Fortescue Metals Fields The Green Narrative

Australia | Aug 31 2021

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.

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