Price Pressure Continues For Fortescue

Australia | Apr 18 2017

Prices achieved for iron ore in the March quarter have plunged, affecting Fortescue Metals, a high-volume, low-grade producer.

-Underperformance of lower grade iron ore expected to continue for the short term
-Sentiment likely to focus on achieved prices in the near term
-Strong reductions in debt levels augur well for being debt free in 2018


By Eva Brocklehurst

Prices achieved for iron ore in the March quarter have plunged, affecting Fortescue Metals ((FMG)), a high-volume, low-grade producer. The achieved price of US$65/tonne was flat quarter on quarter and reflected the absence of provisional pricing benefits along with a widening discount.

The company posted March quarter iron ore shipments of 39.6m tonnes, down -6%, while the mined 44.7mt of iron ore was also lower than brokers expected. Shipments were lower as a result of tropical storms that affected port availability. Sales guidance for FY17 of 165-170mt has been maintained but pricing guidance has been reduced. Fortescue has revised price realisation guidance for FY17 to 75-85% from 85-87%.

There was a high probability that Chinese steel mills, already suffering from falling steel prices, would try to minimise coke requirements by substituting for higher grade iron ore in their mills. Morgans observes this trend is now unfolding, as the company reported a discount on its lower grade iron ore products of 26% versus benchmark.

The broker expects the trend has further to play out as steel prices are still falling. The broker had predicted that the spike in coking coal prices against a backdrop of falling steel prices would affect demand for lower grade iron ores and believes this is now in full effect.

Morgans expects the company can still comfortably achieve its FY17 sales guidance, but the underperformance of lower grade iron ore will continue for at least the next month, during a seasonally weaker time, which could mean the discount blows out further. This may also mean that the stock continues to underperform in the short term given its market position in terms of producing high volumes of low-grade material.

Deutsche Bank forecasts an 80% price realisation for FY17 and believes the downward trajectory in costs will resume in the June quarter. The broker expects price realisation will return to long-run estimates of around 85%.

While there is pressure on free cash flow and the equity from falling iron ore prices and the realised price discount, Morgan Stanley believes these two items remain robust. On the positive side, free cash flow for the year is still close to US$4bn, although the broker has reduced its FY17 forecast for free cash flow by over US$400m.

Morgan Stanley suspects the the market's focus, unnecessarily, will be on the reduction to cash flows and sentiment will be affected by achieved prices in the near term. With both the headline and discount prices under pressure, this creates a headwind for the equity.

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