Fortescue Metals Group Limited (ASX: FMG), the world's fourth-largest producer of iron ore, released a set of impressive quarterly figures yesterday.
- Compared to 1 year ago, C1 costs fell 47% from US$32 to US$17 per wet metric tonne
- Free cash flow for the quarter was around US$600 million (my estimate)
- US$384 million of debt was repurchased from the market at an average price of 80 cents in the dollar realising a pre-tax gain of US$68 million.
The final point is the interesting part for corporate debt investors (you'll often hear debt being referred to as bonds or notes). Fortescue has the following debt profile:
Debt prices are usually quoted at a price compared to "par value" that is typically priced at $100. So, when FMG purchased its debt on the market, it was trading at an average price of only $80.
Just like shares, corporate debt trades at a range of values over time and is largely determined by its rating from the credit agencies (the largest being Moody's, S&P and Fitch) and investors' outlook for the business.
The slump in commodity prices has soured investor sentiment toward mining companies. Falling profits in the industry increase the probability that a company carrying significant debt will be unable to repay it in the future.
This risk flows through to the price of corporate debt, partly explaining why Fortescue's debt was trading at such a significant discount to its par value.
10%+ annual returns from Fortescue
With the background covered, I'm sure you want to know how investors are earning 10% yields?
Using recent market prices we can work out the approximate annual yield that investors will achieve from holding these notes:
1. Senior Unsecured Notes due November 2019 – recent price $85.62 per $100 par value.
Annual yield for investors = 12.8%
2. Senior Unsecured Notes due April 2022 – recent price $75.50 per $100 par value.
Annual yield for investors = 12.5%
3. Senior Secured Notes due March 2022 – recent price $102.75 per $100 par value.
Annual yield for investors = 9.2%
Fortescue's debt holders look set to earn annual returns above 10% provided the company continues to cover all of its debt repayments. Strong cash flows from the latest quarter provides confidence that not only can it cover its debt payments, but it can afford to repurchase additional debt from the market.
These calculations were provided for information only and did not value the call date option.
