Fortescue Metals Group: Better to stick with what works

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
09 December 2020, 3:00 PM
Sectors Covered:
Mining, Energy

  • At its investor day Fortescue (ASX:FMG) revealed plans to build a renewable energy portfolio, entirely independent but sitting within (and funded by) its iron ore business.
  • For years we wondered to what degree Fortescue would diversify its business, but from all the scenarios we considered we never expected renewable energy.
  • With limited experience in energy, we see Fortescue as poorly placed to enter renewables – a space characterised by surging competition, dominated by energy super majors, and deteriorating return profiles.
  • Fortescue’s iron ore business meanwhile is going from strength-to-strength, with first ore at Eliwana achieved and Iron Bridge shaping up nicely.
  • We upgrade our target price (login to view target price) on Fortescue following changes to our iron ore forecasts. While maintaining a Hold rating given recent price strength.

Near-term fundamentals robust to say the least

Fortescue has built itself into a formidable pure iron ore producer, successfully leveraging and growing its iron ore business.

In FY21 Fortescue is guiding to shipments of 175-180mt (vs MorgansE 178mt) and could outpace the guidance if Fortescue can outperform operationally. One of the potential avenues to beating guidance could come from some overlap appearing between Eliwana (just commissioned) and Firetail (almost depleted) during FY21.

Fortescue management certainly acknowledged the current iron ore price environment as offering an attractive opportunity for them to try and sell extra tonnes into.

Big cash dividends still rolling

Fortescue maintained its dividend policy of paying out 50-80% of underlying earnings, with management going further to highlight that it intended to be towards the high end of that range in the near term.

Combined with a spot iron ore price that sits c50%(!) above 2H’FY21 consensus forecasts, this indicates the heavy cash dividends will keep coming from Fortescue for at least the next 6-12 months. As a result we have lifted our assumed payout ratio to 80% (from 50%) for the next two years.

Core strategy splintering in different directions?

At its investor day briefing Fortescue flagged its intention to move into renewable energy. With an independent management team and energy portfolio, still sitting within Fortescue’s iron ore business. We are puzzled by the move, given:

  1. Renewable energy is rapidly becoming a crowded market featuring almost all global energy super majors (Shell, BP, Exxon, Chevron, Total, etc.)
  2. Deteriorating return profiles observed across renewables
  3. Perhaps most importantly – Fortescue’s lack of experience and core competencies in energy. While Fortescue is confident it’s skills will translate, we are concerned that the bulk miner is straying away from its core strategy, which could become a bigger issue to Fortescue’s investment profile once the iron ore cycle matures.

Maintain Hold rating

A contrary mix of attractive short-term fundamentals and dividend profile, versus longer term iron ore cycle and strategy concerns. Yet to commit to any renewables projects, for now Fortescue remains a pure iron ore miner channeling material excess capital into bumper dividends while exploiting an exceptional price cycle.

After upgrading iron ore forecasts we lift our target price (login to view target price), and maintain our Hold rating on a TSR basis. The key risk to our call remains China/iron ore market risk.

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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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