We imagine that Fortescue Metals Group may change its company name to reflect its strategic focus more accurately. The iron ore business is still highly profitable but subordinate to the decarbonisation and green hydrogen agenda.
FMG’s 1Q23 production report showed shipments of 47.5mt has the company on target for its FY23 guidance of 187-192mt. The index price (Platts 62% CFR Index) at 30 September was US$95.95/t, down 20% compared to 30 June. FMG’s average realised price achieved in 1Q23 of US$87.43/t was a 15% discount to the average index price for the period.
With prices down and volumes modestly up, FMG’s cost performance becomes more important to operating profitability. C1 costs (mining and processing, plus rail and port costs) of US$17.69/t were 3% higher than the previous quarter but lower than FMG’s FY23 guidance range of US$18.00-18.75/t. Fuel and labour costs remain key issues.
A large amount of discussion was allocated to FMG’s twin strategies of decarbonisation and green hydrogen. The company reiterated its US$6.2 billion capex plan by 2030 to eliminate fossil fuel risk and reduce operating costs by US$818 million per year once fully implemented. The capex bill is just for FMG’s decarbonisation plans.
Eliminating FMG’s fossil fuel risks is a material controllable factor in FMG’s earnings, but it pales in comparison to the impact of the achieved commodity price each year.
Investment View
We are increasingly concerned about the fixation on replacing fossil fuel usage with green hydrogen, both within the company’s existing operations and as a standalone business. In the quarterly result commentary, Executive Chairman Dr Andrew Forrest (he owns 36.7% of FMG) said: “Business as usual is over… The acceleration of the energy transition for the resources industry requires subsidies for green energy globally. This will be a core message we take to COP27 next month to help other companies to join us.”
Without trivialising FMG’s efforts to reduce its Scope 1 and 2 emissions to net zero by 2030, the company only produced 2.55mt of CO2e emissions in FY22. Qantas produces around 12.5mt CO2e emissions in a normal year (pre-COVID) while RIO produced 3mt CO2e emissions from its iron ore operations in CY21.
In FY23, FMG is expecting to account for US$500-600 million of expenditure at Fortescue Future Industries (FFI) with another US$230 million of capex. This is in-line with the stated goal of allocating 10% of FMG profits to FFI each year.
FFI has a catalogue of projects around the world in various states of agreement that amount to broad numbers far in excess of the company’s ability to fund them all. Dr Forrest insists these projects will be meaningfully positive for shareholders, but amidst a blizzard of hyperbole and enthusiasm, shareholders have yet to see any detailed plans, financial and commercial, to substantiate the rhetoric.
The 23.6% fall in FMG’s share price so far this year is primarily a reflection of falling iron ore prices. If shareholders truly believed in the green hydrogen strategy espoused by FMG, perhaps it would be higher. It suggests to us there is a good deal of scepticism about the message.
Dr Seuss wrote the clever ‘Green Eggs and Ham’ where the subject character rejects the unappealing dish until eventually convinced to try it and discovering it is delicious. Unlike Dr Seuss’s wonderful work of fiction, we doubt Dr Forrest can serve up a green hydrogen non-fiction equivalent dish.
Risks To Investment View
FMG’s earnings are highly sensitive to the iron ore price. Any changes to demand, production, transportation or saleability of FMG’s production would be negative for earnings. The funding of FFI projects presents a major risk to earnings given the expected size and scale of the project list. Green hydrogen may not be cost effective as initially thought.
Recommendation
We have retained our Hold recommendation.
