CASE STUDY 2THE GROUNDED KANGAROO? AN ANALYSIS OF QANTASn Paul Evans, University of Melbourne/ CASE STUDY 3 FORTESCUE METALS GROUP LIMITED Dr Tim O’Shannassy, Graduate School of Business and Law, RMIT University
CASE STUDY 2
THE GROUNDED KANGAROO? AN ANALYSIS OF QANTAS
Paul Evans, University of Melbourne
In November 2008, Alan Joyce took the helm of Qantas as chief executive officer (CEO), replacing Geoff Dixon to become the youngest CEO in the history of Australia’s national airline carrier. Since his commencement, Qantas endured significant operating challenges, culminating in declining profitability from a record pre-tax profit of A$1.4 billion in August 2008 to a statutory loss of A$245 million during 2011–12, its first since privatising in 1995. Natural disasters, spiked oil prices, deregulation and increased foreign carrier competition, worsening employment relations, — along with the introduction of carbon tax legislation in July 2012 — have created significant challenges for Qantas.
History and growth of Qantas
Queensland and Northern Territory Aerial Services (QANTAS) Limited was established in Winton, Queensland, in 1920 and expanded quickly as a transportation carrier. Through increased market exposure — from expansion of domestic and international air networks — and a value proposition built upon a reputation for safety, operational reliability and customer service, Qantas became one of Australia’s most recognised brands.1 Qantas delivered significant profit before tax increases between the 2006 and 2008 annual reporting periods, culminating in its 2008 record profit, an increase of 45.9 per cent on the previous year’s figures. Qantas chairman Leigh Clifford indicated that an increase in domestic and international demand, along with yield and seat factor improvements, resulted in increased corporate profitability.2
A significant change, however, in the operating environment was on the horizon. With darkening economic forecasts globally, focusing on declining economic growth and output, rising unemployment, diminishing disposable income and rising operating costs, Qantas’ record profit run was not to last. Pre-empting a downturn in global economic conditions, Leigh Clifford indicated ‘rising fuel prices and weaker economic conditions may have a negative impact on flying businesses over the coming year’.3 Indeed, external environmental influences decimated profit returns during the following financial year, with profit before tax plunging to A$181 million, a 90 per cent decline on the previous financial year.4 CEO Alan Joyce commented that in recent years Qantas had been hit with a ‘triple whammy’ of high fuel prices, a rising Australian dollar and a major economic downturn in strategic markets (i.e. those of the United Kingdom, Europe and the United States).5 In response to the International Air Transport Association forecast of global aviation industry losses of upwards of $9 billion during 2009 amid worsening economic conditions,6 Qantas was decisive in its implementation of a number of operational tactics to limit the negative fallout from the global financial crisis (GFC). In particular, the executive
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committee utilised an effective hedging strategy to partly mitigate the rising cost of crude oil, (which had doubled in cost to US$140 per barrel). In addition, group liquidity was increased through debt and equity advances, aircraft orders were deferred or cancelled, and cost efficiencies were increased through capacity reductions via grounding of aircraft, headcount reductions and an executive pay freeze.7 Furthermore, economy and business fares on key domestic routes rose by four and ten dollars respectively in a bid to boost profitability.8 The resulting implications of countering fallout from the GFC and improved operating conditions resulted in Qantas trebling before-tax profit to A$377 million during the 2009–10 financial year.
Industrial relations at Qantas
While profitability of Qantas is influenced by external environmental variables, internal forces also influence corporate profitability. Qantas is no stranger to the consequences of deteriorating employment relations. A bitter dispute between executive management and engineering workers in 2008 led to customers experiencing significant punctuality issues, which in turn negatively affected ‘on-time’ performance.9 Protracted industrial action led to public perceptions of the Qantas brand dropping to record lows.10 This was acknowledged in Leigh Clifford’s 2009 annual chairman’s report:
… protracted industrial action undertaken by the Australian Licensed Aircraft Engineers Association between May and July 2008 harmed Qantas’ punctuality, productivity, costs and reputation and full recovery took many months.11
Indeed, industrial action that has seriously affected airline schedules has traditionally had a very negative impact on share price.12
Within a challenging competitive environment, Joyce’s aim remains for Qantas to become a ‘profitable group with a growing international division’.13 To do so, Qantas has strategically targeted Asia as a growing and profitable region. Traditionally, Qantas International obtained significant revenue from Trans-Pacific routes between Australia and the United States and on the ‘Kangaroo Route’ between Australia and the United Kingdom. However, in recent years, increased international competition — specifically from state-sponsored airlines — has seen Qantas’ outbound market share plummet from a 35 per cent high to 18 per cent in 2012.14 To establish a greater presence in Asia, Qantas has committed to restructuring Qantas International, through establishing a premium hub in the Middle East and establishing a full-service premium airline based in Asia under a new brand. Restructuring Qantas International will necessitate a headcount reduction of approximately 1000 workers, affecting positions across management, pilots, cabin crew, engineering and airport administration.15
Worker discontent regarding corporate restructuring caused increased industrial relations hostility during 2011, with union leaders warning that protracted pay negotiations — along with disputes over Qantas’ plans to create a premium-service airline in Asia — could drag on for another year.16 The industrial conflict intensified during 2011 due to labour outsourcing, a key cost-efficiency platform in the transformation of Qantas International. This led to Alan Joyce’s extraordinary 31 October decision to ground the entire domestic and international fleet, and lock out workers. Qantas indicated that industrial action had resulted in financial losses of A$68 million and affected 71 000 passengers through flight delays and cancellations.17 However, such a decision forced Qantas and three warring unions — the Transport Workers Union, the Australian and International Pilots Association and the Australian Licensed Aircraft Engineers Association — into mediation. Fair Work Australia (FWA) deliberated and deemed the current bargaining period terminated, which resulted in a reversal of worker lockouts and a ruling allowed a further 21 days of
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negotiation between Qantas and the three unions. Negotiations collapsed within hours of the 21-day deadline, necessitating binding arbitration through the industrial relations umpire Fair Work Australia.18 Fair Work Australia’s ruling included a 3 per cent pay increase (originally recommended by Qantas) to be backdated to July 2011 for TWU employees but rejected TWU’s proposal for a 20 per cent cap on the use of contract ground staff and for non-permanent workers to be paid the same as full-time employees.19 While no agreement was reached between the airline and the Australian Licensed Aircraft Engineers Association (ALAEA) prior to the 21-day deadline, FWA conducted conciliation between both parties, with ALAEA reaching an agreement with the airline that the status quo would continue for any matters that could not be agreed.20 In contrast, the Australian and International Pilots Association launched legal action in the Federal Court challenging the industrial umpire’s decision to ban industrial action after Qantas’ grounding. The Federal Court dismissed the pilots’ application, ending industrial action by all three unions.21
The implications of Joyce’s decision to ground the Qantas fleet have been widespread. Financially, the cost of the decision has run into tens of millions; and there is the potentially irreversible damage to Qantas’ brand and reputation to consider.22 The Qantas brand is about perception, and a key to successful branding is trust.23 With over 80 000 passengers stranded across the entire Qantas network during the grounding, trust in brand Qantas was significantly tarnished. As one commentator put it:
brands are risk reduction mechanisms… When you look at an airline and you ask yourself: Virgin, Jetstar, Qantas — you ask which one is going to get me home, so you’re asking ‘Can I trust the brand[?]’ — this has been seriously compromised 24
The collateral damage from Qantas’ grounding was broader than disgruntled customers. Complementary businesses throughout the Australian travel and tourism industry were also negatively affected by the grounding. Tourism and Transport Forum chief executive John Lee indicated that the tourism industry could not afford for the current industrial campaign to continue, given the industry has had to contend with natural disasters, a strengthening Australian dollar enticing Australians to travel internationally rather than domestically, reduced buying power of international visitors and weakening economic conditions.25
Additional stakeholders affected by Qantas’ grounding were the employees. An industry-wide employee engagement survey undertaken by the Australian Licensed Aircraft Engineers Association (ALAEA), surveying almost 3000 industry employees, indicated that Qantas’ overall employee engagement rating of 32 per cent was significantly below its direct competitor, Virgin Australia, which had a rating of 76 per cent.26 However, Qantas dismissed the findings of the survey, commenting that such findings were at odds with Qantas’ internal survey findings and in no way reflected user engagement levels of the company’s 30 000 employees. Regardless, employee satisfaction levels among Qantas employees were at a low prior to the 2011 grounding, with Qantas’ long-haul staff having the lowest scores on record — about 14 per cent.27 Indeed, protracted industrial unrest and simmering resentment between parties results effectively in debilitating staff morale.28
Not all Qantas stakeholders were negatively affected by Joyce’s decision — Qantas’ loss was Virgin Australia’s (VA) gain, with VA on hand to offer assistance to passengers stranded by the grounding. John Borghetti, Virgin Australia’s CEO, stated that Qantas’ grounding provided an opportunity for Virgin Australia to hold on to a portion of the additional 30 000 passengers it carried during the three days in which Qantas aircraft were non-operational, no doubt helped by Virgin’s workforce volunteering to help out during the disruption.29 Essentially, the business outcome from Joyce’s decision to ground the fleet and lock out workers was a migration of clients to VA and a loss of market share for Qantas, from 63 per cent to 58 per cent.30 As reliability of performance and service expectations is what
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business travellers expect, Qantas’ actions forced many of its loyal customers to trial Virgin Australia.31 Furthermore, should Virgin Australia be able to provide service parity to that experienced by Qantas business travellers, it will be difficult for Qantas to lure back clients who have defected. If recent annual global airline rankings are a reliable indication of improved service quality, Qantas has reason for concern over Virgin Australia’s transformation. Qantas slumped seven places to 15 in the World Airline Awards, while Virgin Australia soared 20 places from 32 in 2011 to 12 in 2012.32
During the grounding of the Qantas fleet (and for days afterward), there was a ‘stratospheric’ increase in the number of passengers through Virgin Australia’s new business lounges, which put the company in a position to capitalise on the influx of new high-end customers.33 Moving upmarket on domestic services, through the establishment of business-class segments, network expansion of business-class lounges and expansion of VA’s international destination network via international alliances has brought ‘competition to the domestic business class market for the first time in a decade’.34
The road forward
Alan Joyce, determined to transform Qantas International, has established a ten-year alliance with Emirates. Such a move allows Qantas to establish a regional hub in Dubai for European-bound flights and improve network connections in Asia, while the company attempts to build a stronger International Group.35 The alliance will re-route the ‘Kangaroo Route’ from Australia through Dubai to Europe, rather than Singapore. This will realise a number of strategic benefits for Qantas. The alliance is aimed at stemming multimillion-dollar losses on routes to Europe by further reducing the global reach of Qantas planes by sending its passengers overseas on Emirates flights.36 This will lessen the fleet burden as Qantas will be able to retire a number of its aging 747 fleet, but this has caused concern for unions, specifically if the alliance leads to increased job losses.37
Rebuilding brand loyalty is another road on which Joyce and Qantas need to travel. Being a differentiation player in domestic and international markets, through the provision of a premium-service proposition, Qantas will need to positively re-engage with employees to ensure the company rebuilds and extends its reputation for excellence. This will require a movement towards enlightened corporate social responsibility.38 It is recommended that Alan Joyce decline future pay increases (his most recent was 71 per cent) or accept parity wage increases aligned with Qantas employees. Additionally, the re-establishment of trust between Qantas executive and its workforce would be helped by engaging the workforce to participate and contribute to strategy development, and by providing employee voice mechanisms.39
QUESTIONS
1. How would you classify Qantas’ approach to corporate social responsibility/stakeholder management? Explain your reasoning.
2. Brand names are a form of reputational asset: their value is in the confidence they instill in customers. What is your perception of the Qantas brand? How can Qantas attempt to rebuild its brand?
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3. Based on your reading of this case study and your review of Qantas’ homepage (www.qantas.com.au), what generic business strategy is Qantas pursuing? Explain your reasoning.
4. Mintzberg’s description of strategy as possessing an unplanned dimension introduces the idea of emergent strategy. Explain how the concept of emergent strategy has evolved at Qantas.
5. Which macro-environmental forces have influenced the profitability of Qantas? Explain your reasoning.
ENDNOTES
1. Qantas, ‘Our Company’, 2012, www.qantas.com.au.
2. Qantas. (2008). Annual Report 2008, 2008, www.qantas.com.au.
3. Qantas, 2008, loc. cit.
4. Qantas, Annual Report 2009, 2009, www.qantas.com.au.
5. D Flynn, ‘Qantas International facing triple whammy, says Alan Joyce’, Australian Business Traveller, 8 August, 2012, www.ausbt.com.au.
6. Qantas, 2009, loc. cit.
7. ibid.
8. Travel BlackBoard, ‘Qantas raises domestic airfares to pull out of GFC’, 1 December, 2009, Etravelblackboard.com.
9. Qantas, 2009, loc. cit.
10. A Cleary, ‘Alan Joyce’s high stakes gamble to save Qantas’, The Australian Financial Review, 11 November, 2011.
11. Qantas, 2009, op. cit., p. 11.
12. E Knight, ‘Time is right for a Qantas bid’, Sydney Morning Herald, 24 August, 2011, www.smh.com.au.
13. Cleary, loc. cit.
14. ibid.; E Knight, ‘Public wins as Qantas searches for a partner before the music stops’, Sydney Morning Herald, 9 June, 2012, www.smh.com.au.
15. Qantas, ‘Building a stronger Qantas’, August, 2011, www.qantas.com.au.
16. V Morello & S Johnson, ‘Unions promise more Qantas strike action’, Sydney Morning Herald, 28 October, 2011, www.smh.com.au.
17. ibid.
18. K Burke, M O’Sullivan & J Wright, ‘Qantas dispute heads to umpire, more pain possible, Sydney Morning Herald, 22 November 2011.
19. ‘Fair Work Australia rules in favour of Qantas in dispute with TWA’, www.news.com.au, 8 August 2012.
20. G Bamber, ‘The Qantas disputes: one agreement made, two to go?’ The Conversation, 22 December 2011.
21. M O’Sullivan, ‘Qantas pilots lose Fair Work court challenge’, Sydney Morning Herald, 10 May 2012.
22. P Ryan, ‘Grounding eroding Qantas’ reputation’, ABC News, 2 November, 2011.
23. P Harrison, ‘The Qantas brand is heading for the hanger’, Sydney Morning Herald, 2 November, 2011, www.smh.com.au.
24. B Lukas, ‘Lasting brand damage from Qantas grounding’, Nine News, 31 October, 2011.
25. M Skulley, M Beeby, D Crowe, B Woodhead & J Kerin, ‘Qantas IR action terminated’, Australian Financial Review, 29 October, 2011.
26. R Nickless, ‘Productivity: Changing the IR laws won’t be enough’, Australian Financial Review, 1 August, 2012.
27. I Verrender, ‘It’s ideology, not commerce, behind the Qantas quarrel’, Sydney Morning Herald, 5 November, 2011, www.smh.com.au.
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28. P Needham, ‘Qantas dispute takes long haul route as talks fail’, eGlobal Travel Media, 22 November, 2011.
29. Verrender, loc. cit.
30. S Creedy, ‘Qantas numbers losing altitude’, The Australian, 29 September 2012.
31. Harrison, loc. cit.
32. World Airline Awards, www.worldairlineawards.com.
33. N Tabakoff, ‘Virgin Australia does the business in wake of Qantas strike fiasco’, The Telegraph, 3 November, 2011, www.dailytelegraph.com.au.
34. K Schneider, ‘Virgin Australia aims sky high in a bid to lure passengers after $51.8M profit’, News.com.au, 29 February, 2012.
35. M Janda, ‘Qantas to call Dubai second home’, ABC News, 6 September, 2012, www.abc.net.au.
36. M O’Sullivan, ‘Qantas in Emirates alliance to Europe’, Sydney Morning Herald, 7 September, 2012
37. ibid.
38. G J Bamber, ‘How might Qantas rebuild relations with its workforce?’ The Conversation, 14 November, 2011, http://theconversation.edu.au.
39. ibid.
CASE STUDY 3
FORTESCUE METALS GROUP LIMITED
Dr Tim O’Shannassy, Graduate School of Business and Law, RMIT University
Recent media discussion has speculated on the end of the mining boom in Australia. In mid 2012, the Federal Minister for Resources and Energy Martin Ferguson was reported in the media as suggesting that the mining boom is over.1 The Australian economy, the mining industry, and mining states such as Western Australia and Queensland have benefited greatly from the strength of the Chinese economy before, during and after the global financial crisis (GFC). As the Chinese economy modernises and grows, its already substantial demand for Australian iron ore and coal has also increased. The Chinese government remains committed to growing its middle class, moving a further 600 million people from their rural lifestyles into urban dwellings.2 This all requires access to iron ore and coal to help build infrastructure for cities and suburbs. Fortescue Metals Group Limited (Fortescue), located in the Pilbara region of Western Australia, is ideally located to service Chinese demand for iron ore by shipment.3 Reflecting this, employment opportunities and royalty revenues for the resource-rich Australian states have been strong.
The growth of the Fortescue business and the evolution of its management and board of directors since its start-up in 2003 have been rapid. In only nine years Fortescue joined the Australian Securities Exchange (ASX) Top 50; spent or committed to spending A$15 billion in resource projects; completed its first major mine, rail line and port development; and, in 2011, exported 40 million tonnes of iron ore.4 Fortescue has ambitious plans for future capital expenditure and growth. The challenge for charismatic Fortescue founder and chairman Andrew ‘Twiggy’ Forrest and chief executive officer Neville Power is to continue to drive large-scale project financing, project implementation and iron ore export growth through a period of global economic uncertainty.5
Key personalities
Iron ore magnate Andrew ‘Twiggy’ Forrest has been the key person behind the creation of Fortescue and, in 2010, he was Australia’s richest man.6 Forrest’s professional background includes extensive experience as a company director in the mining industry. Forrest is a specialist in large-scale project finance and the execution of large scale mining projects. He is supported at Fortescue by chief executive officer Neville Power. Power joined Fortescue in September 2011 after an executive career in construction with Thiess Pty Ltd and in the steel industry with Smorgon Steel Group. Deputy chairman Herb Elliot is famous for convincingly winning the Olympic 1500 metre track event at the Rome Olympics in 1960 and is considered to be an Australian sporting icon. He has had a successful career in business after athletics — including directorships at ASX Top 100 companies Pacific Dunlop
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Limited and Ansell Limited. The Fortescue Port Hedland port facility is named after him. Fortescue’s chief financial officer Stephen Pearce, who has been with the company since 2010, has a challenging role given Forrest’s ambitions and the speed of Fortescue’s project implementation and growth. This growth requires significant investment of capital while managing a substantial debt burden.7
Infrastructure and operations
Fortescue has developed two areas of operation in the Pilbara region: the Chichester Hub and the Solomon Hub. The Chichester Hub comprises the Cloudbreak and Christmas Creek mines. A 256 kilometre rail line links Cloudbreak to the Fortescue Herb Elliot Port. In 2010, this rail line was extended 40 kilometres west to Christmas Creek. Cloudbreak’s train loading facility can load 16 000 tonnes of iron ore per hour on Fortescue’s trains, which can be up to 240 freight cars and 2.7 kilometres in length. Cloudbreak and Christmas Creek currently produce 55 million tonnes of iron ore per annum and this is expected to increase to 95 million tonnes. At Cloudbreak, deposits are horizontal, so they require a different approach to mining than those sites whose deposits are vertically oriented. This approach necessitates overburden removal through the use of conventional blast, shovel and truck techniques. The iron ore is then cut and loaded by specially-designed surface miners into the trucks for transport. The product is then screened, crushed and refined at the Cloudbreak facility prior to transport to the port.8
The Solomon Hub is located in the middle of Fortescue’s 88 000 km2 tenement area, 120 kilometres west of the Chichester Hub.9 Exploration has located three billion tonnes of iron ore at the site. Construction of the mine started in 2011; however, development was delayed in 2012 after iron ore prices slumped.10
The industry
Mining and mining services are two of the industries in which Australia has national competitive advantage. Mining giants BHP Billiton Ltd (BHP) and Rio Tinto Ltd (Rio Tinto) have dual stock exchange listing arrangements with the ASX and the London Stock Exchange, and both run extensive operations in Western Australia’s Pilbara region. Hancock Prospecting Pty Ltd, controlled by Australia’s richest woman Gina Rinehart, also has extensive operations in the Pilbara region. Iron ore mining in the Pilbara region is capital intensive, requires strong project management skills, access to substantial financial resources, and long lead times for project completions. Distances are vast, and accessing a skilled workforce, housing that workforce, and providing community facilities in remote locations is a challenge.11 The tremendous demand for iron ore and coal from China in the last decade, as well as favourable commodity prices, has assisted contract negotiations for iron ore for the large Australian mining companies. There are well over 2000 companies listed on the ASX and the materials sector is strongly represented in each of the small, medium size, and big company sectors. The success of a start-up such as Fortescue evidences the capacity for new entrants to gain traction in this industry.
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Sources of competitive advantage
Forrest is both very experienced and well networked in the financial and political community — especially in his home state of Western Australia. He has been adept at building positive working relationships with state and federal politicians and his background experience as a skilled project financier and manager on the mining scene has been of value in informing his practice in the Fortescue start-up.
Exploration has been a high priority for Forrest and his team from the earliest days in 2003. Fortescue has been recognised as the company with the highest financial commitment to exploration in Australia. Many of the original exploration team members are present and active today across the Fortescue operations, helping to identify a now substantial 11.4 billion tonnes of reserves of iron ore across only 20 per cent of its 88 000 km2 Pilbara tenement.12 The exploration team’s aim is to add 1 billion tonnes per annum to the resource portfolio of Fortescue, to provide the company with a sustainable competitive advantage. Fortescue has positioned itself as a low-cost producer with a culture that promotes workplace safety and teamwork.13
Fortescue is also well known for its contribution to the wellbeing of a range of stakeholders beyond their shareholders, and this is evident in the way the company has been developing and operating in the Pilbara since 2005. There has been substantial investment in local communities through Fortescue’s housing construction, residential workforce and vocational training and employment program.14 Fortescue’s goal of training and employing 300 Aboriginal people was achieved by 30 June 2011. Fortescue is publicly committed to the Australian Employment Covenant which is a countrywide initiative to create 50 000 jobs for the Aboriginal people.15 Fortescue has also been working with its mining services project partner WorleyParsons on minimising the environmental impact of the dredging program at Port Hedland.16
Human resource management
Growth in the activities of major resource players such as BHP, Rio Tinto and Fortescue has led to cost pressure for labour and equipment in the West Australian mining sector. Labour costs are high in Australia and the workforce is known for its lack of mobility. Prior to the 2012 delay in its expansion plans, Fortescue required 200 new employees per month and actively sought extra workers from the eastern states of Australia. At Cloudbreak, 2000 workers are scheduled eight days on and six days off. It is argued that this schedule is more conducive to family life. There is a 1600-bed operations village at Christmas Creek to provide permanent housing for the workforce.17 Short-term accommodation is available at Fortescue’s 700-room Hamilton Hotel in Port Hedland which is being expanded by a further 272 rooms. More than 300 Fortescue families live in Port Hedland and a Pilbara Residential Home Ownership scheme has been developed to encourage Fortescue workers to settle in the Port Hedland region and make a contribution to community life.18
Corporate governance evolution
Fortescue started business in April 2003. Forrest as founder and key strategist has had a substantial influence on the success of Fortescue so far. Initially, Forrest was non-executive chairman; however, this changed when he was appointed CEO in 2005. Duality of the chairperson and chief executive officer role is nowhere near as prevalent on ASX-listed companies compared to New York Stock Exchange listed companies. Australian and British corporate culture prefers separation of these important roles. Forrest resumed as chairman in a non-executive capacity in August 2011. Present-day deputy chairman Herb Elliott has also played a prominent role at Fortescue, having been an independent director
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from October 2003 to May 2005, and deputy chairman to March 2007, after which he was appointed chairman until August 2011.19 CEO Neville Power is the sole executive director. There are a further eight non-executive directors. Graeme Rowley is a former executive director (operations) and has been a director since October 2003. Ken Ambrecht is an investment banker with KCA Associates LLC. Geoff Brayshaw is a former audit partner with BDO Accountants. He has been a non-executive director since July 2007. Owen Hegarty was appointed in October 2008 and is the former managing director of Oxiana Ltd. Mark Barnaba was appointed in February 2010 and is the chairman of Macquarie Bank Western Australia. Geoff Raby is a retired Australian diplomat and was appointed in August 2011. Herbert Scruggs is a professional company director and was appointed in August 2011. Cao Huiquan is the nominated director from Hunan Valin Iron and Steel Group Company Ltd and was appointed in February 2012.20
Forrest has been involved in a long-running legal matter with the Australian Securities and Investments Commission (ASIC) in relation to whether or not Fortescue and Forrest misled investors in 2004 regarding the status of any legal agreement with Chinese investors to construct a mine, railway and port. A 2009 decision by Justice John Gilmour in the Federal Court found in favour of Fortescue and Forrest.21 This decision was overturned when ASIC appealed to the full Federal Court in 2011. The matter is now before the High Court. At issue is whether the representations made by Fortescue in 2004 to the market were accurate and could be relied upon. There is a risk Forrest will be banned as a director if his appeal fails.22
Business performance
Table C3.123 evidences the success of Fortescue marketing iron ore to China. The downside of this outcome is that this exposes Fortescue to fluctuations in Chinese demand for iron ore and economic growth.
TABLE C3.1 Fortescue Metals Group’s financial performance
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Fortescue’s debt position remains one of the biggest challenges for CFO Pearce; however, he has indicated in the media in previous years that the company has the capacity to take on more debt. Interest expense in 2011 was US$454 million. On 7 October 2010, Fortescue obtained a senior unsecured syndicated debt facility of US$2.04 billion. This facility plus Fortescue cash was used to retire the senior secured notes facility. This syndicated facility was in turn replaced three weeks later by an unsecured loan notes issue by Fortescue for the same amount. In December 2010, a further US$1.5 billion in unsecured loan notes was completed to fund future expansion of the Chichester Hub, development of Solomon Hub, and expansion of port and rail infrastructure.24 The movements in the balances of these debt facilities are detailed in table C3.1 as follows.
Media analysts expressed concern in September 2012 that Fortescue may struggle to service debt commitments if iron ore prices continued to plummet. Iron ore prices peaked in 2011 at US$190 per tonne and eased back in the third quarter of the 2012 calendar year to under US$100 per tonne. Some analysts were not convinced Fortescue was a profitable business with the iron ore price below US$100 per tonne. Fortescue acted quickly, delaying capital expenditure for future expansion plans of US$1.6 billion, reducing its workforce by 1000 employees, and identifying opportunities to reduce operating costs. Fortescue also refinanced its bank debts with a US$4.5 billion facility with Credit Suisse and JP Morgan to lengthen the maturity profile of its existing debt portfolio.25
Fortescue expects the price of iron ore to return to US$120 to US$150 per tonne over the short- to medium-term period. Further encouraging news for Fortescue is that
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the positive cash flow from operating activities achieved since 2009 continues to grow strongly; however, it is unclear what the impact of the September 2012 drop in the spot price for iron ore will be on this key financial measure.26 There is a further potential upside to Fortescue’s cash flow performance if the iron ore spot price strengthens with the target of export of 155 million tonnes of iron ore only 60 per cent achieved to date.27 Some positive news is that the Australian economy grew by 1.3 per cent in the first quarter of 2012 and the average for the past 20 years has been 3 per cent per annum.28 Expectations are for Chinese economic growth to continue at around 7.5 per cent per annum.29
The future
The Australian economy has been recognised as having two speeds, with the mining states of Western Australia and Queensland enjoying improved state gross domestic product and healthy mining royalties in recent years. At the same time, traditional manufacturing states (e.g. Victoria) have struggled with the high Australian dollar reducing their international competitiveness.30 The federal government has also recently introduced a carbon tax and the mineral resource rent tax (MRRT). The MRRT, which came into effect in July 2012, is levied at 30 per cent on ‘super profits’ over A$75 million from iron ore and coalmining operations. Forrest has spoken out against the MRRT in the media, and Fortescue in a statement commented:
It is bad policy and poorly designed… The MRRT will ensure the world’s biggest miners have an unfair advantage in the market place by reducing their overall unit cost compared to smaller miners. It will reduce investment in Australia.31
Economies of scale are critical in the efficient mining of iron ore. Media speculation continues regarding whether the mining boom may be coming to a close. Has Forrest and the Fortescue board of directors correctly identified where the Australian and Chinese economies are at in their respective business cycles? Has Fortescue overestimated the rate at which it can increase iron ore exports to China? Should Fortescue diversify the countries and corporations to which it exports iron ore? How will Fortescue balance its debt liabilities with the spot iron ore price and its expansion plans? Should Fortescue continue to delay the next stage of capital investment?
QUESTIONS
1. Describe the nature and sources of Fortescue’s competitive advantage.
2. How has the setting of goals and values assisted Fortescue in achieving strong organisational performance?
3. What is the ‘state of play’ in the mining industry in Australia and globally?
4. How is the Fortescue board of directors structured? What is Fortescue’s reputation regarding corporate governance practice?
5. What is the future for Fortescue Metals Group? Explain your reasoning.
ENDNOTES
1. A Duffy, ‘Mining boom is dead: Government’, Australian Mining, 23 August 2012, www.miningaustralia.com.au.
2. K Lahey, ‘Twiggy rises to the top as Packer loses his crown’, Sydney Morning Herald, 5 March 2010, www.smh.com.au.
3. ‘Company overview’, Fortescue Metals Group Limited, www.fmgl.com.au.
4. ibid.
5. ibid.
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6. 2011 Annual report, Fortescue Metals Group, 2011.
7. ‘Our business’, Fortescue Metals Group Limited, www.fmgl.com.au.
8. ibid.
9. ibid.
10. M Janda, ‘Fortescue delays expansion, cuts ‘several hundred’ jobs’, ABC News, 4 September 2012, www.abc.net.au.
11. ‘Company overview’, loc. cit.
12. ibid.
13. ibid.
14. ‘Fortescue port expansion’, Fortescue Metals Group Limited, www.fmgl.com.au.
15. ‘Corporate social responsibility’, Fortescue Metals Group Limited, www.fmgl.com.au.
16. ‘Fortescue port expansion’, loc. cit.
17. ‘Our business’, loc. cit.
18. ‘Fortescue port expansion’, loc. cit.
19. ‘Board of directors’, Fortescue, www.fmgl.com.au.
20. ibid.
21. C Yeates, ‘ASIC grilled over Fortescue’, Sydney Morning Herald, 31 March 2012, www.smh.com.au.
22. ibid.
23. 2009 Annual Report, Fortescue Metals Group Limited, 2009; 2011 Annual Report, Fortescue Metals Group Limited, 2011; 2012 Annual Report, Fortescue Metals Group Limited, 2012.
24. 2011 Annual Report, Fortescue Metals Group Limited, 2011.
25. ‘Fortescue secures $US4.5b credit facility’, Herald Sun, 18 September 2012, www.news.com.au.
26. P Ker, ‘Fortescue rebounds on 53% profit jump’, Business Day, 23 August 2012, www.businessday.com.au.
27. P Ker & R Spooner, ‘Fortescue’s Power rejects “boom over” talk’, Sydney Morning Herald, 23 August 2012, www.smh.com.au.
28. J Irvine, ‘The good, the bad and the two-speed economy’, Sydney Morning Herald, 23 June 2012, www.smh.com.au.
29. B Fitzgerald, ‘Hold your nerve, good times will return to China, says Michelmore’, The Australian, 29 August, 2012, www.theaustralian.com.au.
30. Irvine, loc cit.
31. P Mercer, ‘Can Australia’s new mining tax achieve its objective?’, BBC News, 23 November 2011, www.bbc.co.uk.
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