Fortescue Metals Group: Forrest for the trees

About the author:

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

  • A result that focused on the ambitions of FMG, led by chairman Andrew Forrest, to emerge as a global technology leader in renewables and green products. 
  • FMG is investing aggressively towards the goal of becoming the first green iron ore producer, which it expects will attract a material premium for its products. 
  • A worthy objective that may eventually prove inevitable, but we question whether being an early adopter would be a more efficient approach rather than innovator.  
  • Countries being considered by FFI for investment (including Afghanistan and Indonesia) raise questions around how FMG’s risk profile might change. 
  • The FY21 result itself was strong, and in line with expectations. 

A question of strategy

A result that focused mostly on FMG’s ambition of becoming the first green iron ore producer,  with  a  peer-leading  target  of  carbon  neutrality  by  2030.  A  worthy objective but we are cautious on the strategy FMG is using to get there. 

The planned investments in Fortescue Future Industries (FFI) remain difficult to analyse at this stage. Our early attempts at modelling green hydrogen or green ammonia projects suggest high capital intensity that blunts valuations, indicating a long-dated investment profile reliant on future cost structures transforming. 

Within FMG’s thinking is a core belief that customers will pay premium prices to get access to zero carbon products, which we think is a reasonable assumption but impossible to quantify at this stage. 

Our main concern on FFI is around how well FMG is positioned to pursue these objectives. Besides simply having capital it can throw at it, FMG is moving into a space  far  outside  its  established  core  competencies,  while  the  global  energy supermajors it will compete against have an immediate knowledge and experience advantage, as well as deeper pockets. 

The first likely FFI project is a green ammonia project in Tasmania, while FMG’s chairman also acknowledged two other potential FFI projects being considered in Afghanistan and Indonesia during the result call. Representing further risk profile implications could be on the way. 

Ultimately we view the priority to decarbonise its business as impressive, but also think that FMG is perhaps attacking the issue too aggressively. Something it may come to regret if/when iron ore prices revisit more typical levels before green iron ore can be achieved. 

FY21 result analysis

A very in line result. EBITDA US$16,375m (vs consensus US$16,501m vs MorgansF US$16,507m). FY21 NPAT US$10,349m (vs consensus US$10,392m vs MorgansF US$10,419m).  

This allowed FMG to announce a record final dividend of A$2.11ps (vs consensus A$2.17ps vs MorgansF A$2.16ps), at an 80% payout ratio. 

FY22 guidance for shipments, C1 and capex had already been released at 4Q21.

Forecast and valuation update

Only minor adjustments for the FY21 result. PT revised to (login to view).  

Investment view

Our overall view on FMG is much more positive than our view on FFI. FMG has built a formidable iron ore business in the Pilbara and maximised returns. 

Although in the short term we see further downside risk once FMG trades ex-dividend, as recent iron ore volatility may increase selling pressure once investors receive their record dividend. We maintain our Reduce rating.  

Price catalysts

1Q21 operational result. Spot iron ore price and lower grade discounts. Sanctioning of FFI projects. Progress on Iron Bridge construction.

Risks

Potential iron ore price volatility.  

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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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