Business Strategy and Outlook
Fortescue Metals is the world’s fourth-largest iron ore exporter. Margins are well below industry leaders. Lower margins primarily result from discounts from mining a lower-grade (57%- to 58%-grade) product compared with the benchmark, which is for 62%-grade iron ore. The lower grade is effectively a cost for customers, which results in a lower realised price versus the benchmark.
Fortescue has grown rapidly due to highly favourable iron ore prices, aggressive management, and historically low corporate interest rates. Fortescue has expanded its capacity unprecedented and built two thirds of its capacity at the peak of the capital cycle baked in a higher capital base than peers. This means returns are likely to lag those of the industry leaders, which benefit from building capacity at times when the capital cost per unit of output was, on average, much lower.
Fortescue has done an admirable job of reducing cash costs materially versus peers. However, product discounts remain a competitive disadvantage. To this end, the company will add about 22 million tonnes a year of iron ore production from the 61%-owned Iron Bridge joint venture. Iron Bridge grades are much higher, around 67%, which should allow Fortescue to meet its goal to have most of its iron ore above 60%, assuming the company chooses to blend it with the existing products.
Morningstar analyst lowered fair value estimate for Fortescue Metals to AUD 13 per share from AUD 15.10 per share previously. The shares have gone ex-entitlement to the final dividend, an unusually large AUD 2.11 per share or 14% of the previous fair value estimate.
Financial Strength
Fortescue Metals Group’s balance sheet is strong, due to the elevated iron ore price and accelerated debt repayments. Net debt peaked near USD 10 billion in mid-2013, roughly coinciding with the start of expanded production. By the end of 2020, net debt had declined to USD 0.1 billion. Net debt/EBITDA is comfortable and likely to remain so for the foreseeable future. It is expected that given the operating leverage in Fortescue, and the cyclical capital requirements, there is a reasonable argument that Fortescue should run with minimal or no debt on average through the cycle.
Bulls Say
- Fortescue provides strong leverage to the Chinese economy. If growth in steel consumption remains strong, it’s also likely iron ore prices and volumes will too.
- Fortescue is the largest pure-play iron ore counter in the world and offers strong leverage to emerging world growth. O
- Fortescue has rapidly cut costs and significantly narrowed the cost disadvantage relative to industry leaders BHP, Vale, and Rio Tinto. If steel industry margins fall in future, it’s likely product discounts will narrow significantly relative to historical averages.
Company Profile
Fortescue Metals Group is an Australia-based iron ore miner. It has grown from obscurity at the start of 2008 to become the world’s fourth-largest producer. Growth was fuelled by debt, now repaid. Expansion from 55 million tonnes in fiscal 2012 to about 180 million tonnes in 2020 means Fortescue supplies nearly 10% of global seaborne iron ore. However, with longer-term demand likely to decline, as China’s economy matures, we expect Fortescue’s future margins to be below historical averages.
(Source: Morningstar)
General Advice Warning
Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.
