Fortescue Metals Group
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 18 April 2017, 12:24 PM
- Sectors Covered:
- Mining, Energy
Key points
- Fortescue Metals Group (FMG) posted a reasonable operational result for the March quarter, but as expected the price realisation versus benchmark for FMG product has plunged.
- Adding further pain the correction of benchmark iron ore prices continues.
- We predicted that the spike in coking coal price against a backdrop of falling steel prices would impact demand for lower grade iron ores, which we expect is now in full effect. FMG reported a discount during 3Q'FY17 of 26% (vs 7% in 2Q).
- We see further short-term downside risk as this trend continues to play out and steel prices continue to fall.
Price realisation drops off a cliff – as expected
Since Cyclone Debbie we have been predicting a high probability that Chinese steel mills, already suffering from falling steel prices, would seek to minimise their coke requirements substituting for higher grade iron ores in their mills. We see this trend as now unfolding, with FMG reporting a discount on its lower grade iron ore products of 26% vs benchmark Platts 62% CFR. As a result of the sharp drop, FMG has revised its price realisation guidance for FY17 to 75-85% (from 85-87%). We expect the trend has further to play out with steel prices still falling and the Bowen Basin still offline.
Reasonable operational result
Rain impact during the quarter saw FMG post 3Q'FY17 iron ore shipments of 39.6mt (-6% QoQ), and a steady average strip ratio of 1:1. We expect the company will comfortably be able to achieve its FY17 sales guidance of 165-170mt. Meanwhile from the volumes reported it appears the bulk of the decrease in ore mined occurred in the Chichester Hub, which supports the lower-than-expected C1 cost of US$13.06/wmt (+4% QoQ).
Debt balance looking good
FMG has taken extreme measures (and some innovation) to strengthen its balance sheet throughout the downturn that unfolded since 2011. Now, with net debt of US$3.8bn for a management net gearing level of 22%, FMG's balance sheet is back on firmer ground. We expect the company will use this to maximise dividends and potentially an opportunistic push to diversity outside of iron ore.
More downside in the near term
We expect the underperformance of lower grade iron ore will continue for at least the next month, during a seasonally weaker time for iron ore, which could see the discount for FMG products blow out further. This could see FMG underperform in the short term given its market position as a mass-tonne low-grade iron ore producer.
We have lowered our valuation-derived price target after updating our model for the March quarter result, and we maintain our Hold recommendation.
More information
Morgans clients can login to view our detailed report and revised share price target for Fortescue Metals Group (FMG). Alternatively, please contact your nearest Morgans office for access.
Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.
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