Fortescue Metals Group: Losing its identity?

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
13 December 2021, 8:00 AM
Sectors Covered:
Mining, Energy

  • Fortescue Metals Group (ASX: FMG) has announced plans to transition to a new CEO that will complement its planned shift to becoming a global diversified energy and resources player.
  • Given the lack of similarities between iron ore and renewables we expect FMG will struggle to find a new CEO with experience in both.
  • Questions are emerging over how much focus FMG is placing on renewables vs its core iron ore business.
  • The next five years in iron ore are likely to be more difficult than the last five years, warranting more focus or even possibly diversification into other mature markets.
  • We maintain our Hold rating on FMG, but have lost conviction in the overarching strategy and capital framework.

Event: FMG to pursue non-iron ore CEO

Current CEO Elizabeth Gaines will transition to non-executive director and “brand ambassador”, while assisting with the search for a new CEO.

Of some concern, our initial impression is that FMG appears to be prioritising getting a new CEO with experience outside iron ore.

The concern here is that we see FMG as likely to remain entirely dependent on iron ore earnings for at least the next decade, while the landscape in the seaborne iron ore market is likely to change materially.

Analysis: Questions around strategy

While arguably no one has benefited more from the upcycle over the last 5 years than FMG, we see the next 5 years as almost certain to be difficult in iron ore:

  1. the Chinese steel market has matured (less stimulus, environmental reforms, rising recycling) and unlikely to reclaim previous highs
  2. seaborne iron ore supply is recovering (Vale has mitigated risks while we expect RIO’s operational performance to eventually improve)
  3. new supply is coming (most notably Simandou but other supply is also responding to the increased rents on offer).

Given the above, we see now as a critical time for FMG to be focusing on the iron ore market, particularly given its position as a mass-scale low-grade producer. 

Given the iron ore dynamics, we had expected FMG to diversify actively but had thought a safer option might have been to enter other mature markets (i.e. base metals) where cycles and economics are already well established and understood, allowing for a faster transition.

Instead FMG has prioritised diversification through combating climate change in various markets, the projects for which are typically capital hungry with less certain (and often lower) return profiles. Forecast and valuation update

We have further increased assumed discounts on FMG product during FY22-24 (from 20% to 25-30% including grade differential).

Mark-to-market December and March quarter iron ore forecasts - lowering FY22 forecast to (login to view).

With the selloff in iron ore moderating we shift our valuation methodology on FMG back to a DCF/EBITDA (50:50) blend.

Investment view

While having lost conviction in its overarching strategy, we still see strength in FMG’s core iron ore business and see the recent selloff as having pushed FMG into fair value territory. As a result we maintain our Hold recommendation.

Post the above changes we increase our target price to login to view.

Price catalysts

December quarter operational result.

FFI project advancement.


COVID related risks to regional and global steel activity.

China economic risk that could impact near-term steel demand.

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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.

Solid top-line outcome: BAP’s 1Q22 revenue was flat on the pcp, an extremely resilient result given the extent of lockdowns in the period (~70% of stores impacted) and the strength of the pcp (cycling 27% growth). Composition comprised: Trade +2%; NZ -10%; Retail -12%; and Specialist Wholesale +7%. Overall, BAP stated that non-lockdown areas are outperforming expectations. ▪ 1Q22 trade & retail: Trade/Burson revenue was up +2% on the pcp (LFL sales - 1%; cycling 8% pcp); NZ/BNT revenue was down -10% (LFL sales -15%; cycling +4%); and Retail/Autobarn revenue was down -12% (LFL sales -16%; cycling +36%). Within the Retail segment, online sales were +80% on the pcp. Stores percentages impacted by lockdown were: Trade 70%; NZ 100%; and Retail 50%. ▪ Specialist segment results: Specialist wholesale revenue is up 7% on pcp, with Auto electrical/Truckline divisions ‘performing strongly’; and WANO underperforming. ▪ GM pressure expected to be temporary: BAP stated GM was stable across Wholesale and NZ (45% of FY21 revenue); and down ~50bps Trade and Retail (~55% of FY21 revenue), driven by promotional and online pricing in lockdown areas (we assume no margin pressure witnessed in non-lockdown areas). BAP expect margins to revert once lockdowns ease. ▪ The cost base has increased vs pcp, a function of duplicated DC costs (commencement of new VIC DC), and higher group and team member support (covid related) costs. BAP noted FY22 store rollouts and refurbs are on track.

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