Research Update:

Fortescue Metals Group Ltd. Ratings Raised To 'BB'; Outlook Positive On Improving Competitive Position
Primary Credit Analyst: May Zhong, Melbourne (61) 3-9631-2164; may.zhong@standardandpoors.com Secondary Contact: Brenda Wardlaw, Melbourne (61) 3-9631-2074; brenda.wardlaw@standardandpoors.com

Table Of Contents
Overview Rating Action Rationale Outlook Related Criteria And Research Ratings List

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Research Update:

Fortescue Metals Group Ltd. Ratings Raised To 'BB'; Outlook Positive On Improving Competitive Position
Overview
We view that Fortescue's competitive position has improved because its production has increased and costs have reduced. In addition, project execution risk is diminishing for the company. As such, we have raised the corporate credit rating on the company to 'BB', senior secured debt rating to 'BBB-', and senior unsecured debt rating to 'BB-'. The outlook is positive. We believe Fortescue is on track to complete its 155mtpa expansion. We expect deleveraging to occur in the next 12 months, with positive free operating cash flows following the reduction in capital expenditure in fiscal 2014.

Rating Action
On Nov. 6, 2013, Standard & Poor's Ratings Services raised its long-term corporate credit rating on Australia-based mining company Fortescue Metals Group Ltd. to 'BB', from 'BB-'. The outlook is positive. At the same time, we raised the senior secured debt rating to 'BBB-', from 'BB+', and the senior unsecured debt rating to 'BB-' from 'B+'. The recovery rating on the senior secured debt rating is affirmed at '1' and senior unsecured debt '5'.

Rationale
The upgrade reflects our view that Fortescue business risk profile has improved to "satisfactory" from "fair", with the continued increase in its production scale, reduction in its cost position, and diminishing project execution risks. Underpinning our assessment of Fortescue's "satisfactory" business risk profile is its large size and scale as the world's fourth-largest iron ore producer, competitive cost position, and long reserve life. Its limited product diversity and high exposure to China's steel industry and volatile commodity prices offset these strengths.

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Research Update: Fortescue Metals Group Ltd. Ratings Raised To 'BB'; Outlook Positive On Improving Competitive Position

Fortescue has grown to be the fourth-largest iron ore producer in the world, behind Vale, Rio Tinto PLC, and BHP Billion Ltd. The company has a competitive cost position, with a reported C1 cash cost of US$33.17 per wet metric tonne (wmt) in the September 2013 quarter. This position reflects a sustained reduction in strip ratios, benefits from cost reduction initiatives, and a depreciating Australian dollar against the U.S. dollar. The company expects its C1 cost to be US$36-US$38 per wmt in fiscal 2014, assuming a foreign exchange rate of 0.95 Australian dollar to the U.S. dollar. With five mines from two hubs, Fortescue's expansion would improve its asset diversity and operational flexibility. Its proximity to the Asian market gives it a geographic advantage over its European, African, and South American competitors because of lower shipping costs. However, its EBITDA per tonne is lower than the top-three iron ore producers because of discounts on its sales price for lower iron ore (Fe) grade. In addition, Fortescue lacks product and customer diversity. Its significant exposure to the Chinese market makes it more vulnerable to a decline in China's iron ore demand. Nonetheless, the completion of growth capital expenditure and achievement of competitive cash production costs should help Fortescue weather a potential fall in iron ore prices in the medium term. In our view, the execution risk of the 155mtpa expansion is diminishing. The construction of the key infrastructure (port, rail) supporting the 155mtpa capacity has been largely completed, while the commissioning of its Kings mine (40mtpa) is underway. The company expects to achieve the 155mpta production run rate by the end of March 2014. We view Fortescue's financial risk profile as "significant". Our base-case assumes a price of US$110 per tonne for benchmark iron ore (cost and freight (CFR] 62% Fe), and volume of ore shipped to be between 120mt to 130mt (on a wet tonne basis) in fiscal 2014. Under this assumption, we forecast Fortescue's adjusted funds from operations (FFO) to be more than 25% and adjusted debt to EBITDA to be less than 3x in fiscal 2014. Our base case also assumes that the company's gross debt peaked in fiscal 2013. As we forecast Fortescue's free operating cash flow will be positive following the completion of its 155mtpa expansion, we expect deleveraging to occur in the next 12 months. Our base case assumes that Fortescue will repay its US$2 billion bond due in November 2015 within the next 12 months. We estimate that the company's breakeven cost (including interest, royalties, and minimal capital expenditure) will be between US$70 and US$75 per tonne in fiscal 2014 under our price deck.

Liquidity
In our view, Fortescue's liquidity is "adequate", based on our criteria. Relevant aspects of our assessment of the company's liquidity profile are: We expect Fortescue's sources of liquidity in 2013 to exceed uses by

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Research Update: Fortescue Metals Group Ltd. Ratings Raised To 'BB'; Outlook Positive On Improving Competitive Position

1.2x; No debt maturities before November 2015; No financial maintenance covenants; and The company's sensitivity to an unexpected drop in iron ore prices. Principal liquidity sources US$2.8 billion of cash at Sept. 30, 2013; and Cash from operations of about US$3 billion in fiscal 2014.

Principal liquidity uses: Capital expenditure of US$1.9 billion in fiscal 2014.

Recovery analysis
The recovery rating is '1' on the US$5 billion senior secured term loan due in October 2017, which has been issued by Fortescue's finance subsidiary, FMG Resources (August 2006) Pty Ltd. and FMG America Finance. Inc. Due to the prior ranking of the senior secured debt in our recovery analysis, we expect the senior secured debt to realize an average recovery of about 90%100% following a hypothetical default. The rating on the US$5 billion senior secured facility is 'BBB-'. The recovery rating is '5' on the senior unsecured 144a notes issued by FMG Resources (August 2006) Pty Ltd. This reflects our expectation of an average recovery of about 10%30% following a hypothetical default. The rating on the senior unsecured debt is 'BB-'. In our opinion, the likely hypothetical default scenario would involve a structural shift in iron ore market fundamentals leading to significant deterioration in Fortescue's financial profile. These could include a sustained fall in iron ore prices, and underperformance in production combining to cause default, which we assume would be around 2018 in this simulated default scenario.

Outlook
The positive outlook reflects our view that the execution risk of the company's 155mtpa expansion is diminishing. The reduction in capital expenditure, together with the company's increasing production and improving cost profile, should enable its credit metrics to improve. We anticipate that Fortescue will generate positive free operating cash flows in fiscal 2014. We would consider raising the rating if the company: Develop a track record of debt reduction ; Develops an operational track record at the 155mtpa run rate; FFO/debt sustains at about 30% and debt to capital approaches 50%, and Its growth aspiration or capital management are not more aggressive than

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Research Update: Fortescue Metals Group Ltd. Ratings Raised To 'BB'; Outlook Positive On Improving Competitive Position

currently expected. For example, we expect it to focus on organic growth opportunities in the Pilbara region. We would revise the outlook to stable if the anticipated deleveraging does not happen. This scenario could occur if there were a significant weakening in iron ore prices or if the company were to experience a major operational issue.

Related Criteria And Research

Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 Criteria Guidelines For Recovery Ratings On Global Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009 Key Credit Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 2008 Corporate Criteria: Rating Each Issue, April 15, 2008 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008

Ratings List
Upgraded, Affirmed To FMG Resources (August 2006) Pty Ltd. Senior Secured Recovery Rating Senior Unsecured Recovery Rating Upgraded; CreditWatch/Outlook Action To Fortescue Metals Group Ltd. Corporate Credit Rating BB/Positive/-From BB-/Stable/-BBB1 BB5 From BB+ 1 B+ 5

Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at www.spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services licence number 337565 under the Corporations Act 2001. Standard & Poor's credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as

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defined in Chapter 7 of the Corporations Act).

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