Company Overview: Fortescue Metals Group Limited is engaged in the exploration, development, production, processing and sale of iron ore. It owns and operates an integrated supply chain, including its approximately five berth Herb Elliott Port in Port Hedland and the heavy haul railway with approximately 42 ton axle load capacity over 620 kilometers of track. Its operations span over four mine sites in the Pilbara. The Chichester Hub, which includes the Cloudbreak and Christmas Creek mines, is located in the Chichester Ranges, and produces over 90 million tons per annum (mtpa) from three ore processing facilities. The Solomon Hub is located in the Hamersley Ranges, and includes the Firetail and Kings Valley mines, which produce in excess of 70 mtpa. The Company owns and operates its purpose designed rail and port facilities, constructed to deliver iron ore from its mines to Port Hedland and onto its customers. Its Iron Bridge Magnetite project is located over 100 kilometers south of Port Hedland.


FMG Details

Fortescue Metals Group Limited (ASX: FMG) is engaged in the exploration, production, development and sale of iron ore in Australia, China, and internationally. The company is the fourth largest iron ore producer in the world. The other three are BHP Group, Rio Tinto and Vale. The company holds more than 87,000 km² in the Pilbara region of Western Australia, that makes the company to be the largest tenement holder in the state, above both BHP and Rio Tinto. FMG has operations in the Chichester Hub that includes the Cloudbreak and Christmas Creek mines and the Solomon Hub comprising the Firetail and Kings Valley mines in Western Australia. The group has been impacted by volatile scenario in commodity market in year 2018 but current low levels with support from net profit numbers portray a story to be looked at. The returns to shareholders have remained decently balanced despite a mix of performance in 2018. The group aims to have key focus on balance sheet, growth, sustainability and enhanced shareholder returns to be able to move up the competitive ladder. We also understand that iron ore scenario is still under a speculative zone but prospects from Eliwana mine and West Pilbara Fines Product strategy look promising now. The 67% Fe magnetite project is a close watch. Moreover, the update on shipments of West Pilbara Fines in December seems to be as per plan.

 

Returns to Shareholders (Source: Company Reports)

Maiden shipment of West Pilbara Fines: The recent announcement on FMG’s maiden shipment has been of significance. Primarily, shipment of new 60.1% iron content product West Pilbara Fines had left from Herb Elliott Port in Port Hedland bound for Hunan Valin Steel Co., Ltd in China. In FY 19, FMG is expected to produce 5-10 million tonnes of West Pilbara Fines by blending higher iron, low alumina ore from the western pits at Cloudbreak and the ore from the Firetail mine. The company has enhanced the product mix with this shipment. Eliwana is scheduled to begin production in December 2020, and then the production of West Pilbara Fines will expand up to 40 million tonnes per annum. FMG is undergoing development of US$1.275bn Eliwana Mine and Rail that includes 143kms of rail and a 30mpta dry ore processing facility. Eliwana will support the supply of West Pilbara Fines, and the first ore on train is scheduled to start in December 2020.

Decent Performance in the September Quarter marked with Improvement in the Realised Price: During the September 2018 quarter, the average realised price had improved by 12.5 per cent than the June 2018 quarter to US$45 per dry metric tonne (dmt). This reflects 67 per cent realisation of the average Platts 62 CFR Index price that has risen by two per cent over the previous quarter. The company during the September quarter, achieved the shipments of 40.2mt comprising of Mining, processing, rail and shipping all together. Non-China markets had accounted for ten per cent of total shipments during the quarter. Ore mined had increased by 4 per cent and overburden removal rose by 15 per cent compared to the June 2018 quarter as the ore inventories were replaced and company prepared new areas for mining. Therefore, the total material moved rose by 11 per cent compared to the prior quarter and posted the strip ratios of 1.6 (Chichester Hub at 2.0 and Solomon Hub at 1.1) for the first quarter of FY 19. Finished product and run of mine inventories rose by 6.7mt over the quarter, that led to rebuilding the iron ore inventories to provide greater blending optionality. Further, during the first quarter of FY 19, C1 costs were US$13.19/wmt, which is an eight per cent rise from the prior quarter driven by higher overburden removal, scheduled maintenance and higher fuel costs. However, these increases were partially offset by a lower Australian dollar. The company has been progressing well with the conversion to AHS at Christmas Creek and the company has converted 32 trucks that are in operation. Cloudbreak’s relocatable conveyor had doubled throughput capacity through an additional crushing station.

Moreover, during the September 2018 quarter, FMG had taken the delivery of its eighth ore carrier, FMG Northern Spirit. With this, all eight ore carriers have been delivered to provide about 14 per cent of Fortescue’s annual shipping requirements. The ore carriers are now designed to provide operational cost improvements and loading efficiencies. Additionally, during the September 2018 quarter, the company’s Exploration work was primarily focused on iron ore in the Pilbara. For the September 2018 quarter, the total expenditure was US$28 million. On the other hand, FMG continued the drilling of prospective copper-gold targets on the Company’s joint venture in central NSW. FMG is assessing the exploration and development opportunities throughout South America, that includes Ecuador, Colombia and Argentina and the approvals to start drilling on concessions held in the Santa Ana region of Ecuador is pending. In addition, at 30 September 2018, the company had cash on hand of US$972 million. At 30 September 2018, the company’s gross debt was at US$4.0 billion and it had net debt of US$3.0 billion. For the quarter, the company incurred the total capital expenditure of US$276 million. This was inclusive of sustaining capital, ship construction, exploration and development expenditure. At 30 September 2018, the iron ore prepayments of US$794 million remained unchanged. The company projects amortisation of prepayments to be US$270 million in FY19 with the balance in FY20.


Production Summary (Source: Company Reports)

Established an on-market share buy-back program: FMG has established an on-market share buy-back program for up to A$500 million, which is approximately US$355 million during the first quarter of FY 19. The program is expected to remain in place for a period of up to one year with all shares purchased on-market cancelled.

Decent Demand for FMG’s products: China ports stocks of FMG products have decreased. There has been a margin compression in recent steel mill, which is expected to further increase the demand of lower Fe iron ore. Further, there is a rise of demand of FMG products in other regions apart from China due to the proximity to high growth regions and this included maiden shipments to Vietnam & Malaysia.

Fortescue and CSIRO signed the landmark partnership to develop and commercialise hydrogen technology: FMG has partnered with the Commonwealth Scientific and Industrial Research Organisation (CSIRO), Australia's national science agency, to develop new hydrogen fuel technologies. The partnership is expected to capitalise on the economic opportunities associated with hydrogen and underpin the development of a competitive hydrogen industry in Australia. Fortescue has planned to invest $19 million over a five-year period into research at the CSIRO’s Brisbane laboratories. CSIRO will work with FMG for the identification, development and commercialization of technologies to support the creation of an Australian hydrogen industry and the future global uptake. Meanwhile, earlier this year, CSIRO had launched a National Hydrogen Roadmap for providing the blueprint for the development of a hydrogen energy industry in Australia. Hydrogen has the potential to be a completely renewable source of energy. This gas is formed by 'cracking' water, where an electric charge is sent through water to break it down into hydrogen and oxygen. The electricity can then be supplied by wind or solar power. Overall, this agreement is based on FMG’s energy initiatives, that comprised of the conversion of Solomon Power Station to gas generation from diesel and the developing of Fortescue River Gas Pipeline.


Financial Performance over the years (Source: Company Reports and Thomson Reuters)

Outlook for FY 19: For FY 19, FMG expects the total shipments to be between 165-173mt, C1 cost is expected to be between US$12-13/wmt and total capital expenditure is projected to be of US$1.2 billion. Further, for FY 19, the Average strip ratio is expected to be 1.5 and Depreciation and amortisation is projected to be of US$7.10/wmt. The company has maintained dividend pay-out ratio at 50 to 80 per cent of net profit after tax of full year earnings.

Stock Recommendation: FMG stock has risen 13.8% in three months as on December 18, 2018 while it fell about 16% in last one year. The company’s stock is trading at a price of $4.13, and has support around $3.5 and resistance around $4.3. Recently, Metal Bulletin had reported for rise in iron ore prices on the back of improved demand out of China, and this has been changing the landscape once again. Then the fears of trade war between US & China look to be subsiding to some extent and this will support the scenario for commodities. The recent rise in FMG stock after its founder and non-executive chairman, Andrew Forrest, bought $23 million worth of shares at price of around $3.90 also directs to a positive scenario. Meanwhile, the introduction of West Pilbara Fines in FY19 from existing operations will enhance the operating margins of the company and will provide customers with this product prior to full scale production on completion of the Eliwana project. Fundamentally, the price to earnings ratio for FMG is around 10.8x, and this is quite lower than industry average. FMG is expected to demonstrate better financial ratios going forward with developments in hand. Therefore, we give a “Buy” recommendation on the stock at the current price of $ 4.13.


FMG Daily Chart (Source: Thomson Reuters)

 
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