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Treasure Chest: Fortescue The Resilient

Treasure Chest | Mar 16 2020

FNArena's Treasure Chest reports on money making ideas from stockbrokers and other experts. Given the significant correction that has occurred across the market, the spotlight has fallen on the resilient, and one of those is Fortescue Metals.

-Bell Potter highlights iron ore price as “extraordinarily resilient”
-Iron ore has direct exposure to Chinese stimulus measures
-Fortescue Metals' production tracking at the top end of guidance

 

By Eva Brocklehurst

Value opportunities abound in the current market and one of these is Fortescue Metals ((FMG)). Brokers assess the significant correction that has occurred, combined with the resilience of the iron ore price underpins the miner.

Bell Potter observes the iron ore prices been "extraordinarily resilient" over the last six weeks. While the impact of coronavirus on global economic growth and consumption will be significant, the Chinese government has signalled intensive expenditure on infrastructure that should support steel demand.

China's National Health Commission has indicated that the peak in the coronavirus epidemic has passed in China as infection rates are declining. As emergency response levels are lowered several provinces have started to accelerate industrial production or construction projects.

Iron ore has direct exposure to Chinese government stimulus measures, the broker points out. Underpinning this is a lower exchange rate, lower oil price and a higher iron ore price versus previous forecasts.

Macquarie agrees the iron ore market is robust and is underpinning earnings upgrade momentum for Fortescue Metals as well as other iron ore miners. Ord Minnett, too, assesses that investors with a medium-term horizon should be rewarded for owning Fortescue Metals.

Macquarie points out Fortescue Metals is generating strong cash flow at current prices, although this is partially suppressed by higher capital expenditure over the next two years. Despite this, the broker remains impressed by forecast FY20 and FY21 cash flow yields of 19% and 17% respectively.

Production

Moreover, Fortescue's production is tracking at the top end of guidance. Production has been disrupted in Western Australia, as Bell Potter notes Rio Tinto lowered guidance following Tropical Cyclone Damien, and flooding has occurred in Brazil at some mines. However, Fortescue Metals has sustained minimal disruptions.

Higher earnings translate directly through to an increase in Bell Potter's forecast for the final dividend in FY20. In the second half the 62% benchmark price is at around US$91/t while production rates are at the top end of guidance. Bell Potter expects 177mt in FY20, ahead of Fortescue's guidance of 175mt.

The broker also calculates that, for every -US$10/bbl decline in the oil price, there is a C1 cash cost reduction of -US$0.30/wmt. Taking the outlook for the second half in isolation, Bell Potter, not one of the seven stockbrokers monitored daily on the FNArena database, incorporates this into an updated valuation for Fortescue Metals.

This leads to a 12% increase in reported net profit to US$4.7bn. Applying an unchanged dividend pay-out ratio for FY20 implies a 14% increase to forecast dividend payments and an 18% dividend yield. The broker's dividend yield estimate drops to 8.0% in FY21. Hence, Bell Potter upgrades to Buy from Sell and raises the target to $9.10.

The database has three Buy ratings, two Hold and two Sell for Fortescue Metals, with those on the Sell side having not updated for recent movements. The consensus target is $9.98, suggesting 4.3% upside to the last share price. The dividend yield on consensus forecasts for FY20 and FY21 is 23.7% and 18.3% respectively.

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