Wednesday, 20 August 2014

Fortescue - iron ore, debt and China = embrace the volatility (both ways)

Fortescue are nothing if not confident.  Australia's new big iron ore producer has to be otherwise metrics such as net debt of around half the company's c. A$14bn market cap and a prospective consensus rating of around x6 would get you down.

Still, the numbers are getting better with the usual combination of higher volume and lower prices was apparent.  This combination was a net positive but the really positive aspect was cost control...



...and this helped flow into the free cash flow statement which is required given the net debt burden:


At this point I could start talking about big free cash flow yields and the like, but here's the problem: the iron ore price has been dodgy and rolling over year-on-year the realisable price is clearly falling.  



Of course the hope - as previously expressed by BHP Billiton and Rio Tinto - is that China continues to demand product or alternatively...


...expensive capacity (in places like China) gets taken out.  Very plausible over time...but shorter-term, the scope for volatility is clear.   

Especially with that debt burden.  Interesting that the Fortescue share is almost perfectly in the middle of its three year price range...



...and if unsurprisingly the volatility is apparent as per this chart comparing the performance of the Fortescue share with BHP Billiton over the last three years:


My view?  Geared trading counter towards China sentiment and related, scope currently to buy at A$4, sell/short at A$5 ceteris paribus etc.  If you don't like to play such volatility look away and take a look at the newly announced 'core' BHP Billiton share...

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