Can Fortescue Metals Group Ltd become the world’s lowest-cost producer?


Fortescue Metals Group Ltd (ASX: FMG) is on track to become the world’s lowest-cost iron ore producer, achieving cash costs of US$15 per tonne in December 2015 – six months ahead of target.

In the December 2015 quarter, Australia’s third-largest iron ore miner shipped just over 42 million tonnes of iron ore at a record low cash cost of US$15.80 per tonne – compared to US$28.48 per tonne in the same quarter last year. That’s a 45% improvement, and Fortescue doesn’t appear to have finished refining its processes to achieve even lower costs. Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) have reported costs of around US$15-US$16 a tonne.

Another trick Fortescue has up its sleeve is the impending arrival of 8 very large ore carriers (VLOCs). The miner ordered the specially designed ships in June 2014, with the delivery of the first four expected to begin in November 2016 through to May 2017 at a cost of $275 million. In 2014, Fortescue said it spent $1.5 billion on shipping each year, and the arrival of the new (much larger) vessels should significantly increase efficiencies and lower costs even further.

The company received an average price of US$40.46 per dry metric tonne (dmt) over the quarter, around a 13% discount to the benchmark iron ore price. Fortescue ships ore that is slightly lower grade than the benchmark 62%.

Fortescue has maintained its guidance for 165 million tonnes to be shipped in the 2016 financial year, having shipped roughly half that in the first six months of the year. The company says demand for its ore remains strong in China and represents over 17% of imported iron ore.

The iron ore miner has also reduced its debt levels during the quarter, after repurchasing US$750 million of debt at an average price of 82 cents on the dollar – a substantial discount. As a result, the company has a pre-tax gain of US$124 million and saving itself US$56 million in interest payments annually.

Net debt now totals US$6.1 billion, including US$2.3 billion of cash. Fortescue has US$5.4 billion of debt due in 2019 and another US$2.5 billion due in 2022 but has shown a fondness to repay its debt early when it can.

Foolish takeaway

Despite Fortescue’s share price recently hitting 5-year lows, the miner has shown that it can survive and even prosper with iron ore prices under US$40 a tonne. But much depends on where the iron ore price goes over the next few years, and there’s no indication that prices could head higher.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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