OREANDA-NEWS. Fitch Ratings has affirmed Australia-based Fortescue Metals Group Limited's (Fortescue) Long-Term Issuer Default Rating (IDR) at 'BB+'. The Outlook is Stable. Fitch has also affirmed the ratings of Fortescue's senior secured and unsecured debt, issued through FMG Resources (August 2006) Pty Ltd, at 'BBB-' and 'BB+' respectively.

The affirmations reflect the company's improving cost position, which has helped it withstand a period of weak global iron ore prices. Fortescue's demonstrated commitment to reduce debt, having repaid USD3.7bn since November 2013 including amortisation of the Term Loan, also supports the affirmation. Fitch has assumed that the company will not materially utilise its cash reserves of USD1.6bn as at end-December 2014 for purposes other than to repay debt if needed. Fortescue intends to reduce gearing (debt/debt+shareholder funds) to 40% by end-December 2015 compared to around 57% at end-March 2014. The company's gearing target translates to a funds from operations (FFO) adjusted gross leverage of approximately 2.5x, well within the 3.0x trigger for its current ratings.

The rating action also incorporates Fitch's lowered assumptions for iron ore prices. . On 4 February 2015, Fitch revised its mid-cycle price assumptions for the industry-benchmark 62% Fe-content iron ore delivered into China down to USD65/tonne for 2015, USD75/tonne for 2016, and USD80/tonne thereafter. Fitch previously assumed a constant USD90/tonne price across all three periods. The agency now estimates that Fortescue's FFO adjusted gross leverage will increase to 3.2x at FYE15 (prior expectation was 2.1x, fiscal year ends in June), before reducing to 2.8x in FYE16, and that it will trend lower thereafter.

KEY RATING DRIVERS

Improving Cost Position: Fortescue improved its C1 cash costs (which includes mining, port, rail, and operating lease costs) to around USD30/tonne as at end-December 2014 - a 12% improvement compared to its FY14 average. The company expects its C1 costs to average below USD28-USD29/tonne in FY15. The cost improvements are underpinned by lower strip ratios in its newer mines, growing economies of scale on higher volumes sold, and to a lesser extent because of a weaker Australian dollar-US dollar exchange rate. As a result, Fortescue continues to migrate down the global iron ore production cost curve.

Further Deleveraging is Expected: Fitch expects Fortescue's FFO adjusted gross leverage to increase to 3.2x by FYE15 (but 2.6x net of cash reserves) because of the precipitous decline in iron ore prices during 2014. However, leverage is likely to improve in FY16 and FY17, below the 3.0x trigger above which negative rating action may be considered, due to Fitch's view that iron ore prices will improve over the same period.

Strong Liquidity: Fortescue had USD1.6bn of cash reserves at end-December 2014, and its earliest mandatory debt repayment of USD1bn falls due in 2017. Fitch estimates that the company will continue to generate free cash flow (after paying capex and dividends) of between USD500m and USD1bn annually, over the next three years. Fortescue has considerable flexibility around its debt structure and repayments because its secured credit facility, which accounts for over 50% of debt as at end-December 2014, is repayable at the company's discretion. Furthermore, each tranche of its senior unsecured notes, which account for the remainder of its debt, can be called early at Fortescue's discretion.

Lack of Diversification: Fortescue has limited business diversification compared with its higher rated international peers. It has only one product, iron ore, which it sells predominantly in the Chinese market.

Secured Credit Facility: The rating on the secured credit facility is notched up one level from Fortescue's 'BB+' IDR, reflecting the additional provision of quality collateral, including mining tenements. This uplift for a 'BB+' rated company is consistent with Fitch's "Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers" criteria.

KEY ASSUMPTIONS

-62% Fe benchmark iron ore prices including freight cost: 2015: 65/tonne; 2016: 75/tonne; 2017: 80/tonne.
-Fortescue's price realisation versus the benchmark: 89%.
-Freight costs to remain at USD4.2/tonne over the next 12 - 18 months before trending up.
-C1 costs to remain at USD27/tonne through 2017.
-Annual iron ore shipping levels to be maintained at 160 million tonnes per annum.
-AUD-USD exchange rate to remain at 0.77 in 2015, and 0.80 thereafter.
-Fortescue will not utilise its cash reserves for purposes other than to repay its debt.

RATING SENSITIVITIES

Positive: Future developments that could lead to positive rating actions include:
- A demonstrated commitment to maintain a capital structure that is more in line with a 'BBB' category rating; and,
- sustaining FFO adjusted gross leverage at less than 2x and FFO fixed-charge cover at more than 5x (FYE15 projected: 5.0x).

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted gross leverage exceeding 3x and FFO fixed charge cover remaining below 4x.