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Fortescue profit soars on iron ore prices

Lex Hall  |  27 Aug 2019Text size  Decrease  Increase  |  
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Higher iron ore prices have helped Fortescue Metals Group book a mammoth profit but the good times won’t last forever, warns Morningstar’s Mathew Hodge, who has left his fair value estimate for the world’s fourth largest iron ore miner intact. 

Fortescue Metals Group’s (ASX: FMG) has reported a fiscal 2019 adjusted net profit after tax of US$3.2 billion - almost triple the previous year’s US$1.1 billion and slightly ahead of Hodge’s US$3 billion forecast.

Realised prices rose 48 per cent to US$65 per tonne, more than offsetting a modest 1.2 per cent fall in shipments to 168 million tonnes. 

The world's fourth-largest iron ore miner posted a final dividend of 24 cents a share, double what it paid last year, bringing its total dividend to $1.14.

“Profit was aided by rapid iron ore price appreciation through the year,” Hodge says. “An approximate one-month lag between shipping the iron ore and prices being finalised meant that Fortescue reaped a US$1.1 billion revenue windfall from the timing of sales, which was greater than we expected.”

However, Hodge says the iron ore price has peaked and that once it normalises profits will wane. 

He has maintained his fair value estimate of $6.80. In early trading, FMG was up 4.18 per cent at $7.47 - a 10 per cent premium to Hodge’s estimate.  

“Fortescue’s fair value estimate hinges on the rate at which iron ore prices normalise to our long-term assumption,” Hodge says. “Our forecast calls for the benchmark 62 per cent price to decline to US$40 per tonne from 2023.

“This reflects the headwinds to iron ore demand from increased steel recycling, reduced urbanisation, and lower fixed-asset investment in China.”

The price Fortescue received for its ore in the June quarter jumped 30 per cent from the previous quarter to $US92 per dry metric tonne, narrowing its discount to benchmark 62 per cent iron ore to 13 per cent from as wide as 37 per cent a year ago, the miner said in July.

“However, if iron ore prices were to hit our long-term forecast one year earlier, by 2022 instead of 2023, our fair value estimate would decline by approximately 22 per cent, or $1.50 per share.”

Hodge also expects higher capital expenditure costs to rise as mines deplete. 

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Fortescue produces an inferior, lower-iron-grade product, which attracts a discount to the benchmark 62 per cent iron ore fines price.

Fortescue has relied on cheap debt and inflated Chinese economic growth to fuel rapid expansion in what is a cyclical industry. Global economic headwinds from the US-China trade war have also raised fears that demand could slow.

If conditions are less favourable than the peaks of 2010-18, Fortescue risks destruction of equity value as a result of high operating and financial leverage.

is senior editor for Morningstar Australia

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