Leveraged to higher iron ore prices
Founded by Andrew “Twiggy” Forrest in 2003, Fortescue Metals Group (ASX:FMG) has grown to be the world’s fourth largest iron ore producer behind Brazil’s Vale, Rio Tinto and BHP.
Fortescue’s mines are located in the Pilbara region of Western Australia near BHP and Rio Tinto’s iron ore mines and the Roy Hill mine owned by Gina Rinehart. FMG now exports around 180 million tonnes of iron ore from its Chichester and Solomon mining hubs, while it is also developing a third hub, the Western Hub, that is home to the Eliwana mine. An additional, high quality iron ore mine is being built at Iron Bridge, north of its existing hubs.
FMG’s mines are connected to its port facilities in Port Hedland via 763 kilometres of railway that it owns and operates. Its major customers are in China, with additional customers located in Japan and South Korea.
Source: Fortescue (ASX:FMG)
Standout
The iron ore sector has clearly been a standout during the results season. The ‘Big Three’ have delivered around $65 billion in cumulative earnings, and dividends totalling more than $38 billion – more than double paid out last year, and some $10 billion more than that in 2019. This has occurred in a financial year where strong demand from China and supply constraints saw iron ore prices more than double to record levels.
Iron ore prices have corrected heavily (recovering slightly recently) since the end of June, and this has also ushered in a steep correction in the share prices of BHP, Rio and Fortescue.
Source: Thomson Reuters
Fortescue’s result was yet another reminder what strong cash generating machines these companies are, and this is even true at current levels for the iron ore price. The exit we have seen in the past month or so has possibly been down to the view that we have seen ‘peak iron ore’ but we are not so sure that this is the case, particularly with the amount of steel that China and other countries are going to need as part of the post Covid reboot.
Iron ore prices have retraced from the highs but are now back at their breakout level – which now provides key support. The bull market is far from over in iron ore in our view, and we will see higher levels recaptured later this year
Many had thought the boom years of a decade ago were “as good as it gets.” The combined profits of the latest earnings season are almost double what was seen back in 2011. Will history repeat? Time will tell, but we think that the resource “super cycle” has much more to go.
Result recap
Fortescue (ASX:FMG)shipped 182.2 million tonnes during 2021, exceeding guidance, and the highest in its nearly two-decade history. Assisted by the iron ore price hitting a record before its recent bear market, revenue surged 74% higher, to US$22.3 billion. Fortescue’s iron ore price averaged US$135 per dry metric tonne, 72% higher than the previous year, and along with low costs of US$13.93 per wet metric tonne, the company reported underlying earnings before interest, tax, depreciation and amortisation (EBITDA) of US$16.4 billion, nearly double the previous year.
Earnings per share were US$3.35 or A$4.48, and the company declared a A$2.11 per share dividend, fully franked, taking total dividends for 2021 to A$3.58 per share.
Source: Fortescue (ASX:FMG)
The main driver of Fortescue’s result were higher iron ore prices, adding US$9.376 billion of EBITDA compared to 2020, with increased volumes (+2%) adding a further US$200 million. However, the increased sales revenue also led to higher royalties, which were US$715 million higher and the biggest drag on the result.
The company’s balance sheet is in good shape, with net cash of US$2.7 billion compared to net debt of US$285 million a year ago, albeit before payment of the final dividend and a US$1.0 billion final tax payment for 2021. The company is in tip-top shape to progress its various development options along with its investments in renewables.
Growth options
Fortescue (ASX:FMG) guided to similar shipments of between 180 to 185 million tonnes in 2022, although rising fuel and logistics costs along with an appreciating Australian dollar versus the US Dollar, mean higher estimated unit costs of between US$15 and US$15.50 per wet metric tonne.
Global steel production has been elevated, primarily in China and more recently in the rest of the world, as the global economy reopens. With economic growth also picking up, helped by fiscal stimulus on infrastructure projects in China and the United States, low inventories at Chinese ports and constrained supply from major producers such as Rio, BHP, Vale and Roy Hill, this bodes well for iron ore prices in the near-term.
Source: Fortescue (ASX:FMG)
Contributing to the company’s record production during 2021 was Eliwana, its newest mine, ramping up to full production of 30 million tonnes per year. Fortescue is also currently building its Iron Bridge mine, which is set to produce 22 million tonnes per year by December 2022. Iron Bridge’s ore will have 67% iron content, above the benchmark of 62%, and will be mixed with lower quality iron ore produced at Fortescue’s other mines. At a capital cost of US$3.3 to US$3.5 billion, this expansion will have higher unit costs of around US$33 to US$38 per wet metric tonne, but will likely help Fortescue command higher prices from its customers in Asia.
The company also has a large inventory of tenements in various minerals, both here and overseas. As well as its extensive footprint of iron ore tenements in the Pilbara, FMG is targeting copper-gold in Western Australia, New South Wales and South Australia. It also has over 300,000 hectares of tenements in Argentina, 135,000 hectares in Ecuador and tenements in Peru, Chile, Brazil and Kazakhstan.
The company has pledged to be net zero carbon by 2030 and to that end has established Fortescue Future Industries (FFI), consisting of a global portfolio of renewable energy, green hydrogen (green H2) and green ammonia projects. FMG will direct 10% of its profit towards these efforts, to target the US$12 trillion estimated global market for green hydrogen by 2050. FFI spent US$122 million on these efforts in 2021, with spending surging to US$400 to US$600 million in 2022.
Source: Fortescue (ASX:FMG)
While its efforts in renewables are at an early stage, Fortescue is investing significant sums in this area, and this provides some potential blue sky in addition to its well-performing iron ore operations.
Summary
Fortescue (ASX:FMG) reported a great result, with underlying earnings of US$16.4 billion, nearly double the previous year and helped by good cost control. Fortescue has certainly been making the most of robust iron ore prices over the past year, with the company shipping 182.2 million tonnes during 2021, exceeding guidance and the most in its nearly two-decade history.
Eliwana, Fortescue’s newest mine, ramped up to full production of 30 million tonnes per year. Another mine is being built at Iron Bridge, north of Fortescue’s existing hubs in the Pilbara, which will produce 22 million tonnes of additional ore, with better quality than the company’s existing mines, and likely command higher prices.
With potential blue sky from its investments in renewables such as green hydrogen, we think Fortescue is well placed to benefit from high iron ore prices in coming years, as the world economy reopens and demand for steel remains strong in response to government stimulus programmes.
We recommend Fortescue (ASX:FMG) to Members as a buy at current levels.
Disclosure: Interests associated with Fat Prophets holds shares in Fortescue (ASX:FMG).
