Downer EDI Limited share price tumbles as Fortescue cuts costs

Credit: iStock

Mining giant Fortescue Metals Group Limited (ASX: FMG) has boosted its cost-reduction efforts by cutting ties with mining services business, Downer EDI Limited (ASX: DOW), at its Christmas Creek mining operations.

The news comes following years of heavy falls in commodity prices, with one tonne of iron ore currently fetching less than US$55 a tonne. It was fetching around US$135 a tonne at the end of 2014, according to The Metal Bulletin, and around US$185 at its peak in 2011, but has since fallen heavily due to huge increases in production combined with waning demand.

Companies throughout the sector have been heavily focused on reducing costs, and many mining services business have paid the price with services increasingly being taken in-house.

In continuation of that trend, Fortescue has today stated that, at the completion of the current contract with Downer EDI on 30 September 2016, Fortescue will transition to a full-ownership model at its Christmas Creek operations.

It said: “Adoption of an owner operator model will further reduce Fortescue’s costs through ongoing improvement of the efficiency and productivity of our Christmas Creek mining operations.”

It also noted that production from the Creek is not expected to be impacted as a result of the transition.

Although Downer EDI stated that this decision is not expected to have an impact on its 2016 financial results, that is because the changes won’t take place until after the end of the period. In February 2015, Downer EDI noted that the contractual arrangement ending September 2016 was worth $720 million, so it is a significant loss for the company’s mining business.

Although it remains a risky bet due to its heavy debt load and its reliance on high iron ore prices for earnings growth, Fortescue has done a remarkable job of cutting costs in recent times, putting its cost base near the likes of larger rivals BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO).

Fortescue’s share price has remained mostly flat today despite the announcement, while Downer EDI’s share price fell 5.9% to $3.52.

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