Fortescue Metals (ASX: FMG) Presents A Buying Opportunity After The Recent Decline

Fortescue Metals (ASX:FMG)

Henry Fung

Henry is a co-founder of MF & Co. Asset Management with over 19 years of experience as a trader, investor and asset manager. Henry is the instructor of the Professional Trading Course, which is a free 5-day course on how to become a profitable trader.

May 1, 2023

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Today we will look at why we think Fortescue metals shares (ASX:FMG) have great upside potential with our FMG share price forecast and analysis.

Fortescue Metals Group is a pure-play iron ore producer with the fourth-largest capacity in the world. The company is also morphing into a leader in mining decarbonisation and green hydrogen through its Fortescue Future Industries subsidiary. FMG hit a rough patch after China’s property sector landed in a debt crisis and iron ore prices slumped from their 2021 highs.

Despite depressed prices and slowing demand from China’s zero-Covid policy, FMG continued record production and despatch in the nine months ended March 2023.

The stock has faced selling pressure after the latest quarterly update with investors fearing a further decline in iron ore prices.

At the current FMG share price, Fortescue Metals shares have underperformed the ASX 200 year to date by about 2.5%.

Fortescue Metals (ASX:FMG) - FMG share price

About Fortescue Metals Shares (ASX:FMG)

Fortescue Metals is an integrated mining company based in Western Australia established in 2003 and exports more than 180 million tonnes of iron ore each year. The company operates three mining hubs in the Pilbara region of Western Australia, which are connected to the Herb Elliott Port and Judith Street Harbour through a 760-kilometer high-speed, heavy-haul railway. In addition to owning a tug fleet, Fortescue also has eight custom-built ore carrier ships with a capacity of 260,000 tonnes.

Through Fortescue Future Industries (FFI), its renewable energy and industry company, Fortescue is working towards achieving leadership in renewable hydrogen and green ore by creating a worldwide portfolio of green operations. FFI will also play a significant role in Fortescue’s objective of achieving carbon neutrality by 2030.

Fortescue’s headquarters are located in East Perth, Australia, and the company’s market capitalization is A$64.5 billion.

Fortescue Metals (ASX:FMG) - infrastructure

Source: Fortescue

Fortescue’s Operations And Balance Sheet Are Strengths But Its Single Product And Potential Growing Supply Are Weaknesses

Fortescue Metals’ (ASX:FMG) integrated business model gives it the scale to compete with mining giants along with the economics to weather unfavorable pricing with ease.

The company’s mining, processing, rail, and shipping operations combined to deliver record shipments of 143.1 million tonnes (up 2.58% YoY) over the 3 quarters to March in FY23.

According to the company’s Q3’23 production report, it produces iron ore at a C1 cost of US$17.73 per wet metric ton, which grew 12% YoY. (C1 costs are defined as direct costs, which include costs incurred in mining and processing plus local G&A, freight and realization, and selling costs).

This cost structure is extremely competitive compared to major miners and gives the company resilience to face cyclical downturns and tremendous operating leverage during booms.

The company also made strides in sales operations as it achieved a vastly improved 87% realization of the Platts 62% Fe Index in the third quarter, up from 70% in Q3’22. FMG was also aided by prices improving about 25% in Q3 to US$109/dmt, up from about US$87 in the first half.

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Fortescue Metals (ASX:FMG) - price and margins

Source: Fortescue

The company’s robust balance sheet showcases its capacity to weather the fluctuations of a cyclical resources market and seize growth opportunities as they arise as can be seen by FMG’s growth even as iron ore prices have corrected steeply since June 2021.

According to a recent estimate by Goldman Sachs, Fortescue Metals shares (ASX:FMG) is likely to improve its earnings per share by 4% in FY 2023 and 2% in FY 2024.

In FY’23, the company completed its Iron Bridge iron ore project, although at a big cost overrun of more than 50%. The first production of wet concentrate from the magnetite project was received on April 21.

Iron Bridge, which has a slated capacity of 22 million tonnes, is crucial to the company’s fortunes as it will strengthen the company’s portfolio with higher value magnetite, compared to the current lower purity and more commoditized hematite. This can be a tremendous value-add as the higher purity leads to lower emissions when used to make steel, now a key concern across countries. Higher quality ore (67%) will give the company more flexibility in pricing power and open new arenas of the iron ore markets. FMG will issue guidance on Iron Bridge in the June earnings season.

The company is also on track to produce the first ore from its Belinga project in Africa. The mine spans 4,500 km2 and the company claims that it has the trappings to be a world-class resource. Early production will be 2 million tonnes per annum and FMG plans to spend about US$200 million in FY23-24 on its development.

However, though Fortescue Metals shares’ (ASX:FMG) pure-play iron ore exposure is a huge advantage in the good times, it can be a weakness when the cycle is adverse. As a result, the company’s valuations may take a serious hit with cyclical ore prices.

When we last reported in 2021, Iron Bridge represented serious execution risk, both in terms of ore prices and cost overruns, both of which have, unfortunately, manifested. Given the current frosty but improving relations between Australia and China and the decline in iron prices in recent months, the project could also be a source of financial risk.

Other weaknesses include a highly uncertain and bearish macro-environment combined with multiple new projects in the pipeline by mining majors across the world such as the massive Simandou mine in Guinea, on which China has been pushing hard.

That being said, the company’s cost structure should keep it in the green despite corrections in prices.

Fortescue Metals (ASX:FMG) is All-In On The Decarbonization Opportunity But Exposure to China is A Threat

FMG Founder Andrew Forrest is moving fast on his vision for basing a new business on the plank of global priorities on emissions and clean energy.

In a two-pronged move aimed at diversifying its product base and decarbonizing its own mining business, Fortescue has committed 10% of its annual profits to Fortescue Future Industries (FFI), an arm that is tasked with implementing a foray into clean energy via hydrogen and the creation of a global portfolio of opportunities in renewable energy and green industry.

Fortescue Metals (ASX:FMG) - technology and inovation

Source: Fortescue

The company’s commitment to decarbonization and its progress on the same cannot be understated in terms of the vast global opportunity from renewable electrification, green hydrogen, green iron ore, and green ammonia.

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The company garnered significant interest after revealed in its Q3 earnings report that it had successfully produced 150kg of green ore using its proprietary electrolysis process which completely removes coal and therefore, carbon, out of the production process. This could be a huge opportunity for the company given the environmental concerns that loom over the mining industry.

The company has also completed the first stage of its hydrogen electrolyzer plant at Gladstone, Queensland with a 2GW capacity.

FFI intends to supply 15 million tonnes a year of green hydrogen by 2030. On the hydrogen front, the company has also bet big on hydroelectric and geothermal projects in Norway and Kenya which will supply about 300MW each of clean energy for hydrogen production, thus indicating about 84,000 tons of hydrogen production. FFI plans to use this hydrogen to make green ammonia, a key fertilizer, and a cause of food inflation due to soaring natural gas prices, the current source of hydrogen for ammonia/urea production.

FFI is also planning green hydrogen projects in the USA and Europe both of which are offering serious incentives for decarbonization.

The company is also pushing for the Albanese government to explore bilateral deals with Europe which is offering attractive incentives for green hydrogen imports.

Lastly, FFI has five more green hydrogen projects globally under the scoping phase.

In Australia, FFI is nearing a final investment decision deadline on converting an Incitec Pivot gas-powered ammonia plant in Queensland to hydrogen power by the end of this year, though at present, the project is problematic due to energy costs.

FFI is also working on developing green trains, trucks and shipping, and decarbonization technologies. FFI recently closed its acquisition of Williams Advanced Engineering for US$221 million which will advance its capabilities in battery technology and green heavy machinery.

Lastly, FFI recently announced plans to acquire the Rawlinna Station, which is Australia’s largest sheep station spread over a million hectares for an undisclosed price. The station will be used for renewable energy assets such as solar and also holds mining potential.

The long-term potential of FFI notwithstanding, more immediately, FMG and its pure-play or predominantly iron ore players faces serious risks from China as a concentrated customer base.

Though Fortescue Metals shares (ASX:FMG) have issued bullish commentary that the Chinese economy has shown a decent but uneven recovery, the Chinese construction industry, which consumes nearly half of its already world-leading demand of steel continues to be in the doldrums as March economic data from China showed a 29% slump in new construction activity.

Meanwhile, embattled property developers have not shown signs of recovery. Notably, Evergrande recently botched its restructuring schedule.

Furthermore, iron ore prices have corrected steeply over the past couple of months after the China National Development and Reform Corporation (NDRC) announced a crackdown on unreasonable commodity prices by vowing to improve dependence on domestic ore and scrap steel.

This could pose a problem for FMG over the medium term as China is the world’s largest consumer of steel, accounting for nearly half of the global demand.

Unfortunately, this also comes at a time when China and Australia are just starting to repair their frosty relations.

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It should also be kept in mind that despite the rosy future from a potentially successful foray into green energy, FFI’s capital requirements are likely to be a drain on FMG’s cash flow. This could impinge on FMG’s debt profile, gearing and dividend payouts.

Fortescue Metals Shares (ASX:FMG) Financials

In 1H’23, FMG reported its highest-ever annual shipments of ore over the nine months to the March’23 quarter. However, this did not translate into equivalent financial performance due to sluggish ore prices and rising production costs.

Fortescue Metals (ASX:FMG) - financial highlights

Source: Fortescue

In 1H’23, the company reported revenue of US$7.835 billion (down 4% YoY), an EBITDA of US$4.325 billion (down 9% YoY), and a Net Profit of US$2.368 billion (down 15% YoY).

Ore sold was up 5%, average revenue/ton was down 9% and C1 costs were up 14%. The company also increased the projected outlay on Iron Bridge from US$3.6 billion to US$3.9 billion.

FMG’s latest official report, the Q3 production update, showed nearly flat production QoQ and YoY while costs grew 3% QoQ and 12% YoY. The company has about US$4 billion in cash and a net debt position of US$2.1 billion, after a dividend payout of US$1.5 billion and US$681 million of capex.

The company currently has a gearing of 26%, which is slightly below its target range of 30%-40%.

The company maintained FY23 guidance of shipping 187 million tonnes – 192 million tonnes, cost of US$18 – US$18.75/ton, and ex-FFI capital expenditure of US$2.7 billion – US$3.1 billion. FFI capex is projected to be US$500 million-US$600 million on opex and US$230 million on capex.

Fortescue Metals Shares (ASX:FMG) Valuation

A comparison of Fortescue Metals shares with arch-rivals Rio Tinto and BHP is tabulated below. 

 PeriodFortescueRio TintoBHP
  ASX: FMGASX: RIOASX: BHP
5 Year Sales Growth %5YA15.546.7712.72
Price/BookFY2.152.113.21
Price/EarningsTTM7.338.538.15
Operating Margin %TTM49.6432.346.3
Net Profit Margin %TTM33.8522.3646.09
Return on Equity %TTM35.1924.4539.04
Dividend Yield %TTM9.366.338.82
Source: Investing.com    

At the current FMG share price, It is evident that Fortescue Metals shares are superior in sales growth, P/E, operating margins, and dividend yield. In terms of P/B, the company is ever so slightly short of being the cheapest.

Though FMG lags behind BHP on account of ROE and Net Margins, BHP has multiple other products in its portfolio and enjoys slightly higher ore quality.

Overall, at the current FMG share price, Fortescue Metals shares present a superior value proposition to its rivals.

A Recent Decline In Its Stock Price Makes Fortescue Metals Shares (ASX:FMG) An Attractive Buy

A pessimistic outlook on iron ore prices has led investors to press the sell button on the stock. However, FMG’s fortunes are joined at the hip with economic activity in China, which has shown an encouraging uptick as per recent data.

The concern is that growth in China is recovering, but unevenly, and seems to be bypassing the all-important property construction sector. Meanwhile steel manufacturers are reporting subdued margins.

On the other hand, Chinese policymakers are all for reigniting economic growth this year, and this would boost demand for steel inevitably. Furthermore, there are reports that steel inventories are low and that steel makers are opting for the cheaper ore that is FMG’s forte.

In these circumstances, investors may take a bet on FMG on the grounds that the company is well-placed to weather a slow iron ore market with its competitive cost structure, and when the ore cycle turns, it will benefit handsomely from the higher volumes added by Iron Bridge.

Are you looking for more stocks to buy? In our opinion, buying the right stock at the right time is just half the battle – knowing how to manage the position and risk is just as, if not more important. Take our free 5-day trade like a professional course, it give you the foundational knowledge required to become a profitable trader.

This is general advice only. MF & Co Asset Management has not considered your personal financial needs, objectives or current situation. This information is not an offer, solicitation, or a recommendation for any financial product unless expressly stated. You should seek professional investment advice before making any investment decision.

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