March 26

Fortescue Ltd (FMG) – Iron ore optimism

Fortescue is Australia’s No.3. iron ore miner behind Rio Tinto and BHP, and also has a growing green energy business via the company’s Fortescue Future Industries division. A monster $1.08 per share fully franked dividend was the highlight of Fortescue’s first half of FY24, up 44% on last year’s $0.75 per share interim payout. The dividend boost largely reflects higher earnings with net profit after tax rising 41% to US$3.3 billion, or US$1.08 per share. The buoyant result reflects a 20% increase in realized iron ore price, while volume shipments fell a modest 1.8%. Unit costs rose just 2%, a decent result given prevailing inflationary pressures. Fortescue is generating massive cash flows, with supportive iron ore markets, and most is flowing to shareholders as dividends. We make no material changes to our forecasts and retain our $17.30 per share fair value estimate.

Despite looming issues around real estate construction and infrastructure activity in China, the iron ore price remains buoyant and is nearly double the five-year average to the end of FY19. We think the latter is a more reasonable approximation of the likely mid-cycle price. Fortescue shares are significantly overvalued, in our view. To justify the current share price, we would need to assume the iron ore price averages about US$120 per metric ton long-term, and unit costs stay close to current levels. This scenario seems highly unlikely. We think the share price incorporates significant optimism around future iron ore prices, ultimately a bet on consistent additions of houses, buildings, and bridges in China. This is despite challenges from a declining population and shaky property sector. We also expect the bumper fully franked dividends to appeal to some shareholders, in particular, who derive a meaningful after-tax benefit.


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