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FMG

Fortescue Continues To Ride Record Iron Ore Prices, But Will China Curb Steel Production?

Sam Waldron

Sam is a freelance writer for equities and markets with Australian Stock Report. He has studied a Bachelor of Commerce at the University of Sydney. Sam currently holds RG146 qualifications.

Fortescue Metals Group (FMG: ASX) is an Australian iron ore company, being the fourth largest iron ore producer in the world, and third largest in Australia behind BHP and Rio Tinto.

 

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Source: Baseline Group

 

While the ASX 200 index tumbled 33% during the onset on the Covid-19 pandemic from late February to March 2020, FMG shares only lost 14% of its value during that same period, and since then Fortescue shares has strongly recovered with a price appreciation of over 135%, well surpassing pre-pandemic price levels. This is in comparison to a 45% growth in the ASX 200 in this same period, showing how well FMG shares has outperformed the bulk of its peers on the ASX 200 over the past year and a bit.

 

FMG stocks along with other miners have been performing well largely due to cyclical factors, particularly that of iron ore prices reaching record highs, at over US$210 per tonne. It has actually strongly outperformed other miners such as BHP and Rio Tinto due to the fact that FMG is an iron ore pure play while the aforementioned have a more diversified metals base, of which none have had better tailwinds than iron ore.

 

This has been due to factors on both the demand and supply side which has put heavy upward pressure on iron ore prices. Being a crucial input to steel, iron ore has been particularly high in demand in China as it has looked to infrastructure stimulus to expand their economy out of the pandemic and to further expand their capability as an economic power.

Although some Chinese government bureaucrats have pledged to cut production in light of environmental concerns and high cost of inputs, the National Bureau of Statistics showed that China produced record levels of steel output at 97.85 million tonnes just in April, up 4.1% from March. This clearly indicates that at least for the time being they are actually ramping up production rather than curbing it. This has been occurring for quite a while given that the April 2021 production output was up 15.1% year on year from April 2020. This bears well for FMG shares as an iron ore pure play.

 

Contrary to what some may think, the high input prices such as iron ore has not put off steel producers, as steel prices have also skyrocketed, keeping margins very healthy for Chinese steel producers. Steel prices are expected to continue to maintain and even increase on already high levels, as market orders remain strong as steel inventories are being depleted. If China were to be believed in saying that they won’t surpass 2020’s production level of 1.065 billion tonnes of steel, of which they are already well on track to surpass, this risk of a pullback in production may be made up for in the rest of the world, as they look to infrastructure stimulus to boost their Covid-19 economic recovery, such as the potential passage of the US$1.9 trillion infrastructure package.

 

Iron ore prices have also been high due to supply shortages, particularly with major producer Brazil being partially sidelined due to the pandemic raging in its country. The bear case for iron ore prices, which directly affects FMG shares, is how quick Brazil returns to full capacity in its production output to boost global supply levels, as well as if China follows through on curbing steel output production, and how much of that is made up by infrastructure stimulus in the rest of the world.

 

Fortescue’s strong results driven by surging iron ore prices has turned FMG stocks into a very solid dividend paying share, paying a total of $2.47 per share in 2020, a significant increase from just $1 a year before, and consistently well under $0.40 until just a few years ago. If current iron ore price and demand trends continue, investors should expect these high dividend levels to continue in future announcements.

 

For the March 2021 quarter, Fortescue Metals Group ASX recorded strong results with 42.3 million tonnes shipped in line with its record shipment levels in the same quarter last year. A part of the reason of Fortescue keeping up its strong production performance was the commissioning of the Eliwana mine at the end of 2020, whereas without it Fortescue’s production would have been down due to the impacts of significant rainfall in the Pilbara. However, Fortescue Metals Group ASX failed to meet expectations with iron ore price realisation down 5% quarter on quarter. With revenue at US$143.12 per dry metric tonne and C1 direct costs of $14.90 per metric tonne, Fortescue are running up huge profit margins per tonne, despite these C1 costs increasing 16% from the previous quarter due to a higher Australian dollar and seasonally lower volumes.

 

As C1 cost guidance remains the same for the rest of the financial year, with revenue per metric tonne increasing as iron ore prices have, FMG shares are heading towards strong full year results as operating leverage tailwinds remain. However, as an investor it is important to consider that strong results will not necessarily mean a positive price reaction, as with the sharp increase in FMG stock price leading to FMG shares trading at high multiples. According to Goldman Sachs, FMG shares are trading at 1.6x NAV, compared to Rio Tinto and BHP trading at around 1.0x. The NAV (Net Asset Value) is the market capitalisation value to the value of the mine’s discounted future cash flows, less debt, meaning price of FMG shares are trading at 1.6x its value. FMG is also particularly exposed to an operating leverage crunch if the bear case for iron ore prices do play out, which means where a percentage drop in iron ore prices leads to an even greater percentage drop in margins.

 

The Fortescue share price today is $22.75.


Disclaimer:

This article has been prepared by the Australian Stock Report Pty Ltd (AFSL: 301 682. ABN: 94 106 863 978)
(“ASR”). ASR is part of Amalgamated Australian Investment Group Limited (AAIG) (ABN: 81 140 208 288 Level 13, 130 Pitt Street, Sydney NSW 2000).

This article is provided for informational purpose only and does not purport to contain all matters relevant to any particular investment or financial instrument. Any market commentary in this communication is not intended to constitute “research” as defined by applicable regulations. Whilst information published on or accessed via this website is believed to be reliable, as far as permitted by law, we make no representations as to its ongoing availability, accuracy or completeness. Any quotes or prices used herein are current at the time of preparation. This document and its contents are proprietary information and products of our firm and may not be reproduced or otherwise disseminated in whole or in part without our written consent unless required to by judicial or administrative proceeding. The ultimate decision to proceed with any transaction rests solely with you. We are not acting as your advisor in relation to any information contained herein. Any projections are estimates only and may not be realised in the future.
ASR has no position in any of the stocks mentioned.

 

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