Fortescue Metals Group: Inflation wipes Iron Bridge return

About the author:

Adrian Prendergast
Author name:
By Adrian Prendergast
Job title:
Senior Analyst
Date posted:
31 May 2021, 2:30 PM
Sectors Covered:
Mining, Energy

  • Reporting material cost inflation in the Pilbara, Fortescue Metal Group (ASX:FMG) has had to downgrade development capex, opex and sustaining capex assumptions for Iron Bridge.
  • Capex now expected to be US$3.2-$3.5bn (100%), with FMG trying to innovate cost savings to keep some control on its spiraling budget.
  • Iron Bridge C1 cash cost guidance has increased to US$33-$38/wmt (vs current group average ~US$15/wmt).
  • Sustaining capex for Iron Bridge lifted to US$5-$7/wmt (vs current group average of US$1-$2/wmt).
  • Iron Bridge downgrades offset by mark-to-market on iron ore prices. Maintain HOLD rating with a changed price target (login to view).

Downgrades remove positive return

With the inflation cycle in WA in full flight FMG has updated on its developing Iron Bridge magnetite project, with downgrades across the board in terms of costs.

Post a 12-week review on the project, FMG has materially increased its development capex guidance to US$3.2-$3.5bn (from US$2.5-$2.7bn), while lifting average C1 cash cost guidance to US$33-$38/wmt (vs current group average of ~US$15/wmt), and expected sustaining capex to US$5-$7/wmt (vs current FMG average of US$1-$2/wmt).

The magnitude of cost pressures in WA, in particular labour shortages, are easily visible following job trends. While competing with BHP and RIO for resources in the Pilbara would further complicate FMG’s efforts.

Doing what it can

FMG is innovating where it can to try and offset some of these cost pressures. The most visible measure the miner is taking is to build a new (cheap) facility at Lumsden Point in Port Hedland.

Funded by FMG at a modest cost, the new port facility will give the JV a new offload facility allowing it to receive larger modules being used to construct Iron Bridge.  FMG is also reviewing its entire contractor strategy, which optimistically could lead to some further cost gains.

Spot iron ore price all that matters… for now

Adopting the new guidance has seen our valuation on Iron Bridge decline from A$0.04ps to -A$0.28ps. This however has been more than offset by a mark-to-market on current spot iron ore prices to our FY21/22 forecasts (summary further).

Post these offsetting changes our blended valuation (DCF:EBITDA) is only slightly changed (login to view).

Given the strength of current near-record spot iron ore prices, it remains the case that any volatility in spot will continue to have a material impact on FMG’s valuation.

Bad news not enough to puncture dividend euphoria

The Iron Bridge downgrades are disappointing, but in our view not enough to drag on robust investor sentiment which understandably is placing a premium on FMG’s robust dividend strength.

We forecast a dividend yield for the next twelve months of ~15% for FMG, channeling its bumper earnings into cash dividends. This leaves us comfortable with our HOLD rating on a TSR basis, while we remain on the lookout for any signs of the iron ore price cycle maturing.

The key risk to our call is iron ore price.

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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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