How Concern Decisions Are Made Inwards A Boom: Fortescue Metals Edition
The Australian nail - the ane that leaves foreigners gobsmacked when run into our housing prices, debt levels together with full general economical cheeriness - has been powered past times atomic number 26 ore together with (to a lesser extent) coal.
These are the components of steel - together with steel is the foundation metallic of infrastructure - bridges, skyscrapers, gas pipelines together with rail. Coal together with (especially) atomic number 26 ore are the raw cloth for the slap-up Chinese construction together with infrastructure build-out.
Below I demonstrate exactly how extreme the atomic number 26 ore nail is past times extracting BHP revenue together with EBIT margin past times commodity from BHP's concluding annual report:
I desire to depict attending to the critical lines. Iron ore revenue (in millions of USD) progresses from 10,048 to 11,139 to 20,412 inwards 2009 to 2011 inclusive.
Underlying EBIT from atomic number 26 ore was 13,328 ane G m inwards 2011.
That is a 65.3 percent EBIT margin. These margins would brand a luxury goods maker salivate. LVMH (the iconic luxury goods powerhouse) had an EBIT margin of most 23 percent. To brand the margin for LVMH equal the margin from BHP's atomic number 26 ore functioning y'all ask to exclude all selling costs (by far the mass of costs) from LVMH's accounts.
You larn the thought this is profitable. Breathtakingly profitable.
But it has non e'er been. Back inwards 2000 BHP made 2.5 billion EBIT on 21 billion of revenue. BHP solely made that because its operations were most the lowest cost inwards the world.
The numbers higher upward (almost 32 billion of EBIT) reverberate the powerful commodities cycle.
For an Australian investor (or an investor inwards the large Australian mining stocks) the (literally) lx iv billion dollar query is what is the normalized turn a profit of atomic number 26 ore companies? At the minute (in what mightiness hold out the tail-end of a wild boom) the turn a profit province of affairs reflects 2 things (i) an historically real high atomic number 26 ore cost together with (ii) historically high costs (especially labour) incurred to larn the materials out of the ground.
The destination cost of atomic number 26 ore is going to depend on global cost curves. Some real dicey mines are getting funding (for illustration Alderon financed past times Liberty Mutual who are going to waste materials their policy-holder funds)*. I exercise non know the kind of cost curves but it seems unlikely to me that atomic number 26 ore volition remain equally profitable on a cost-of-goods-sold footing (and 3 times equally profitable all up) equally selling luxury goods.
Whatever happens - BHP's mines volition remain operational though. They are real high degree (mostly over 60 percent atomic number 26 content together with alongside acceptable impurities) together with alongside expert carry infrastructure inwards place. The solely atomic number 26 ore functioning that is competitive is RIO - where the grades are a lilliputian higher still.
Fortescue - an aggressive miner somewhere inwards the middle of the cost curve
BHP together with RIO are the real best atomic number 26 ore operations inwards the world. Vale is clearly pretty expert likewise (but farther from Communist People's Republic of China where the demand is strongest).
There are some very marginal atomic number 26 ore operations getting funding (see Alderon equally linked above). Also at that spot newly developed large mixed-quality operations (particularly on the West Coast of Africa). The contest is rising.
I don't know (nor does anyone else really) where the cost flexure volition hold out - but it is probable that Fortescue Metals Group volition hold out somewhere inwards the middle. At the minute it is sure enough a better-than-average mining functioning - it is hemetite (rather than a low-grade atomic number 26 ore that needs extensive pre-processing earlier shipping) but the grades are typically most 57 percent. Fortescue exports some mildly processed ore (fines etc) alongside higher grades for higher prices.
These are expert atomic number 26 ore properties. They are exactly non equally expert equally the BHP together with RIO ones.
You tin run into this inwards the accounts too. Here are the concluding half:
Gross turn a profit is 1426 ane G m on 3357 ane G m inwards sales - an eye-watering 42 percent margin. After management costs margins are lilliputian thinner.
These margins are withal salivating-good - but they are twenty per centum points worse than BHP. This is a modestly inferior mining functioning that is stupendously profitable because atomic number 26 ore prices are real high.
Fortescue tell us their vision:
They desire to hold out the "lowest cost, most profitable atomic number 26 ore producer". And whilst they are frighteningly profitable they are a long way from beingness the lowest cost producer together with given the departure inwards grades it is unlikely they tin ever closed that gap.
Some calculation of turn a profit versus atomic number 26 ore price
The average cost realized during the concluding one-half (the one-half alongside the P&L above) was USD139 per tonne.
If I convey $20 per tonne off that cost Fortescue is a darn expert business. Better than the P&L higher upward indicates because they receive got mega-large reserves and the volumes are expanding real fast.
But if the atomic number 26 ore cost drops past times $50 this is real hard together with if it drops past times $60 this is disastrous.
If y'all convey $60 off the atomic number 26 ore cost from concluding one-half levels together with then BHP remains profitable (albeit much less profitable than it is now).
I notation that atomic number 26 ore briefly touched prices inwards the 60s during the GFC - but prices ramped upward alongside Chinese infrastructure pass almost immediately.
One observation though: at a cost inwards the 110 to 120 gain BHP together with RIO remain to a greater extent than profitable than Louis Vuitton. This exactly remains an outrageously attractive business.
Just how large are the expansion plans of Fortescue
Fortescue mightiness lack 20 points of margin against BHP. But they desire to brand that upward inwards volume. Seldom receive got I seen a companionship that keen on uppercase expenditure. They exercise thus much of it that they receive got wiped their liabilities nether Australia's resources rent taxation (at to the lowest degree for adjacent few years).
The uppercase expenditure is good illustrated inwards this video from the company:
It tin also hold out seen inwards the relaxation sail - where the companionship has come upward through this enormously powerful atomic number 26 ore nail alongside ever increasing book and ever increasing debt.
Yes - y'all exercise run into that relaxation sail right. Exploration, evaluation together with evolution assets of USD5 billion (give or convey a little) together with debt of USD6 billion.
And it tin all hold out paid if the atomic number 26 ore cost remains high.
But if the commodity wheel goes dorsum to the nighttime days when BHP's margin was some 10 percent this ane is pushing upward daisies. They receive got 20 per centum points less margin than BHP together with alongside a commodity compaction similar their margin volition become negative together with the debt volition non hold out able to hold out serviced.
Jim Chanos (the noted shortseller best-known for picking on Enron) has publicly stated equally much.
Of course of study the direction don't run into it that way. They receive got a stance of atomic number 26 ore prices consistent alongside their business. Indeed I can't imagine how long anyone bearish on atomic number 26 ore prices would remain some Fortescue. Having a less than sanguine stance of atomic number 26 ore prices would hold out most equally sensible at Fortescue equally trying to hold out a proselytizing moral conservative working at the bar inwards a swingers club. You are non going to overstep away along your job.
Still atomic number 26 ore prices were covered inwards this amazing interview of Nev Power (Fortescue CEO) past times Alan Kohler:
Get this: they receive got modelled some a cost ($110 per tonne) which is high plenty to overstep away along BHP earning far meliorate margins than Louis Vuitton. As if BHP has a god-given correct to brand Louis Vuitton facial expression marginally profitable.
Those are prices that mightiness fifty-fifty brand the Alderon projection cited higher upward borderline viable.
Whatever: Nev Power is sure - but sure - that the cost registered inwards the GFC was an aberration. To stance it otherwise agency that he could non mayhap handgrip a senior seat at Fortescue.
And I am sure Nev Power is a rational human being - but I methinks he has succumbed to the capitalist version of rationality. Whatever makes y'all a dollar (or inwards this instance for the senior people at Fortescue a few billion dollars) is what is rational (and moral too).
If I were non curt this I would want them expert luck alongside that. As it is I receive got a small bet against Mr Power together with Fortescue. (But together with then maybe I am exactly hedging my Commonwealth of Australia risk...)
John
*Disclosure: I am curt less than 10 G dollars worth of Alderon Iron Ore. The projection is dizzy - but the stock is likewise illiquid together with the borrow is likewise tight to rest short. But it would hold out a much meliorate curt than Fortescue if y'all could borrow together with sell it inwards quantity. I am also curt other marginal atomic number 26 ore properties. They likewise are - I retrieve - meliorate shorts than Fortescue.
These are the components of steel - together with steel is the foundation metallic of infrastructure - bridges, skyscrapers, gas pipelines together with rail. Coal together with (especially) atomic number 26 ore are the raw cloth for the slap-up Chinese construction together with infrastructure build-out.
Below I demonstrate exactly how extreme the atomic number 26 ore nail is past times extracting BHP revenue together with EBIT margin past times commodity from BHP's concluding annual report:
I desire to depict attending to the critical lines. Iron ore revenue (in millions of USD) progresses from 10,048 to 11,139 to 20,412 inwards 2009 to 2011 inclusive.
Underlying EBIT from atomic number 26 ore was 13,328 ane G m inwards 2011.
That is a 65.3 percent EBIT margin. These margins would brand a luxury goods maker salivate. LVMH (the iconic luxury goods powerhouse) had an EBIT margin of most 23 percent. To brand the margin for LVMH equal the margin from BHP's atomic number 26 ore functioning y'all ask to exclude all selling costs (by far the mass of costs) from LVMH's accounts.
You larn the thought this is profitable. Breathtakingly profitable.
But it has non e'er been. Back inwards 2000 BHP made 2.5 billion EBIT on 21 billion of revenue. BHP solely made that because its operations were most the lowest cost inwards the world.
The numbers higher upward (almost 32 billion of EBIT) reverberate the powerful commodities cycle.
For an Australian investor (or an investor inwards the large Australian mining stocks) the (literally) lx iv billion dollar query is what is the normalized turn a profit of atomic number 26 ore companies? At the minute (in what mightiness hold out the tail-end of a wild boom) the turn a profit province of affairs reflects 2 things (i) an historically real high atomic number 26 ore cost together with (ii) historically high costs (especially labour) incurred to larn the materials out of the ground.
The destination cost of atomic number 26 ore is going to depend on global cost curves. Some real dicey mines are getting funding (for illustration Alderon financed past times Liberty Mutual who are going to waste materials their policy-holder funds)*. I exercise non know the kind of cost curves but it seems unlikely to me that atomic number 26 ore volition remain equally profitable on a cost-of-goods-sold footing (and 3 times equally profitable all up) equally selling luxury goods.
Whatever happens - BHP's mines volition remain operational though. They are real high degree (mostly over 60 percent atomic number 26 content together with alongside acceptable impurities) together with alongside expert carry infrastructure inwards place. The solely atomic number 26 ore functioning that is competitive is RIO - where the grades are a lilliputian higher still.
Fortescue - an aggressive miner somewhere inwards the middle of the cost curve
BHP together with RIO are the real best atomic number 26 ore operations inwards the world. Vale is clearly pretty expert likewise (but farther from Communist People's Republic of China where the demand is strongest).
There are some very marginal atomic number 26 ore operations getting funding (see Alderon equally linked above). Also at that spot newly developed large mixed-quality operations (particularly on the West Coast of Africa). The contest is rising.
I don't know (nor does anyone else really) where the cost flexure volition hold out - but it is probable that Fortescue Metals Group volition hold out somewhere inwards the middle. At the minute it is sure enough a better-than-average mining functioning - it is hemetite (rather than a low-grade atomic number 26 ore that needs extensive pre-processing earlier shipping) but the grades are typically most 57 percent. Fortescue exports some mildly processed ore (fines etc) alongside higher grades for higher prices.
These are expert atomic number 26 ore properties. They are exactly non equally expert equally the BHP together with RIO ones.
You tin run into this inwards the accounts too. Here are the concluding half:
Gross turn a profit is 1426 ane G m on 3357 ane G m inwards sales - an eye-watering 42 percent margin. After management costs margins are lilliputian thinner.
These margins are withal salivating-good - but they are twenty per centum points worse than BHP. This is a modestly inferior mining functioning that is stupendously profitable because atomic number 26 ore prices are real high.
Fortescue tell us their vision:
They desire to hold out the "lowest cost, most profitable atomic number 26 ore producer". And whilst they are frighteningly profitable they are a long way from beingness the lowest cost producer together with given the departure inwards grades it is unlikely they tin ever closed that gap.
Some calculation of turn a profit versus atomic number 26 ore price
The average cost realized during the concluding one-half (the one-half alongside the P&L above) was USD139 per tonne.
If I convey $20 per tonne off that cost Fortescue is a darn expert business. Better than the P&L higher upward indicates because they receive got mega-large reserves and the volumes are expanding real fast.
But if the atomic number 26 ore cost drops past times $50 this is real hard together with if it drops past times $60 this is disastrous.
If y'all convey $60 off the atomic number 26 ore cost from concluding one-half levels together with then BHP remains profitable (albeit much less profitable than it is now).
I notation that atomic number 26 ore briefly touched prices inwards the 60s during the GFC - but prices ramped upward alongside Chinese infrastructure pass almost immediately.
One observation though: at a cost inwards the 110 to 120 gain BHP together with RIO remain to a greater extent than profitable than Louis Vuitton. This exactly remains an outrageously attractive business.
Just how large are the expansion plans of Fortescue
Fortescue mightiness lack 20 points of margin against BHP. But they desire to brand that upward inwards volume. Seldom receive got I seen a companionship that keen on uppercase expenditure. They exercise thus much of it that they receive got wiped their liabilities nether Australia's resources rent taxation (at to the lowest degree for adjacent few years).
The uppercase expenditure is good illustrated inwards this video from the company:
It tin also hold out seen inwards the relaxation sail - where the companionship has come upward through this enormously powerful atomic number 26 ore nail alongside ever increasing book and ever increasing debt.
Yes - y'all exercise run into that relaxation sail right. Exploration, evaluation together with evolution assets of USD5 billion (give or convey a little) together with debt of USD6 billion.
And it tin all hold out paid if the atomic number 26 ore cost remains high.
But if the commodity wheel goes dorsum to the nighttime days when BHP's margin was some 10 percent this ane is pushing upward daisies. They receive got 20 per centum points less margin than BHP together with alongside a commodity compaction similar their margin volition become negative together with the debt volition non hold out able to hold out serviced.
Jim Chanos (the noted shortseller best-known for picking on Enron) has publicly stated equally much.
Of course of study the direction don't run into it that way. They receive got a stance of atomic number 26 ore prices consistent alongside their business. Indeed I can't imagine how long anyone bearish on atomic number 26 ore prices would remain some Fortescue. Having a less than sanguine stance of atomic number 26 ore prices would hold out most equally sensible at Fortescue equally trying to hold out a proselytizing moral conservative working at the bar inwards a swingers club. You are non going to overstep away along your job.
Still atomic number 26 ore prices were covered inwards this amazing interview of Nev Power (Fortescue CEO) past times Alan Kohler:
ALAN KOHLER: Now, y'all must hold out feeling a fighting nervous most what's going on inwards Europe at the moment. About a calendar week agone your chairman Andrew Forrest said it's all a tempest inwards a teacup beaten upward past times the media. Do y'all withal retrieve that?
NEV POWER: I retrieve the issues inwards Europe receive got had a real potent lawsuit some the global economies, together with belike far to a greater extent than than what y'all would expect, thus the difficulty at that spot is that yes, they are inwards problem over at that spot inwards those economies, but if y'all convey the total total of the touching on of those economies, say, on Communist People's Republic of China together with Australia, they're relatively small.
But the equity markets receive got been hitting very, real hard inwards comparing to that effect, thus what Andrew was talking most was the fact the equity markets receive got been spooked past times Europe far greater than the actual physical impact.
ALAN KOHLER: But what matters to y'all of course of study is the atomic number 26 ore price.
NEV POWER: Yes.
ALAN KOHLER: What cost receive got y'all got inwards your frontwards planning, inwards your budgeting?
NEV POWER: Well, nosotros run into inwards the curt term that it'll merchandise inwards that gain of $130-$150 a tonne together with it has been real resilient over the concluding 12 months or thus trading some that range. But looking frontwards we've allowed the forecast to drib downward to some $110 a tonne together with done all our modelling some that, thus nosotros run into that long term that'll hold out the sustainable price.
ALAN KOHLER: But inwards the 2008 crisis it got downward to equally depression equally $55 a tonne, thus if there's some other crisis - this is what I'm talking most y'all feeling a fighting nervous - if there's some other crisis, Kingdom of Spain collapsing, Hellenic Republic or whatever, y'all could run into the cost become downward to that bird again.
NEV POWER: Well, Alan, it did become downward to some a lilliputian nether $60 a tonne but that was for a fleeting minute together with it recovered to over $100 a tonne inside weeks - together with that was a global fiscal crisis, that was a existent global crisis.
ALAN KOHLER: But the argue it recovered thus chop-chop the Chinese economic scheme recovered thus chop-chop together with correct at nowadays it's slowing.
NEV POWER: Well Alan, the Chinese economic scheme is going through a short-term fluctuation, but overall it's growing real strongly. It's growing inwards that seven to 8 per cent gain which reflects dorsum to a 4 to five per cent increment inwards steel which nosotros run into equally a actually potent increment together with something I retrieve a lot of countries would aspire to.
ALAN KOHLER: Thanks real much for joining us, Nev Power.
NEV POWER: Thank you, Alan. It's expert to hold out here.
Get this: they receive got modelled some a cost ($110 per tonne) which is high plenty to overstep away along BHP earning far meliorate margins than Louis Vuitton. As if BHP has a god-given correct to brand Louis Vuitton facial expression marginally profitable.
Those are prices that mightiness fifty-fifty brand the Alderon projection cited higher upward borderline viable.
Whatever: Nev Power is sure - but sure - that the cost registered inwards the GFC was an aberration. To stance it otherwise agency that he could non mayhap handgrip a senior seat at Fortescue.
And I am sure Nev Power is a rational human being - but I methinks he has succumbed to the capitalist version of rationality. Whatever makes y'all a dollar (or inwards this instance for the senior people at Fortescue a few billion dollars) is what is rational (and moral too).
If I were non curt this I would want them expert luck alongside that. As it is I receive got a small bet against Mr Power together with Fortescue. (But together with then maybe I am exactly hedging my Commonwealth of Australia risk...)
John
*Disclosure: I am curt less than 10 G dollars worth of Alderon Iron Ore. The projection is dizzy - but the stock is likewise illiquid together with the borrow is likewise tight to rest short. But it would hold out a much meliorate curt than Fortescue if y'all could borrow together with sell it inwards quantity. I am also curt other marginal atomic number 26 ore properties. They likewise are - I retrieve - meliorate shorts than Fortescue.
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