OREANDA-NEWS. Fitch Ratings has assigned Australia-based FMG Resources (August 2006) Pty Ltd's proposed USD1.5bn guaranteed senior secured notes due in 2022 an expected rating of 'BBB-(EXP)'. The final rating is contingent upon the receipt of final documents conforming to information already received.

The facility is guaranteed by Fortescue Metals Group Limited (Fortescue; BB+/Stable) and its subsidiaries that currently represent 97% of the group's consolidated assets and 97% of its net income. The rating of the secured facility is notched-up a level from Fortescue's 'BB+' Long-Term Issuer Default Rating to reflect additional provision of quality collateral, including mining tenements. This uplift for a 'BB+' rated company is consistent with Fitch's criteria.

If the proposed notes are issued, Fortescue's overall secured debt will increase to USD6.8bn (including its finance leases) or 92% of the company's debt as of 31 March 2015. However Fitch does not believe this level of secured debt will impair Fortescue's senior unsecured creditors. This is because Fitch expects overall secured debt to be less than 2.5x Fortescue's prospective EBITDA of USD3bn at the end of the financial year to 30 June 2015 (FYE15), and less than 2x of EBITDA at FYE16. Prospective EBITDA is based on Fitch's mid-cycle commodity price assumptions and forecasted production volumes.

The facility's security package does not include mechanisms that introduce payment priorities or other forms of structural preference versus other creditors. Importantly, the unsecured bonds have the same issuer and guarantee structure as the secured debt.

The proposed notes will be primarily used to refinance Fortescue's senior unsecured debt maturing in 2017 and 2018. This will push back a bulk of the company's debt maturities to 2019, 2021 and 2022.

KEY RATING DRIVERS

Improving Cost Position: Fortescue cut its C1 cash costs (which include mining, port, rail, and operating lease costs) to around USD26/tonne as at end-March 2015 - a 26% improvement compared to March 2014, and a 9% improvement compared to 31 December 2014. The company expects its C1 costs to average below USD26-USD27/tonne in FY15 and USD18/tonne in FY16. 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, 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 Expected: Fitch currently 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 and in 2015. 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.

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.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
-62% Fe benchmark iron ore prices, including freight cost, for 2015 at USD65/tonne; 2016 at USD75/tonne; and 2017 at USD80/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 average USD27/tonne in FY15 and USD18/tonne in 2016 and 2017.
-Annual iron ore shipping levels to be maintained at 160 million tonnes a year.
-Australian dollar-US dollar exchange rate to remain at 0.77 in 2015, and 0.75 thereafter.
-Fortescue will not materially 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