Citic Pacific

Citic in ore project for the long haul

Production delays and cost overruns at iron ore project are short-term pain for long-term gain, says Citic Group chairman Chang Zhenming

PUBLISHED : Friday, 28 February, 2014, 10:20am
UPDATED : Saturday, 01 March, 2014, 5:09am

Citic Group chairman Chang Zhenming has some advice for investors who are fretting about the escalating losses at its Australian iron ore mining project: "Be patient and look at the long term."

His six-page letter to shareholders of the state-owned conglomerate was sprinkled with catch phrases regarding the Citic Pacific venture.

"We ask for your patience." "No pain, no gain." He even cribbed a quote from Winston Churchill: "Now this is not the end … it is, perhaps, the end of the beginning."

What Chang made abundantly clear is that shareholders may have to endure years of losses before the iron ore mining and processing project in Western Australia will turn a profit.

Sino Iron is an attractive longterm investment, supported by China’s appetite

This is because only one line has entered production, delivering its first shipment in December. Line two, whose commissioning was delayed due to a problem with a damaged gearless motor, is now due to start commercial production in July.

Lines three to six are expected to be commissioned one after another by the end of 2016.

The project, China's largest investment in Australia and the nation's largest resources investment globally, accounts for almost a third of Citic Pacific's assets.

Besides starting up over three years behind schedule, it suffered a cost blowout - with US$9.9 billion spent so far, compared to the original total budget of US$2.47 billion.

Chang admitted that both Citic Pacific and the general contractor Metallurgical Corp of China underestimated the project's complexity, and overestimated the amount of Chinese labour it is allowed to use to comply with Australian regulations. He also said Citic Pacific would have been better off adopting a more hands-on approach instead of relying on MCC.

The project's net loss widened to HK$1.62 billion last year from HK$781 million in 2012, as it had to book interest and depreciation expenses after production started last year.

They were previously capitalised in the balance sheet, and now have to be reflected in the profit and loss statement.

A Citi research report forecast Citic Pacific's net interest expenses will surge to HK$4.5 billion this year from HK$2.75 billion last year, and estimated its underlying net profit, excluding one-off gains, would fall 58 per cent this year to HK$2.05 billion.

Chang warned investors the iron ore project faces potential impairment losses in the coming years, but this would depend on the level of year-end iron ore prices. It booked HK$381 million of asset impairment charges last year, the Citi report said.

Analysts polled by Bloomberg forecast iron ore prices would gradually fall to US$102 a tonne by 2017 from US$135 last year because of plentiful supplies from Australia and Brazil. A Standard Chartered Bank research report projected Australia's iron ore exports to rise by 100 million tonnes this year to 674 million tonnes, the biggest ever increase. It expected Brazil exports will increase by 55 million tonnes this year.

It forecast China's iron ore imports to be lower this year, after growing 10 per cent last year, because steel output growth is expected to fall to 3 per cent from 7.5 per cent as the focus of economic growth moves away from fixed asset investments towards services. Domestic ore is also expected to gain market share from imports.

Chang would not provide Citic Pacific's own estimate of the required iron ore selling price for the project to break even, which Citi's analysts estimated to be US$108 a tonne in a late 2012 report.

They expected the six production lines - each with four million tonnes of output capacity - to reach full utilisation in 2018 at the earliest. The commissioning of all six lines is needed for production costs to be driven down enough to achieve economies of scale, Chang said.

A company spokesman last year denied Citic Pacific undertook the iron ore project in 2006 mainly because of pressure from Beijing to help the mainland's steel mills reduce their reliance on the three overseas mining giants that control the bulk of the world's seaborne iron ore supply, saying it was done purely for commercial considerations.

Chang said about 40 per cent of the project's output is expected to be used by Citic Pacific's steel division, with the rest to be sold primarily to other mainland steel mills.

Despite the mining project's setbacks, Chang called on Citic Pacific's shareholders, investors, lenders and employees to "continue to write our China story".

Investor response to his statement and the company's better than expected 2013 results was positive, with its share price rising 0.9 per cent on the day of the results announcement, against the Hang Seng Index's fall of 1.2 per cent.

Chang remained optimistic about the Australian project's long-term prospects, despite analyst concerns about its viability due to high operating costs.

"I still get asked if I had ever thought about pulling back on the project when I was on board Citic Pacific a few years back," he told shareholders. "My answer back then, and remains today, was that Sino Iron is an attractive long-term investment, supported by China's appetite for iron ore, as the country continues to develop."