Is now the time to start trading metals as Chinese investment rumours arise?
Shares of Australian commodities companies surge as Chinese investment flows in
The Australian commodities sector is enjoying a bull run on the back of news that Chinese firms are applying to the FIRB (Foreign Investment Review Board) for authorisation to make investments in Fortescue Metals – an iron ore producer.
Fortescue Metals Group Ltd (FMG.AX) was last trading at A$2.38 with a previous close of A$2.32. The stock’s 52-week range falls between A$1.75 and A$5.03 with a market capitalisation of A$7.41 billion and a price/earnings ratio of 5.50.
The stock rose 15% on Tuesday 26 May 2015, touching A$2.50 in early trading on Sydney’s ASX. This gain continued from a strong performance on Monday 25 May 2015. News reports from the AFR (Australian Financial Review) suggest that two Chinese firms – Citic and Baosteel – are currently in discussions with Fortescue Metals to boost the company’s asset holdings.
Three years ago, Baosteel and Fortescue partnered up with their iron ore assets when they created another subsidiary known as FMG Iron Bridge, in Hong Kong. The company is 12% owned by Baosteel and 88% owned by Fortescue. Formosa, a Taiwanese company, obtained a 31% share of FMG Iron Bridge in 2013.
Chinese companies swarm on FIRB
At this time it remains unclear how many Chinese companies have made applications to the Foreign Investment Review Board. From its perspective, Fortescue Metals Group Ltd continues with its legal obligations vis-à-vis disclosure and is not monitoring applications made to the FIRB.
Recently, the business model used by the Fortescue Metals Group came under scrutiny as iron-ore prices lost almost 50% of their value during the 12-month period March 2014 to March 2015. Fortescue is in need of investment funding, since the company’s capital structure is perceived as tenuous by industry analysts.
The Chinese investments in Fortescue are all about maintaining an additional iron ore supply, without worrying about losing market share to other companies like BHP, Vale or Rio. The Australian industry minister informed the Australian Broadcasting Corporation (ABC) that he would scrutinise the terms of any potential deal that emerges.
Declining commodities prices raise alarm bells
Falling iron ore prices have caused concern in the market. The price has dropped from $100 to under $60, thereby endangering many proposed developments such as the West Pilbara Iron Ore Project. At low prices, these projects are not sustainable but the future prospects for such initiatives remain on the cards.
The Chinese have a special interest in protecting their supply of iron ore in the market. Fortescue provides this option for China. As the world’s fourth largest iron ore producer, Fortescue has been critical of other companies in BHP and Rio for increasing production during a time of decreasing prices. While Fortescue’s balance sheet remains unstable, its rivals are still profitable at current iron ore prices.
Fortescue attempts to refinance debt
In an effort to refinance its $7.5 billion of debt, Fortescue sold $2.3 billion of junk bonds at a higher yield. This follows on from two unsuccessful attempts to obtain financing in 2015. Fortescue is attempting to reduce its break-even price to A$53 per tonne over the course of the next three months. By the end of 2016, Fortescue is looking to reduce its break-even price to A$51.2.
Fortescue’s cost structure rivals that of Vale, but the CFO of Fortescue, Stephen Pearce, believes that not all investors realise this. Fortescue currently has $2 billion in liquid assets and is debt-free until 2019. Further, the company expects costs to be reduced further by 2016, allowing for positive cash margins at prevailing prices.
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