Fortescue Metals Group: Fears over Iron Bridge ease

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
18 February 2021, 3:00 PM
Sectors Covered:
Mining, Energy

  • Along with a strong 1H21 result, Fortescue Metals Group (ASX:FMG) provided its flagged update on its developing Iron Bridge magnetite project.
  • While still subject to change, Fortescue revealed a US$400m increase in capex budget to US$3.0bn (vs Morgans assumption of US$3.1bn), which after FX adjustments is only a c7% budget slip.
  • Dividend surprise with interim of A$1.47 (vs MorgE A$1.42 vs consensus A$1.33).
  • Meanwhile Fortescue also outlined that it plans to start investing as much as 10% of annual iron ore earnings in renewable energy projects.
  • We maintain a Hold rating on a TSR basis, with a revised target price (login to view).

Developments genuinely not capex related

In its update on the Iron Bridge magnetite project, Fortescue CEO Elizabeth Gaines revealed a ~US$400m capex budget slip to US$3.0bn. This is slightly behind our estimate of a US$520m increase to US$3.1bn. Once normalized for the assumed currency impact, this only marks a c7% increase in Iron Bridge’s capex budget.

Although still subject to change, this is a surprisingly small downgrade for the project relative to the major changes that swept through Fortescue’s senior management team this week. With our fears over Iron Bridge easing, this increasingly looks like decisive action taken to prevent culture slip.

FFI a tougher proposition for us

Our energy sector coverage has demonstrated how difficult it is to achieve acceptable returns from renewable energy projects, where hurdle rates for projects commonly drifts to mid-single digits (with the actual outcome often worse).

 Fortescue’s announcement that it plans to invest up to 10% of underlying earnings each year in renewable projects within its new Fortescue Future Industries (FFI) business therefore comes as some concern.

We will have to reserve judgement for when we can analyse one of the renewable projects FFI invests in, but at this stage we view it as much more likely that these investments will only work to dilute its core iron ore earnings.

Strong 1H21 result with another big dividend

Fortescue had recently guided to 1H21 underlying NPAT of US$4.0-$4.1bn, with the result coming in at US$4,084m (vs consensus US$4,091m vs MorgE US$4,036m). EBITDA was also close to estimates at US$6,639m (vs consensus US$6,735m vs MorgE US$6,836m).

With its balance sheet almost in a net cash position, Fortescue elected to flex its payout ratio to its max 80% for a sizable A$1.47 interim dividend (vs consensus A$1.33 vs MorgE A$1.42).

Meanwhile FY21 shipments guidance was lifted to 178-182mt (was 175-180mt), and C1 cash costs guidance slipped to US$13.5-$14/wmt (from US$13-$13.5/wmt) on cost pressure (in particular a stronger AUD).

Maintain Hold rating

The only significant change to our assumptions post the 1H21 result was to increase our sustaining capex assumption in line with management commentary of circa US$700- $800mpa. This has seen our blended target price revised from A$21.50 (login to view revised target price).

With Iron Bridge concerns easing, the market’s focus on Fortescue has rightly returned to its robust earnings profile and large dividends, as a result we maintain our Hold rating on a TSR basis. Key risks to our call is related to China macro (steel demand drivers) and FX.

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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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