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Fortescue Hits Paydirt With Dividend Policy

Australia | Aug 22 2017

This story features FORTESCUE LIMITED. For more info SHARE ANALYSIS: FMG

Brokers brushed aside the FY17 results for Fortescue Metals, enthusing over the surprise increase in the second half dividend and the new dividend pay-out policy.

-Iron ore price volatility overshadowed by ability to make money through the cycle
-Expected to lift average returns while retaining a flexible dividend policy
-Lingering uncertainty around discounts on price realisation

 

By Eva Brocklehurst

Fortescue Metals ((FMG)) delivered a surprise increase in its second half dividend, to 25c, reflecting an improved balance sheet and strong cash flow. Brokers brushed aside earnings results, which generally were perceived to be a miss versus expectations.

The volatility of the iron ore price was the main contributor to any shortfall but this has been overshadowed by the ability of the company to make money through the cycle, as well as the upgraded dividend outlook. The main negative is the lingering uncertainty around discounts on price realisation.

Bell Potter observes hard work has paid off, after gains in productivity and cost reductions in the prior year, and this sends a strong signal regarding the maturity of the business.

Morgan takes a positive view now the balance sheet is repaired and the spot iron ore price is back up to near US$80/t. The broker makes several adjustments to forward assumptions, increasing the discount to be received from the company's iron ore sales in FY18 to 23% from 18% and FY19 to 17% from 15%.

Price Realisations

Guidance is for a realised iron ore price of 75-80% of the 62% fines index with better realisation in the second half than the first. This fits with Morgan Stanley's view that demand for lower grade iron ore will recover now that metallurgical coal prices and the availability of coke are normalising. The broker expects the index to trade in the US$50-60/dmt range in time.

Provided miners remain rational and consumption doesn't collapse, the broker suspects the prospect for a stable iron ore horizon is increasing. Credit Suisse is of the view that price discounting is a cyclical dynamic and when record Chinese steel margins ultimately normalise then price discounting will normalise as well. The time frame is more difficult to ascertain. Nevertheless, the potential should not be underestimated, in the broker's opinion.

Goldman Sachs, not one of the eight stockbrokers monitored daily on the FNArena database, maintains a Sell recommendation and $4.75 target, primarily because of a view that iron ore prices will weaken from here. In contrast, Bell Potter, also not one of the eight, believes the company is in great shape and retains a Buy rating and $6.65 target.

The company has set strong cost reduction targets for FY18, continuing the reductions from FY17, where C1 cost fell -17%. Guidance is for C1 costs between US$11-12/wmt FOB. This is based on an Australian dollar rate of US$0.75 and West Texas Intermediate crude at US$53/bbl.

Cost reductions are to be supported by improved productivity and the integration of technology such as autonomous haulage, enhanced plant reliability and optimised shutdowns. In exploration, the company continues to target new commodities retaining a positive outlook on copper and gold.

Deutsche Bank expects mining costs to fall further with automation and productivity initiatives and remains of the view that FY18 guidance for 170mt in sales is conservative. The broker considers the stock fully valued and retains a Hold rating.

Dividend Policy

The company has instituted a new dividend policy of 50-80% pay-out of profits. The FY17 dividend of 45 reveals an 8% yield, fully franked, and a 52% pay-out ratio. This signifies a willingness to return cash and signals to Morgans, that the company, while maintaining a flexible policy against a backdrop of volatile iron ore prices, will lift average returns.

With gearing back to a manageable 27%, the company is in a position to increase returns and still pursue options for growth in iron ore. In line with the change in dividend policy the broker lifts the assumed dividend pay-out ratio to 60%, given low assumed capital expenditure at this stage.

Credit Suisse also believes the new dividend policy is a sign of confidence that the company can continue to generate cash, while maintaining standard qualifications, such as the dividend being contingent on prevailing iron ore prices and competing capital requirements.

Is this the start of a trend? Morgan Stanley suspects that many miners, particularly iron ore miners, are pursuing value over volume strategies and increased returns may become the new norm. This will require a shift in both corporate mindset and investment expectations, where the focus moves to steady-state production and an emphasis on gradual gains to offset headwinds like strip ratios or grade deterioration.

Macquarie upgrades dividend pay-out assumptions to match the company's guidance. The broker highlights that resources at the Western Hub have almost tripled, which underpins the future development case. Both Western Hub and Nyidinghu are to be developed as replacement options for the depleted Brockman ore from Firetail. 

The company expects to make a decision in terms of the timing and priority of developing either the Western Hub or Nyidinghu Hub/mine. One of these will be online by 2021-22 in order to offset Firetail's decline.

However, impurities were higher than Macquarie expected at Western Hub. Initial Brockman resources at the site appear to contain elevated levels of phosphorus, which may potentially force changes to the proportion of Brockman ore used after Firetail is exhausted.

Citi has upgraded to Neutral from Sell in the wake of the results, believing higher iron ore prices and higher dividend guidance will support the share price. The broker expects the company to be debt free by the end of FY19.

Shaw and Partners, not one of the eight monitored daily on the database, has renewed confidence in the company although acknowledges the share price will follow the iron ore price. The broker believes consensus estimates are too low and, with a reasonable view on current pricing, upgrades are likely to follow even as and when the iron ore price normalises. The broker is delighted with the idea the company could sustain a yield of 5-7% and retains a Buy rating. Target is $6.40.

FNArena's database shows three Buy ratings and five Hold. The consensus target is $6.01, suggesting 1.1% upside to the last share price. Targets range from $5.40 (Morgan Stanley) to $6.60 (Macquarie). The dividend yield on FY18 and FY19 forecasts is 5.6%.

See also, Fortescue Plans To Beat On Costs, Again on July 28 2017.
 

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