In This Iron Ore Environment Ferrexpo Is Laughing, But Not Cavalier
By Daniel O’Sullivan
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Very strong maiden full-year results from London-listed Ukrainian iron ore miner Ferrexpo were ahead of analyst expectations, not just because a couple of City savants overestimated costs on the London listing in June 2007, but more significantly because the company has also managed to unwind the discount at which its pellet product previously traded. Chief executive Mike Oppenheimer says that in the old days – pre-listing, and presumably also before his appointment in late 2005 – Ferrexpo used to treat customers in a somewhat ‘cavalier’ fashion. For example one old habit was to divert tonnage out of already-agreed contracts and into the spot market when prices looked irresistible. But that kind of behaviour can get you a reputation, and in Ferrexpo’s case it led to lower realisations when negotiating with offtakers.
No longer. Oppenheimer is pleased to recount that through a greater focus on marketing and customer satisfaction, and when all appropriate adjustments are made for product form, quality and shipping costs, Ferrexpo can now garner the same contract prices as competitors. And as for chasing high spot sale prices, Oppenheimer says that while Ferrexpo has indeed made a couple such sales already this year at the ridiculously high prevailing margins, the proportion of Ferrexpo output committed to long-term contracts has in fact now climbed to 90 per cent compared to the 85 per cent level for 2007.
Meanwhile, the environment for negotiating new fiscal year contracts with effect from this month could hardly be better. Due to pellets traditionally being priced at a fixed premium over ore, pellet producers are normally under-geared to the benchmark ore price rises negotiated by the major seaborne ore suppliers. In other words, all else being equal, the 65 per cent increase in ore prices recently conceded by Asian steelmakers would be expected to feed through into a proportionately lesser increase - something around 45 per cent - in the pellet price established, on the basis of ore plus fixed premium.
Yet Oppenheimer expects the price increases in new contracts with his predominantly Central and Eastern European customer base to be far closer to 80 plus per cent than the 45 per cent he would otherwise anticipate, given the precedent set by Italian steelmaker Ilva, which has just agreed to an 87 per cent increase in the pre-shipping price it pays for pellets from Brazilian iron ore giant Vale. How has such a pellet premium blow-out emerged? The tightening screws of environmental compliance are spurring European steelmakers to increase pellet feed over sinter in any case, but Oppenheimer says this year in particular elevated steel prices are motivating furnace owners to extract the maximum amount of product possible per charge, making pellets a more valuable commodity in themselves.
Given this favourable background, Ferrexpo’s exemplary cost control is the icing on the cake. Thanks to an ongoing business improvement programme which in particular has delivered more efficient power usage, Ferrexpo’s cash costs per tonne of pellets increased just nine per cent compared to prevailing Ukrainian inflation of 23 per cent in 2007. With already-established gas and power price hikes operating as the major drivers for local inflation in 2008, likely to come in at around 17 per cent, Oppenheimer is confident Ferrexpo cost increases for the coming year will again come in lower, although the margin will not be as wide.
Despite the eyecatching operational indicators – a nine per cent increase in iron ore production, an eight per cent increase in pellet production from this ore, a 19 per cent increase within this in the high iron-content pellets the company ultimately wants to be known for, and a doubling of pre-tax profits – perhaps the most significant news in the financials is that Ferrexpo now intends to construct two new open pit mines to the north of existing operations, Yeristovskoye and Belanovskoye, in parallel rather than sequentially, as was originally planned. So the original aim, as outlined in the listing document, of increasing production from some nine million tonnes per year (mtpy) of pellets currently to 16mtpy in 2014 has been superseded by a new target of some 33mtpy in 2018, on the back of a quadrupling in underlying iron ore production.
Oppenheimer says that costing for this new plan has yet to be fully worked out, but an initial stab would put the required capex spend over the next decade at some US$5bn in nominal terms. Ferrexpo has previously said it wishes to recruit a strategic investor to help share the costs of expansion, and this more ambitious plan makes that even more imperative. Thus a new operating entity has already been established on a standalone basis to carry out the Yeritovskoye and Belanovskoye projects, not only so that best practice can be instituted across these ventures from the start but also to make easier an incoming equity investment specifically in the expansion. |
