Australia | Aug 31 2021
This story features FORTESCUE METALS GROUP LIMITED. For more info SHARE ANALYSIS: FMG
Fortescue Metals has high hopes its greening credentials will attract a product premium yet, in the here and now, the focus remains on the iron ore price
-Iron ore still could rebound in the December quarter, China's steel production to grow
-Continues to target a 10% allocation of net profit to Fortescue Future Industries
-Decline in resources offset by maiden resource at Mindy South and update at Wonmunna
By Eva Brocklehurst
The path to a greener future is the conversation Fortescue Metals ((FMG)) is increasingly determined to have, intent on leading the way amongst iron ore miners. As Morgans observes, the company expects improving green credentials will attract a premium for its product.
In the meantime, iron ore is carrying the business and providing a significant net cash position and strong dividend yields. The numbers in FY21 were hard to fault, Shaw and Partners concludes, yet points out expectations have now built substantially.
The broker fears the peak in the iron ore price cycle has passed and will retreat over time. Consensus iron ore price forecasts are now below the spot price and earnings estimates for FY22 no longer have the upgrade trend that has been the case for the past year.
The company has acknowledged weaker steel markets and the re-emergence of coronavirus restrictions in some areas of China have caused the iron ore price to correct but still expects a rebound in the December quarter and Chinese steel production to grow.
Credit Suisse points to data that shows some mills in China are showing a preference for low-grade products, keeping their blast furnaces operational while limiting steel output and believes this could be an effective interim solution, helping to narrow the low-grade discount over the short term.
FY22 guidance is unchanged and assumes slightly higher iron ore shipments as well as a 10% increase in unit costs and -10% reduction in capital expenditure. FY21 was the third consecutive year of record earnings, underpinned by a resilient iron ore price, improved price realisation and cost control.
Guidance for FY22 is 180-185mt of iron ore shipments at a C1 cost in the range of US$15-15.50/wmt, implying C1 cost increases of 8-11%. Prices are likely to decline and cash costs increase, yet Bell Potter asserts operating cash flow and profitability remain supportive of robust dividends and models a prospective 12-month dividend of $3.31 for a forecast 15.5% yield.
Credit Suisse also notes the pullback in the stock now presents better value, and for those that believe iron ore prices may remain elevated for longer, assesses the stock should continue generating cash with a solid dividend yield.
Still, the broker is cautious, given the potential for a declining iron ore narrative and limited growth beyond the Iron Bridge project. Risks to the upside include ongoing iron ore price strength and increased demand for steel resulting in higher than expected free cash flow.
The spot iron ore remains volatile yet underpins earnings upgrade momentum and, at spot, Macquarie's estimates rise 14% and 77% for FY22 and FY23, respectively. Fortescue is trading on a 10-11% free cash flow yield on the broker's forecasts and that increases to around 20% at spot prices for FY23 and beyond.
Fortescue Future Industries is a key focus going forward in terms of financial commitments and strategic objectives and the company is confident its track record of innovation in iron ore should translate to success with this venture in time.
Nevertheless, Credit Suisse believes this is a "trust us" narrative and without a tangible business case at this stage the market is unlikely to ascribe any value. Primarily the intention is to be carbon neutral by 2030 through the development of "green" mining and rail haulage while establishing generation via green hydrogen and green ammonia projects.
Fortescue continues to target a 10% allocation of net profit to FFI for renewable energy projects, albeit only when the project is investment ready, and has reiterated around US$500m of total expenditure in FY22 mainly on project studies and technologies.
The company has a 15mtpa green hydrogen production target by 2030 and is aiming for net zero emissions by 2030. The construction of a hydrogen fuel cell haulage truck has already occurred but brokers believe it is too early to quantify the commercialisation.
The one exception may be the Bell Bay hydrogen project which has a closer proximity for a decent return. Yet Credit Suisse notes this is still unlikely to recoup the ongoing expenditure and there could be still at risk of delays as other projects catch up in the queue.
Expenditure intentions in FY22 for FFI do not include the potential investment in Bell Bay's 250MW project, which Goldman Sachs estimates may cost between US$500m-1bn.
Other possible renewable projects include solar and wind investment in the Pilbara to de-carbonise the mining fleet. Morgans agrees the planned investments are difficult to analyse and questions whether being an early adopter of green technology would be a more efficient approach compared with being an innovator.
The broker assesses the modelling of green hydrogen, or green ammonia projects, requires high capital intensity that "blunts valuations” and the long-dated investment profile is reliant on the transformation of future cost structures.
While reasonable to assume that customers will pay premium prices to get access to a zero carbon product, Morgans asserts it is impossible to quantify this. Moreover, this area is outside the company's established competencies and global energy majors are expected to compete – with the advantage of knowledge, experience and deep pockets.
In sum, Morgans believes the company is attacking the issue too aggressively and may have some regrets when and if iron ore prices fall back to more normal levels before the green potential can be realised.
Macquarie was unimpressed with the split in FFI guidance into capital and operating expenditure and emphasises the path to carbon neutrality will require investment across all parts of the iron ore operation.
Citi, too, finds it hard to value the expenditure, but does not doubt the company's determination. Fortescue has applied for over 215 patents and once the technology is fully integrated intends to share it.
In an adjacent ESG issue, in terms of offshore projects, Fortescue asserts participating governments will need to agree on conditions including legislation regarding modern slavery, outlawing forced child marriages and providing equal education outcomes for boys and girls.
International asset identification includes geographies such as Indonesia, Latin America, Africa PNG, Europe New Zealand, North America and the Democratic Republic of Congo.
Reserves & Resources
Meanwhile, back at the mines, resources declined by -465mt or -8% in FY21, largely because of a review of the in-situ bulk densities at Cloudbreak, Christmas Creek, Valley of Queens, Eliwana and Flying Fish. Macquarie, nonetheless, is encouraged by the largely unchanged impurity levels in the resources and operating mines.
Still, the decline in resources overall was largely offset by the delineation of a maiden resource for the Mindy South deposit of 279mt and an updated resource estimate at Wonmunna has added 75mt. That was not the case for reserves where impurity levels within the ore reserves increased 5% for silica and alumina and 4% for phosphorus.
Shaw, not one of the seven brokers monitored daily on the FNArena database, considers it time to consider seriously recycling some capital from Fortescue Metals into other value opportunities and retains a Hold rating with a $19.50 target.
Also among these seven, as a result of the recent depreciation in the share price Bell Potter upgrades to Buy from Hold with a target of $22.52, while Goldman Sachs is less convinced, retaining a $19.90 target and Sell rating.
The database has something for everyone, two Buy, three Hold and two Sell ratings. The consensus target is $21.61, suggesting 1.4% upside to the last share price. Targets range from $18 (UBS) to $29 (Ord Minnett).
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