Fortescue Metals Group (ASX: FMG) is the largest pure play iron ore producer in Australia. The company owns and operates the Chichester Hub that includes the Cloudbreak and Christmas Creek mines located in the Chichester ranges; and the Solomon Hub comprising the Firetail and Kings Valley mines located in the Hamersley ranges of Pilbara, Western Australia. It is also developing the Eliwana mine situated in the Pilbara region of Western Australia. In addition, the company holds a portfolio of properties situated in Ecuador and Argentina. Further, it provides port towage services.
Fortescue recorded a stellar quarter with respect to production and shipments:
- Iron ore shipments of 42.3million tonnes (mt), in line with record third quarter shipments last year. Year-to-date shipments of 132.9mt are 2% higher than the comparable period in FY20
- Average revenue of US$143/dry metric tonne (dmt) increased 17% compared to the previous quarter
- C1 cost of US$14.90/wet metric tonne (wmt) increased 16% compared to Q2 due to seasonally lower volumes and the strength of the Australian dollar, with year-to-date C1 costofUS$13.45/wmt
Fortescue’s strong operating performance continued, with mining, processing, railing and shipping combining to deliver shipments of 42.3mtin Q3 FY21, in line with the record third quarter shipments achieved last year. The performance benefited from commissioning of the Eliwana mine in December 2020, which contributed to an increase in ore mining and processing during the quarter, despite the impacts of significant rainfall across Fortescue’s Pilbara operations. The Eliwana mine transitioned to the Operations team in January 2021 with the focus on the commissioning and ramp up of the ore processing facility.
Chinese crude steel production was 1,065mt for calendar 2020 and 271mt in the first quarter of 2021, an increase of 15.6% compared to the same period in 2020. Underlying demand for iron ore remains strong and in conjunction with seasonally weaker supply, index prices strengthened during the March quarter. Fortescue’s Chinese sales entity, FMG Trading Shanghai Co. Ltd sold 2.6mt in Q3 FY21 from regional ports in China, with sales of 8.4mt in the nine months ended 31 March 2021.
Red Dirt Prices Soar
With iron ore prices soaring, FMG and other iron ore players have quite literally been making hay while the sun shines. After a slight drop off in growth of iron prices in the first quarter of 2021, prices have again started to skyrocket since the back end of March. The price has more than doubled in the last 12 months as the world turns to infrastructure to facilitate an economic recovery. With a high of US$193.85 per dry metric tonne recorded just last week, iron ore prices have now surpassed the record previously set in 2011.
Infrastructure heavy stimulus plans began in China with their quick recovery. The country is responsible for 55% of the world’s steel production. In addition to China, the likes of the USA, Germany have also joined in with stimulus packages supporting incredibly high infrastructure spending. Joe Biden’s “once in a generation” $2 trillion infrastructure stimulus cheque has added to the Chinese demand for iron ore.
Current trajectories suggest that there is lots of room for immediate upside in iron ore prices. However, with the long term sustainability still in question. Strong Chinese fundamentals are underpinning the high prices. The country produced 271 million mt of steel in Q1 2021, flat from Q4 2020. However, their steel inventories have kept dropping during this time – indicating that demand will sustain and will likely increase as more economies emerge from the pandemic and increase infrastructure spending – which is after all the bedrock of economic policies to revitalise a stagnant economy.
As we have stated several times over the course of the past few months, tight supply of iron ore has resulted in resilience of commodity prices. Particularly in the past 3 months, Brazil, and Australia, the two largest iron ore producers have encountered seasonal reductions in production capacity. Australian miners Rio Tinto and BHP saw a decline in production by 11% and 5% quarter over quarter respectively, while the largest miner in Brazil, Vale, saw its ore production drop by 20%. These constraints, however, are expected to ease in Q2.
China will continue to sway iron ore prices. In 2011, the last time we saw prices over US$190dmt, China unveiled a $586 million stimulus package to combat the effects of the GFC. This time around, stimulus cheques around the world have been surpassing the amount.
The cash balance was US$3.6 billion on 31 March 2021, compared to US$4.0 billion on 31 December 2020. Cash outflows in Q3 FY21 included US$3.5 billion for the FY21 interim dividend and US$909 million of capital expenditure, inclusive of sustaining capital, major projects, and exploration. Total capital expenditure year-to-date is US$2.8 billion.
Gross debt was US$4.6 billion on 31 March 2021, compared with US$4.1 billion on 31 December 2020, and net debt was US$1.0 billion.
During the quarter, Fortescue issued US$1.5 billion Senior Unsecured Notes at an interest rate of 4.375% with a maturity of April 2031. Use of proceeds include the refinance of the firm’s 4.75% Senior Unsecured Notes due 2022 and the 5.125% Senior Unsecured Notes due 2023, together with transaction costs.
Net proceeds of approximately US$160m are retained as cash on hand. The redemption process is scheduled for completion by 30 June 2021 when Fortescue’s gross debt is expected to be approximately US$4.3 billion.
The Notes issue further optimises Fortescue’s capital structure by refinancing the earliest debt maturities, extending the weighted average maturity profile, and reducing interest expenses. Fortescue’s balance sheet is structured on low cost, investment grade terms, maintaining flexibility to support ongoing operations and the capacity to fund future growth.
Fortescue Future Industries
Fortescue announced a revised target to achieve carbon neutrality by 2030, ten years earlier than the previous target. Fortescue Future Industries (FFI) is assessing renewable energy and green hydrogen opportunities globally. It will be a key enabler of Fortescue’s carbon neutrality pathway through the development of renewable energy, green hydrogen, and green ammonia projects in Australia and internationally.
FFI will deliver several key decarbonisation projects in the short term, including:
- Developing a ship design powered by green ammonia and trialling that design in new ammonia engine technology, at scale
- Testing large battery technology in Fortescue’s haul truck so Trialling hydrogen fuel cell power for Fortescue’s drill rigs
- Trialling technology on Fortescue’s locomotives to run on green ammonia
- Conducting trials to use renewable energy in the Pilbara to convert iron ore to green iron at low temperatures, without coal.
Fortescue is investing over a billion dollars into FFI each year. The availability of green hydrogen and renewable power is expected to drive further sustainable industrialisation of the port, including production of green steel, fertilisers, chemicals, fuels, and other sustainably manufactured industrial products. These changes will not only align the firm in what is going to be a global push towards clean energy but will also bring benefits such as low capital intensity and low operating costs in the long term.
Fortescue has announced they are on course for their FY2021 guidance targets.
- Iron ore shipments of 178 -182mt
- C1 costs of US$13.50 -US$14.00/wmt
- Capital expenditure revised to US$3.5-US$3.7 billion reflecting the ongoing strength of the Australian dollar, continuation of critical path works at Iron Bridge and investment by FFI in decarbonisation initiatives.
Fortescue Metals Group has 2 very strong metrics that are the hallmark of a mining giant – Sustainable growth in production volumes, and consistently being able to produce at a low cost. In addition to these metrics, the business is supported by very strong tailwinds for the demand and price of the commodity. This has resulted in higher margins and hence higher profitability.
Given that the average revenue realised per dry metric tonne of iron sold in 2021 is north of US$140, the revenues and profit margins have swelled, and we are expecting FMG to end the year with over $20 billion in revenues and $15 billion in EBITDA – translating to EBITDA margins of 72.5%. This is in sharp contrast to average iron ore prices of around US$70 in 2019 and early 2020. The number also considers the guidance that FMG has announced for the full year.
While the iron ore price is expected to remain high in the immediate future, over time, the prices should normalise and revert back to their mean – sending revenues and margins lower. FY2022 can still be expected to have iron ore prices around US$100 – US$110 per dry metric tonne, resulting in swelled revenues and margins once again, albeit not as swollen as the numbers we will witness in FY2021.
These strong numbers in FY2021 have benefitted shareholders. FMG has been able to pay high dividends in 2021. Currently, FMG is arguably the best dividend stock on the ASX. The Board has declared a fully franked interim dividend of A$1.47per share. The interim dividend was 93% higher than the FY20 interim dividend and represents an 80% payout of H1 FY2021 Net Profits after Tax. This has been consistent with Fortescue’s dividend policy of a payout ratio of 50% to 80% of full year NPAT. The full year FY2020 is expected to be equally good as the first half, and the expectation is that we shall see a similar high final dividend payout later this year.
FMG is the best pure-play iron ore producer in Australia with low-cost operations and a high dividend payout policy. The bullish iron ore cycle is on-going and both – stock prices and the underlying commodity prices have soared. While Fortescue remains to be arguably the best dividend stock on the ASX, we recommend long-term investors “Hold” their positions.