Fortescue

"Driven people = driven outcomes"

Money is a trailing indicator of happiness. Old John D Rockefeller got it right with his quote above. If you put your heart and soul into something you are passionately interested in the rest will take care of itself.

This is why in the equity market we only back passionately driven people. No passengers, no people who are solely motivated by money and status. This is about backing people with educated enthusiasm who have the vision to deliver on their enthusiasm. The people we back only look forward. They are solely focused on the future and the quickest, smartest, and most profitable route there. They have a steely focus and that focus cannot be interrupted by short-term events outside of their control. They take glancing blows but they know how to get up, dust themselves off, and continue to relentlessly pursue their usually ambitious goals.

As long-time readers would know, we back people first and assets second. You can have the greatest assets in the world but you will never generate appropriate economic returns without the highest quality driven and visionary people running those assets. However, it seems most analysts believe models run companies. The earnings are the end game; the people are the start game.

The biggest mistake everyone makes is underestimating the shareholder return differential that different levels of management ability can generate. Those with ability deliver compounding outperformance. Those lacking ability deliver compounding underperformance versus their peers. That underperformance, particularly if associated with high quality assets, often leads to the strong taking out the weak which allows the weak to escape with some share price dignity and their "management" reputations partially restored.

It's all about people; people, people, people. The ability to retain the best ones and the ability to ensure succession. It's also about the ability for these high quality people to share in the value they create for shareholders.

That is why at Southern Cross we are spending so much time away from the desk. We strongly believe you have to "get out to find out". While many of you probably think we are at lunch spending your brokerage, the truth is the more likely answer is we are out visiting companies attempting to work out whether they have the "people" worth backing. There is a tremendous correlation between getting out and accurate stock picking (e.g. SCE is rated no.1 for share price forecasting for BHP and is in the top 3 share price forecasters of 70% of stocks we cover according to Bloomberg).

The travel bill has tripled at our firm this year (no, not upgrading to first class!) but it's been our best ever year of value added stock picking. I don't think this is a coincidence. Getting out in the real world is how you reduce recommendation risk; it is as simple as that. Last week Southern Cross had operatives in Dubai, The Pilbara, Port Hedland, Perth, Melbourne, London, Sydney and Singapore seeing companies, governments and investors. Think global; act local

The more competitor research I read the more I believe "research" has become "commoditised journalism". The analysts have become journalists, simply reporting yesterday's news today. That is why research packs are 200 pages in the reporting season and 10 pages at the moment. It's all after the event analysis of yesterday's events and all the morning research packs are the same. There's no value add in this approach to research and this continues to provide opportunities for those who are prepared to spend a lot of time on planes and wear out some shoe leather.

But you have to love what you are doing to maintain the energy and drive to continue to keep seeking out opportunities. It's too easy to sit at your desk and "wait to be told" but that is not how you generate outperformance. It's all about enthusiasm and drive. Exactly what Old John D described above.

While going to the "new world" and seeing the new world economic order with our own eyes has given us the underlying confidence in the commodity cycle and Australia's place in that cycle, the real value add comes from visiting companies and getting confidence in management teams and the assets they control. In a market that broadly "waits to be told" this is how you can get significantly ahead of the investing curve. Just remember how much money follows "consensus".

This all comes back to basic "Peter Lynch Theory". I am a complete disciple of Peter Lynch Theory. Lynch believes "the best investments you can see with your own eyes". You'll never beat any index or benchmark by sitting at a desk waiting for news or earnings to be released to the market. When news or earnings are released it should confirm your view, not be the catalyst for investment.

I looked at my passport last night and it confirmed that I personally have never done more travelling in a single year. When I look back at this year there are clearly many highlights, most of which have been in the resource sector. However, the single most value added trip we participated in this year was clearly the Anzac Day site visit to Fortescue Metals Group.

If you build it they will come

Andrew Forrest had been urging me to come and see FMG's project since the stock was around $8.00 in late 2006. Andrew would ring me and say "c'mon Mr Resource super bull how about you come and see the biggest onshore resource project in Australia". Andrew continued to tell me that the project was real and under construction and the only way I would ever appreciate its scale was to come and see it. FMG sent me photos of the early construction activity and even these photos showed the potential scale of the footprint of the project. These photos got me interested as did the views of our Rex Adams who had been to FMG a year earlier and confirmed the geology of the project.

Being natural contrarians also attracted us to the FMG story. Here was a stock that was running quite hard, had a growing market capitalisation, yet every single person you talked to thought it was over-priced hot air. I suspect most people had been brainwashed by the very negative views spouted by one of FMG's established competitors. However, smart US investors were on the register in big scale. The contrarian in me gets interested in this style of situation. I couldn't help thinking "wouldn't it be funny if this really did become the new force in iron ore".

Here we are just 8 months later and it is very clear that FMG will be "the new force in iron ore". The stock is 200% higher than our first buy recommendation on the stock after the site visit, while those who participated in the capital raising earlier this year ($36.00) have already made 55% on their investment. BHP have also made a move on RIO which confirms the structural change in commodity pricing, while consensus iron ore price forecasts have been revised dramatically higher. FMG is on the cusp of becoming the only large cap listed pure iron ore producer in the world in record time; against all the odds and all the sceptics.

This is a great development for the Australian resource sector and Australia (employment, taxation, dividends, royalties, exports, ongoing expansions etc). There should be absolutely no doubt now that FMG is the real deal and will be producing and shipping iron ore by May next year. The risk is going right out of the stock, and I think it's interesting that 100 investors and analysts attended last week's site visit. The site visit we were on in April had about 10 people, most of whom were existing offshore shareholders. How interest changes as projects approach production and cashflow "modelability". As projects become lower and lower real risk, analyst and investor interest broadens exponentially. FMG is about to become mainstream with global brokers writing research on the stock and the register attracting domestic institutional investors. That makes the timing of the proposed 10:1 FMG share split appear exquisite. The intention of the share split is to improve trading liquidity in the stock.

The photos below are a selection of what investors and analysts saw on the site visit.

Anderson Point ship loader

Stacker

2km FMG train on FMG track

Continuous miner working well

Crushing plant and train loader well advanced

The market clearly played the man and not the ball here. They thought there was only one man and not the depth of experienced management that FMG clearly has. The market listened to the smear campaign run by one of FMG's larger competitors. That was the mistake the vast bulk of market participants made. The ball (i.e. the assets pictured above) are the game now. This is not, and should not be, about any individual anymore. This is about the assets and the cashflow they will produce under the FMG management team. This is about the eventual scale of production and what multiple the market will pay for this globally unique large scale pure play iron ore producer. Iron ore is basically a logistics game; it's not rocket science once you have the logistics in place.

In my mind FMG is now a classic corporate target. We are in the middle of a once in a generation carve up of the global resource sector initiated by BHP's move on RIO. Today there are even rumours of Vale bidding for Xstrata. As we keep writing, a complete carve up of the sector is on.

Listen to Mick

To quote Mick Davis from Xstrata, "What an exciting time it is when the biggest mining company in the world [BHP] wants to buy the second or third biggest. Whether that transaction goes through or not, time will tell."It certainly, I think, has created another new dynamic and momentum for consolidation in the industry,"

Mick is right, and it's worth remembering Mick has created more shareholder value than just about anyone over the last 5 years via his more aggressive belief in the sustainability of the cycle. This BHP/RIO proposal, whether RIO like it or not, has clearly created a "new dynamic and momentum for consolidation in the industry".

This is why it still amazes me that there really hasn't been any follow through in the pricing of next generation resources stocks since the RIO bid. Mick Davis has followed through bidding cash for JBM, RSP, and potentially ZFX, and now may be a target himself, but investors have only re-rated RIO despite the clear and present risk that the RIO Board overplays its hand here. Just about the last resource stock we would be buying at current prices is RIO particularly given the comments by RIO CEO Albanese that the BHP deal is "dead in the water". If that's right Tom then your stock is $30.00 too high.

But this not about RIO being dead or alive. The starter's gun has been fired and the race is on for assets. The next generation stocks we recommend have production growth and production growth in politically stable companies makes them clear corporate targets. There is no larger scale corporate target than a producing Fortescue Metals Group. FMG will ship its first cargo of iron ore in May 2008. From that day FMG becomes a corporate target. Interestingly, there were 5 Chinese corporates on the site visit. On Friday night SinoSteel bid for Midwest Corporation (MIS) for an implied price of $10 per resource tonne. FMG current trades on $5 per resource tonne and that is despite having $3bil of infrastructure built versus MIS $0 of infrastructure. This MIS bid makes FMG look ridiculously cheap.

For all the knockers and all the sceptics the fact remains that FMG is real and happening. This is Australia's largest onshore greenfields resource project and it is headed towards being a tremendous success. This is the greatest Australian story of the commodity cycle so far, particularly given the underdog nature of the project and the odds against it being a success. We should all be congratulating the FMG team on what is a wonderful achievement and backing them in the long-term to become a 200mtpa producer with a 50 year mine life. FMG is clearly the stock to replace RIO in the ASX indices. Interestingly, despite the bid for RIO, FMG has outperformed RIO by 130% since Anzac Day. There is some irony in that.

It is fair to say that the FMG team (3000 people) have followed John D Rockefeller's advice. They have put their heart and soul into this project and they are about to be rewarded. Our 12 month FMG price target remains $68.00, yet I stand by the comments I first wrote on FMG back in April that over the next 5 years FMG will be a $100.00 stock. Buy now before the 10:1 share split. Australian institutions now need to own this stock. There are no legitimate excuses any more.