Fortescue Metals Group: Strong shipments but costs suffer
About the author:
- Author name:
- By Adrian Prendergast
- Job title:
- Senior Analyst
- Date posted:
- 29 April 2022, 8:30 AM
- Sectors Covered:
- Mining, Energy
- A surprisingly strong share price reaction to a mixed quarter, with rising investor sentiment on strong shipments driving revenue despite costs slipping on all fronts.
- Management downgraded FY22 C1 cost guidance, while confirming that FY23 is expected to be worse, with energy, labor and services costs key contributors.
- Another blowout in budget/schedule at Iron Bridge.
- Price realisation of 70% remains well below the ten-year average with Fortescue Metals Group's (ASX:FMG) low-grade product struggling in a well-supplied low-grade market.
- Iron Bridge capex estimate has increased after delays from COVID-19 related constraints and cost pressures are made worse by recent China lockdowns.
Mixed 3Q22 Result
FMG reported total iron ore shipments of 46.5mt (-2% qoq) vs consensus of 45.6mt prompting the company to upgrade FY22 guidance to 185-188mt (from 180- 185mt). Meanwhile ore processed dipped to 44.2mt (-10% qoq), seemingly on lower access to ores (perhaps driven by either added red tape post Juukan Gorge and/or labor/services constraints).
Price realisation of FMG products of 70% vs benchmark, with average revenue of US$99.52/dmt, was a slight increase qoq (68% in 2Q22) although still below the average from the past ten years of ~82%.
Despite realisations being depressed well below long-term averages, we do not expect a near-term recovery as peers, such as RIO with its SP10 product, continue to flood the market.
C1 costs of US$15.78/wmt were +3% qoq with inflationary pressures across key input costs increasing throughout the quarter. This triggered a downgrade in FY22 C1 cost guidance to US$15.75-$16.00/wmt (from US$15.00-$15.50/wmt).
FMG’s key development project, Iron Bridge, suffered a further blowout in schedule and budget with WA’s first COVID wave understandably complicating construction. FMG commented that workforce levels were 30% below the planned levels in 3Q22.
Also struggling with the intensifying inflationary environment, the capex estimate for the project has increased to US$3.6-$3.8bn (from US$3.3-$3.5bn). First production at Iron Bridge is now expected in 3Q23.
FY22 group capex guidance has decreased to US$3.0-$3.2bn (from US$3.0- $3.4bn) excluding FFI with some planned FY22 spend now scheduled for FY23.
A mixed result from FMG with strong iron ore shipments triggering an increase in FY22 guidance, while costs have suffered from inflationary pressures and Iron Bridge faces intensifying challenges.
Cost pressures are expected to continue into 4Q22 and through FY23, with lagged cost increases in key inputs such as diesel still rising (FMG consumes ~700 million litres of diesel a year) while labour costs tend to be sticky, while general input costs are expected to worsen due to the COVID surge in China according to FMG.
FMG’s green hydrogen focus is progressing with first production expected later this year at Christmas Creek. The global ‘hydrogen race’, which FMG is a part of, appears more focused on satisfying demand for low-carbon fuels (and in FMG’s case perhaps adding to the long-term marketability of its iron ore products).
Forecast and valuation update
We have: increased FY23 C1 cost estimates to US$17.1/wmt (from US$14.5/wmt) and FY24 to US$16.6/wmt (from US$13.6/wmt); Mark-to-market our AUD assumptions; and pushed back assumed Iron Bridge startup to Mar-23 and assumed construction capex to US$2.8bn (FMG share).
Net of these changes our SOTP DCF valuation based target price has decreased to (login to view).
We see further upside potential in 1H’FY23 iron ore prices from a combination of accelerated China stimulus and seaborne supply risks (RIO/Vale).
While a strong tailwind, we see the revenue strength being dragged on by robust cost strength on all fronts. We maintain our Hold rating on FMG on a TSR basis.
Inflationary cost pressures and potential for China lockdowns to exacerbate this.
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