Australia | Dec 10 2020
This story features FORTESCUE METALS GROUP LIMITED. For more info SHARE ANALYSIS: FMG
Fortescue Metals is moving from strength to strength, improving productivity and maintaining a high dividend pay-out as the iron ore price succumbs to a tight market
-Gaining market share in Japan and Korea
-Tight iron ore market likely to continue into 2021
-Are renewable investments the right course?
By Eva Brocklehurst
Returns remain elevated at Fortescue Metals ((FMG)), which did not disappoint investors with its latest update. Management has highlighted its intention to pay dividends at the high end of the 50-80% of net profit range.
Morgans observes the iron ore business is moving from strength to strength and Fortescue has become a formidable producer. The broker expects cash dividends will ensue for the next 6-12 months at least.
Nevertheless, as a pure iron ore miner, channelling excess capital into dividends and exploiting an exceptional iron ore price, the broker is concerned about the company's sudden commitment to renewables.
With iron ore at US$150/t, around 50% ahead of second half consensus forecasts, and an "unwavering" dividend policy, Credit Suisse is also confident of another strong return in February.
Ord Minnett downgrades to Accumulate from Buy, following the strong run-up in the share price. The broker was impressed with the compnay's review of the operating performance and the maintenance of FY21 guidance for 175-180mt of ore being shipped at costs of US$13-13.50/t.
Material improvements have occurred in ore processing facilities and truck availability. More gains are anticipated from the installation of a wet high intensity magnetic separator at Christmas Creek. Port capacity of 210mt has now been approved and the company appears to be gaining market share in Japan and Korea.
Supply constraints from Brazil have meant the iron ore market is tight and this is likely to continue into 2021. Cash flow should be strong as a result and Macquarie forecasts a free cash flow and a dividend yield of 12% on average.
The broker calculates Fortescue has paid out US$9.4bn in dividends over the last decade and will pay a further US$27.3bn over the next decade. Upgrade momentum is strong and, at spot prices, FY21 and FY22 free cash flow yields are 16-18%.
Yet Morgans considers the attractive short-term fundamentals and dividend outlook is contrary to the longer-term iron ore cycle, amid concerns over the emerging strategy.
Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database, believes Fortescue is fully valued but anticipates strong capital returns will continue to support the share price over the short term. The broker maintains a Neutral rating with a $20.10 target.
Eliwana & Iron Bridge
The company has made progress at Iron Bridge with all blending opportunities on the table, although the strength of the Australian dollar has put costs under pressure. The next decision on the hub is to come in the mid 2020s with integration of Cloudbreak being considered.
Over the past decade production has increased to 178mt, from 40mt in FY10, and further growth via Eliwana and Iron Bridge should drive capacity closer to 200mtpa, Macquarie assesses. The broker notes shipments have increased significantly, averaging 170mtpa over FY15-20, and the introduction of Eliwana should mean shipments edge higher once again.
First ore has been produced and production is expected to ramp up to 30mtpa by FY24, offsetting the decline at Firetail. The Eliwana footprint is smaller than Firetail so capital expenditure per tonne is reduced. Morgans believes a beat on guidance could come via the overlap between Eliwana and Firetail in FY21.
Iron Bridge should then be a player from FY23, lifting shipments to around 200mtpa. Engineering on the project is 85% complete and first ore is targeted in the first half of 2022. Fortescue is still reviewing blending options at Iron Bridge.
Fortescue expects steel production growth beyond 2021, with any moderation in China offset by emerging markets such as Southeast Asia and India. As a result, seaborne iron ore demand should well supported into the next decade, given modest EAF (electric arc furnace) take-up in China and scrap not being competitive with steelmaking raw materials.
Stronger iron ore prices have enabled the company to pursue sustainability goals and this allows for investment in renewable energy. The company has set a net zero emissions target by 2040 and is currently spending US$700m on its Pilbara Energy Connector project that will interconnect existing gas-fired power generation with new solar and large-scale battery technology.
While keen to understand the plans in greater detail, Ord Minnett notes there was no update on the target of 235GW of renewable power. A Bell Bay, Tasmania, a green hydrogen plant is being evaluated in 2021.
Morgans admits to being surprised that Fortescue has chosen to diversify through renewable energy. The broker considers the company poorly placed in what is a crowded market characterised by increased competition and dominated by large energy companies.
The Fortescue Future Industries business will be structured as a separate entity, the company has assured investors, with no recourse back to the parent for future investments. An opportunity exists, in the company's view, to bring its superior record of execution to investment in renewables but it remains unclear to several brokers what metrics will be used to screen the opportunities.
Macquarie expects iron ore projects will be the focus for the short term and capital for renewables will essentially be what remains after core operations and capital returns. The broker considers the availability of funds for the venture rather limited, calculating US$400m over the next five years, although at resilient spot iron ore prices this could increase to US$8bn.
The database has three Buy ratings, three Hold and one Sell (Morgan Stanley, yet to comment on the update). The consensus target is $18.80, suggesting -13.8% downside to the last share price. The dividend yield on present FX values is 10.8% for FY21 and 7.7% for FY22.
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