Fortescue has its eye on cutting costs

Fortescue Metals Group (ASX: FMG), the world’s fourth largest iron ore producer, is looking to renegotiate half of its US$10 billion debt pile.

The goal is to cut interest payments, increase cash flows and profits, reduce the cost of capital and allow the miner to make earlier repayments on its massive debt load. In an announcement to the ASX today, Fortescue says it looking to reprice a US$5 billion Senior Secured Credit Facility, which is due in October 2017.

The company says it currently pays around 5.25% in interest, and is looking to lower that as well as to extend the term of the loan. The process is expected to take two weeks to finalise, subject to satisfactory pricing and market conditions. In other words, should the bottom rapidly fall out of the iron ore price, and Fortescue getting a sufficiently discounted interest rate.

Despite expectations by many commentators that the iron ore price was going to fall in the second half of this year, record Chinese steel output and iron ore imports have managed to keep the iron ore price above US$130 a tonne. As we have mentioned several times, it’s cheaper for Chinese steel mills to source higher quality Australian iron ore at lower prices than it is from local producers. Chinese iron ore miners are typically high cost with lower grades and many are located away from the coast where many of the steel mills and port facilities are located.

An expected jump in supply, as the big three, Rio Tinto (ASX: RIO), Brazil’s Vale and BHP Billiton (ASX: BHP) ramped up production has also not materialised. China’s thirst for iron ore hasn’t yet been quenched. Fortescue itself is on target to achieve annual production of 155 million tonnes a year, putting it not far behind BHP’s annual production. That should see Fortescue produce enough cashflow to easily pay back its debt before it comes due.

Foolish takeaway

Investing in Fortescue still comes with big risks. Anything could go wrong as we found during the global financial crisis, when credit markets closed, and heavily indebted companies struggled. Instead, Foolish investors may want to consider taking a closer look at junior iron ore miner BC Iron (ASX: BCI), which has a growing $172 million pile of cash on its balance sheet, with debts of just $104 million, and paying a healthy fully-franked dividend.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned.

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