Fortescue reassures as iron-ore crisis hits Australia

By John Weavers

SYDNEY, April 16 (IFR) - Iron-ore giant Fortescue Metals (Dusseldorf: FVJ.DU - news) Group lifted confidence in Australia's struggling mining sector on Thursday, when it revealed a stronger cash position and lower operating costs than analysts had expected.

For many, Fortescue has become the local symbol of Australia's battle against collapsing commodity prices, with iron ore plunging more than 60% from its 2013 peak to around US$50 per dry metric tonne.

In quashing fears that it will be forced to halt production or raise new equity, however, the miner has raised hopes that Australia's resources companies can hold off a full-blown crisis.

The sector, however, remains under severe pressure. The end of Australia's mining boom, which insulated the country from the global financial crisis, has triggered a series of micro and macro economic problems.

Driven down by falling export revenues, the Australian dollar has slumped close to 20% against the US dollar in the last eight months.

Fortescue recently pulled a planned US$2.5bn bond, and has faced speculation that it will follow domestic peer Atlas Iron and halt iron-ore production and mothball its domestic mines.

On Monday, Standard & Poor's placed Fortescue's BB+ ratings on negative watch, mirroring similar moves for diversified mining giants Rio Tinto (Xetra: 855018 - news) and BHP Billiton (NYSE: BBL - news) , which are rated A- and A+, respectively.

Deutsche Bank (Xetra: 514000 - news) analysts said they anticipated one-notch downgrades or no changes to the ratings of Rio Tinto and BHP, but saw "a greater probability of a material (perhaps two-notch) rating downgrade" for Fortescue.

Still, Fortescue's third-quarter results announcement has restored some faith.

Some analysts had put Fortescue's total iron-ore production costs as high as US$70 per tonne, around US$20 above current market levels, before the company surprised to state that its break-even cost for mining iron ore had been slashed to US$39 a tonne, including interest and capital expenditure.

NO EQUITY ISSUE

The report on Thursday propelled Fortescue shares 9% higher, while holders of the company's US$9bn debt were reassured with its prediction that the cash balance would remain at or above US$1.5bn through the current quarter.

During a post-report conference call, CEO Nev Power stressed that the company did not need any more cash, quashing talk that an equity raise could be on the agenda.

However, Fortescue is hardly out of the woods. Its fortunes are inextricably tied to iron-ore prices, which many, including Citigroup (NYSE: C - news) , expect to fall further. Citigroup has cut its average forecast for the second half of calendar year 2015 to US$37 a tonne and sees it rising to just US$40 in 2019.

Australia's federal treasurer Joe Hockey is now factoring in an iron-ore price of US$35, which, he warns, means the Commonwealth government may have to write off revenue of up to A$25bn (US$19bn) over the next four years. This compares with his "conservative" US$60 per tonne estimate in last December's budget update.

Such a shortfall, along with the government's failure to pass meaningful deficit reduction measures, leaves its plans for a return to budget surplus in tatters. Central government gross debt climbed from less than 10% of GDP in 2008 to 30% in 2014 and further increases are inevitable.

Nevertheless, Australia remains one of only nine countries worldwide to be rated Triple A with a stable outlook from all three main ratings agencies.

Furthermore, there is no shortage of buyers of highly liquid Australian Commonwealth and state government debt, which still offers attractive pick-ups over international comparables, despite the resumption of the Reserve Bank of Australia's easing policy.

On Wednesday, Moody's affirmed Australia's Aaa sovereign rating, citing the economy's large size, its flexibility and relatively robust growth, as well as government debt ratios that are lower than in many similarly rated peers.

Despite lower prices for many of its commodity exports and the slowdown in Australia's mining investment surge, GDP expanded 2.7% in 2014 with Moody's predicting growth above 2% for the next two years.

"High household debt levels, the potential for lower non-commodity growth or a shock in international markets, also pose risks. However, our stable outlook on Australia's Aaa rating indicates our view that the risks from the above factors will remain contained over the outlook horizon," Moody's said. (Reporting By John Weavers. Editing by Daniel Stanton, Steve Garton and Dharsan Singh.)