Fortescue Metals Group: Strong operationally while discounts blow out
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 28 January 2022, 12:30 PM
- Sectors Covered:
- Mining, Energy
- A good looking quarter, with strong 2Q22 production and shipments.
- FY22 guidance was unchanged, although FMG did cut FX by 4% (essentially lifting costs). Capex guidance was increased US$200m for the WAE acquisition.
- We have a divided view on FMG, on one hand liking the earnings power of its core iron ore business, while bearish on its FFI push.
- FFI’s initial loss-making status has essentially further increased FMG’s dependence on iron ore earnings.
- We maintain a Hold rating on FMG with a (login to view) target price.
Strong operationally, weaker pricing
Fortescue Metals Group (ASX:FMG) posted 2Q22 shipments of 47.5mt (+4% qoq) vs consensus of 46.4mt according to Visible Alpha data. Realised price continued to weaken in 2Q22, although the achieved average of US$74.36/dmt did beat consensus (discount on FMG product of 32% vs consensus 38%).
C1 costs meanwhile were flat in 2Q22 at US$15.31/wmt (vs MorgansE US$14.99/wmt).
No change to headline FY22 production (180-185mt) or unit cost guidance (US$15-$15.50/wmt), although FMG did adjust its FX assumption from $0.75 to $0.72 while keeping its cost guidance unchanged (flagging an expectation of inflationary pressures).
FMG did lift its capex guidance for FY22 to US$3.0-$3.4bn (ex-FFI), for the inclusion of the US$200m Williams Advanced Engineering (WAE) acquisition.
A good operational result from FMG’s core iron ore business, while the 3Q22 recovery in iron ore prices has helped to support short-term earnings, FCF generation and dividend potential.
FMG continues to pursue what we see as a very aggressive push into a large number of ESG-themed industries in different geographies.
Our concern here is FMG’s low starting point in each of the new markets it is pursuing, which suggests capital efficiency will be the first victim before getting to any considerations around the possible long-term return profile.
With potential for steel activity to mature in 2022 we are interested to see how FMG’s large ESG-themed investment framework sustains a downcycle in iron ore.
While seeking to diversify outside of iron ore, we would argue that the move into FFI (which could see a long period of losses while FMG gets established), is actually equivalent to increasing FMG’s dependence on iron ore earnings.
Forecast and valuation update
Post the strong 2Q22 result we have upgraded production assumptions, with the largest changes to Chichester production, while leaving discount assumptions unchanged. We have also lifted 2H22 C1 cost assumptions for the currency-adjusted guidance.
Net of these changes our blended (DCF:EBITDA) target price has increased to (login to view).
Trading close to our (login to view) target price, and 5.6x FY23F EBITDA, we maintain a Hold rating on FMG. With the recent rise matching the bounce in spot iron ore prices. We are confident that we are now beyond peak iron ore.
Given FMG’s high sensitivity given its position as a mass-scale low-grade iron ore producer it could see added earnings pressure if the current downcycle extends.
Short-term spot iron ore prices (given sensitivity).
1H22 earnings result and dividend.
Steel demand drivers particularly in China.
Execution risk in FFI, including R&D risk.
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