will stay strong long term.
This still requires staying alive in the short term.
Some analysts and investors in BHP and Rio are effectively calling this a Darwinian process of natural selection where only the fittest can and should survive. But others are being persuaded that Forrest's logic is right - that there can be only losers, most particularly Australia. It's not as if BHP Billiton and Rio Tinto have not made major strategic errors of judgment in the past.
Essentially, the BHP and Rio national interest argument is that if they don't increase tonnage from Australia, other countries will. And, in commercial terms, that the world's two lowest-cost producers still make money for shareholders on every tonne, no matter how low the price sinks. Forrest scoffs at such logic. His most polite term is that it's "sadly fallacious".
"When they are saying other people will do it if we don't, they are actually talking about themselves," he says.
He argues no other company in the world could now invest to build production unless the capital had already been committed at boom time price - as with Gina Rinehart's Roy Hill Mine in the Pilbara and Vale's new mine in Brazil. According to Forrest, it is overall returns that matter, rather than considering only the profit on each extra tonne. Rio and BHP are destroying those with their expansion plans, he says, as well as everyone else's.
"No one would contemplate investing to expand in collapsing commodity price markets, apart from those who have no interest in shareholder wealth or are engaged in market-share-at-all-cost pricing," he says. "All the new projects were financed when prices were higher. Commercial capital would now be too expensive.
"So no one else will replace those tonnes. You need a price of at least $US100 a tonne to expand, and the global banking sector is so disillusioned with the lack of leadership and the return on all capital, rather than just incremental capital, that there is a flight of capital from the resources sector."
That market pressure will only intensify, especially if the iron ore price has further to fall. It was Forrest's disgust at his competitors' strategy that led to an off-the-cuff response at a Shanghai dinner that the majors should agree to "cap" production.
He now concedes it was a mistake to use the word "cap" because of potential anti-competition implications. But Fortescue was stunned at the instant over-reaction of Rod Sims at the Australian Competition and Consumer Commission, suggesting this could mean illegal collusion or attempts to form a cartel.
Rio's Sam Walsh dismissed Forrest's comments as "hare-brained". But Rio and BHP could only have enjoyed the furore. There was never the slightest possibility either would take the advice to stop plans to lift production to 360 million tonnes and 290 million tonnes respectively.
After an early flurry of confected concern by Treasurer Joe Hockey, the federal government is also keen to stay silent, saying it's for the market to sort out.
This sort-out is happening - but at enormous and growing cost to government budgets and Australian taxpayers. And for what reason, exactly? Forrest describes this as the "Walsh effect" - simply driving down returns. West Australian Premier Colin Barnett is as vehemently contemptuous as Forrest of Rio and BHP's tactics.
To Forrest's critics, of course, FMG can't escape responsibility for oversupply by ramping up production to 165 million tonnes per annum, with the potential to lift to 180 million tonnes. Forrest justifies this by describing it as past investment when it's the future investment in expansion that's the problem.
But it's now Fortescue's problem that's most acute. So, as well as savagely pruning costs, Forrest has received interest from some large Asian companies about the possibility of taking a modest stake in FMG assets in return for a large capital injection. Fortescue already has a strategic Chinese investor in Hunan Valin, which has 15 per cent, compared with Forrest's holding of
33 per cent.
Nor is Fortescue alone in believing the company represents a buying opportunity, given it has completed construction of its new mines, rail and port network. US-based Capital Group, one of the world's biggest long-term investors managing $US1.3 trillion, recently bought 6 per cent. It has just raised that to 7 per cent, even as the ore price continues its decline.
Fortescue has also received strong interest from US capital markets about a possible return. This was after it pulled a planned $US2.5 billion refinancing effort last month when it failed to get money as cheaply as it wanted. FMG continues to insist there's no rush as the next scheduled debt repayment of $1 billion is not due until 2017 and that there is considerable interest from the banking community to refinance that. Fortescue, says Forrest firmly, will always be strong. A nervous market is yet to be convinced.
Jennifer Hewett attended the Boao Forum as a guest of FMG.
