China ore bust? Fortescue's record week

The story of Fortescue Metals Group is the stuff of legend. Founded in 2003, it grew out of obscurity in 2008 and tapped into China’s ravenous appetite for iron ore as a key ingredient in its steel-making. Since then, FMG has grown to become the world’s fourth largest iron ore miner, behind BHP, Rio Tinto and Brazilian giant Vale.

And FMG had a pretty good week this week: its share price hit a record high of $13.28 amid growth in Chinese production, an inflated iron ore price of about US$90, and a supply shock in Brazil, which is in the grip of the coronavirus and still recovering from that deadly Brumadinho dam disaster in January last year.

Fortescue Metals Group FMG - MAX

Source: Morningstar

Nor did the decision later in the week by China to tighten inspections on iron ore imports dampen sentiment. Will FMG’s price continue to soar? It has a steely balance sheet, good projects in train, a healthy dividend payout, and chief executive Elizabeth Gaines is adamant Chinese demand for imports remains despite the Middle Kingdom’s ore stockpiles.

But can the iron ore price keep going? Morningstar director Mathew Hodge isn’t so sure. In fact, he expects it to halve over the next few years as China’s demand moderates and Brazil recovers. His fair value estimate for FMG is $6.80, which means it’s overvalued by about 100 per cent.

“Fortescue now trades at a premium to our $12.00 bull-case valuation,” Hodge says. “Our bull case incorporates an average iron ore price to 2024 of US$74 per tonne and US$60 per tonne from 2025 onwards. This compares with our base case assumptions of US$58 to end 2024 and US$43 from 2025 onwards.”

Hodge’s assessment on FMG, which you can read here, coincides with China’s shock parliamentary meeting yesterday at which it declined, for the first time in three decades, not to set an annual growth target.

Elsewhere this week, Emma Rapaport talks to Morningstar equity analyst Brian Han on why shareholders in embattled cinema and theme park operator Village Roadshow are in such a bind over the takeover offer from BGH Capital; we look at the fortunes of two pokies plays, Aristocrat Leisure and Ainsworth Game Technology; we unearth the one stock under Morningstar coverage that carries an “extreme” uncertainty rating (hint: free-to-air telly); Grant Slade builds a case for why the outlook for the housing construction industry isn’t as ugly as you think; and we assess the predicted 35 per cent fall in dividends, and examine which regions will be most affected.

Stockpickers will find solace in Emma Rapaport’s survey of quality names that are undervalued, while Anthony Fensom checks the Asian outlook, and reveals which nations are showing most progress in combatting the coronavirus.

In Firstlinks this week, Graham Hand investigates the budget bungle and hears from former Westpac chief David Morgan, who lays out his expectations for the recovery, and steps back to take a big-picture view on the slow bounce back.

And finally, Peter Warnes explains why he was left scratching his head at the mixed message of Fed chairman Jerome Powell and the central bank’s stimulus measures.

“This is market intervention by a central bank on an unparalleled scale,” Warnes says, “removing the risk of default by providing life-sustaining liquidity, even to those least deserving. What example is this providing for the future? It encourages risk-taking and excessive leverage with a promise of a bailout.”

 Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.