Fortescue Metal Group Case Analysis

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Register to read the introduction… 23
IBIS World ‘B0801 Iron Ore Mining in Australia industry report’, May 2013, page 18.
24
Ibid page 10.
25
Ibid page 9.
17

4

iron ore falls, FMG must increase production to maintain profitability (as in 2012);26 however workforce shortages may provide an obstacle to increasing production capacity.

(e) Minerals Resource Rent Tax (MRRT) – An additional tax expense will decrease FMG’s profits.
Deloitte notes that ‘the combined effect of the mineral resources rent tax (MRRT) and the carbon tax has the potential to push down corporate profits and interfere with project feasibility assessments’.27
FMG’s June quarter 2013 update indicates that no MRRT was paid in 2013.

1.2 Industry analysis – level of competition in the iron ore production industry.
1.2.1 ‘Porter five forces analysis’
An analysis of the five competitive forces suggests that the level of competition in the industry is moderate, as opposed to intense, meaning that there is an opportunity to earn above average profits in the medium term. The strongest competitive force is ‘competitive rivalry among existing firms’ as firms compete on price and expand production to capture a share of the growth in demand. 1) Competitive rivalry among existing firms There are 88 businesses that operate in the Australian iron ore industry. FMG has a 10.1% market share, Rio Tinto Limited (‘Rio Tinto’) 29.1% and BHP 25.1% and the remaining 85 businesses making up the other 35.7%.28 However the competitors of FMG are not limited to industry participants in Australia; the industry operates globally which tends to increase levels of competition.29 Iron ore is a relatively homogenous product, which encourages competition on price, and producers have high fixed costs (such as wages and operating leases on equipment) and low marginal costs, which creates pressure to lower prices to maintain production capacity. 30 However, industry revenue is expected to grow at a rate of 12.7% until 2018, which means that firms need not capture existing market share from their competitors to improve their profitability. 31 26 See Table 1 of supporting material appended to this report for production quantities and associated revenues since 2008. Deloitte, ‘Tracking the trends 2013 – The top 10 issues mining companies may face in the coming year’ (2012), page 18. Page 4 of the June quarter update informs the reader that no MRRT was paid in FY13. 28 IBIS World ‘B0801 Iron Ore Mining in Australia industry report’, May 2013, page 21. 29 Ibid page 18. 30 Michael E Porter, ‘The five competitive forces that shape strategy’ (2008) Harvard Business Review, page 32. 31 IBIS World ‘B0801 Iron Ore Mining in Australia industry report’, May 2013, page 4. 27 5 2) Threat of new entrants Historically high iron ore prices (as illustrated in Chart 1) and associated potential for profit may attract new entrants, however significant barriers to entry tend to reduce this competitive threat. (a) Economies of scale – Existing firms such as Rio Tinto, BHP and FMG enjoy reduced costs due to economies of scale.32 This creates a barrier to entry by requiring a potential entrant to invest on a large scale to match existing competitors, or to ‘accept a cost disadvantage’. 33 (b) Capital expenditure and exploration – The production of iron ore requires significant investment in exploration and fixed capital assets (most often hundreds of millions of dollars).34 There can be a time gap between identification of exploitable deposits, mine construction and production of ore. For
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Larger mining operations also
‘possess both cost and negotiating benefits’. 51 For example, the additional units of production will contribute towards covering the fixed costs associated with port and rail facilities, and will then contribute towards profit.52 As detailed in the director’s report in the annual financial report for the year ended 30 June 2012, FMG’s strategy is to expand its current iron ore production capacity to
155m mt pa and to continue to develop its mining tenements in the Pilbara region. 53 In its update for the June quarter 2013, FMG confirmed that it will achieve ‘production at the 155m mt pa run rate across the supply chain by the end of December 2013 and sustainable production at 155m mt pa as we exit the 2014 wet season’.54 Assuming a forecast price of USD120 per mt, and that the 155m mt

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