Fortescue Metals Group: Shrinking margin for error

About the author:

Author name:

By Adrian Prendergast

Job title:

Senior Analyst

Date posted:

16 February 2023, 8:00 AM

Sectors Covered:

Mining, Energy

• A steady 1H23 earnings result from Fortescue Metals Group (ASX:FMG), which contended with lower prices and higher costs during the half.
• FMG flagged that it intends to declare FID on 5 FFI projects in CY23, located in Australia, Brazil, USA and Norway, although it did not give specifics.
• Reflecting on FMG post its 1H23 result, we see a business aggressively pursuing its unparalleled green hydrogen and decarbonisation ambitions but now significantly reduced cash flow support.
• We expect FMG to continue winding back its dividend payout ratio unless iron ore prices increase sustainably.
• We maintain our REDUCE rating on FMG, with the stock trading above our 12- month target price of (login to view).

1H23 steady vs expectations

FMG reported 1H23 revenue of US$7,835m, vs Vuma consensus US$7,746m vs MorgansE US$8,052m, which was -15% half-on-half (hoh).

Underlying EBITDA of US$4,352m, vs consensus US$4,295m vs MorgansE US$4,511m, which was -25% hoh. 

Underlying NPAT of US$2,368m, vs consensus US$2,337m vs MorgansE US$2,391m, which was -31% hoh. 

FMG’s interim dividend of AUD75 cents was just ahead of consensus AUD73 cents, although was below our estimate of AUD81 cents, with FMG pulling back its dividend payout to 65% (dividend policy 50-80%). 

Given the in-line earnings, a key focus in the result briefing remained FMG’s Fortescue Future Industries (FFI) growth plans. Mark Hutchinson, FFI’s CEO, presented FFI’s intentions to have 5 separate green hydrogen projects reach a final investment decision (FID) during CY23.

These projects are located in Australia, USA, Brazil and Norway. FFI was still also working on prospects in Africa and the Middle East, although FMG/FFI was unable to provide any details on specific projects.

All FY23 production, C1 cost and capex guidance was unchanged.

Analysis

We will have to wait and see when it comes to FFI. But it is hard to ignore the likely high capital intensity and lower and longer return profile (relative to iron ore).

This is especially difficult when FMG’s iron ore business is already battling lower iron ore prices, an elevated cost environment, and US$6.2bn (real) of planned decarbonisation spend over the coming years. 

If benchmark iron ore prices, or discounts on lower grades, decline from current levels we expect it will at least put pressure on FMG’s ability to sustain its dividend within its 50-80% policy range, or in a worst-case scenario create a funding problem for FFI projects and FMG’s work to decarbonise.

Forecast and valuation update

We have updated our estimates for the 1H23 result. We have removed planned Nyidinghu major capex from FY25 and replaced it with a more steady assumed contribution to mine and smaller hub replacement.

Post changes our blended target price has increased to (login to view).

We have reduced our assumed dividend payout ratio to 50% from 65%.

Investment view

Trading above our target price we maintain our REDUCE recommendation.

Price catalysts

• 3Q23 operational result (April 2023).
• FFI projects FID (2023).
• Full year earnings and dividend (August 2023).

Risks

• Iron ore price risk.
• Execution risk on iron ore/FFI growth and decarbonisation.

Find out more

You can find further detailed analysis of company results this reporting season by browsing our reporting season tag, and view a full list of upcoming results on our Reporting Season Calendar.

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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.