Production is humming at Fortescue, but some cost headwinds and lower realised prices bring some reality to the story. China’s steel output is lower so far this year but could readily turn if the government wills it. FMG has developed a fixation with hydrogen that is consuming increasing amounts of profits. FMG delivered a punchy 49.5mt in 4Q22 which pushed FY22 production to 189.1mt, comfortably above the 180-185mt guidance range. The company is pointing to production of 187-192mt for FY23f which includes a first contribution of about 1mt from the Iron Bridge magnetite operation which will eventually produce 22mtpa of high grade 67% Fe magnetite iron ore. Average C1 costs for FY22 came in at US$15.91/wmt as diesel, labour and other consumable costs pushed higher. FMG sees C1 costs in FY23f in a range of US$18.00-US$18.75/wmt. While costs are rising, they are significantly lower than 10 years ago (US$48.45/wmt) and steadily reduced to a low point in FY18 at US$12.39/wmt. Capex remains an item worth monitoring as the Iron Bridge project progresses. The full cost of Iron Bridge has nudged up to US$3.6-3.8 billion (FMG share is US$2.7-2.9 billion), with US$849 million (FMG share) spent in FY22. FMG’s total capex spend in FY22 was US$3.1 billion, not including the US$148 million capex at FFI (Fortescue Future Industries). FMG’s anticipated capex in FY23f is US$2.7-3.1 billion (ex FFI capex at US$100 million). FMG’s balance sheet remains in a strong position with net debt as at 30 June US$900 million (gross debt US$6.1 billion, cash US$5.2 billion).
Investment View
The iron ore story is unequivocally positive for FMG. The operating and development profile has its warts, but the output is still financially attractive for shareholders. Our Hold recommendation incorporates a view of rising costs and more modest prices, noting that FMG’s discount to the benchmark index price has again widened. We continue to keep a wary eye on activities at FFI. The Executive Chairman’s holy grail of producing 15mt of hydrogen by 2030 has spawned a porridge of projects as far flung as the militia-stricken DRC to Indonesia, Ethiopia, Kenya, Brazil and Australia. FFI’s financial plans, targets and return on investment remain a mystery, but the costs to FMG are real enough. In FY22, FMG spent US$534 million of which US$384 million was expensed. Worryingly for shareholders, FMG’s capital framework allows for up to 10% of FMG profits to be utilised by FFI and the company noted it underspent its FY22 allocation by US$728 million. FY23’s budget so far allocates US$600-700 million to FFI with US$500-600 million of this as operating expenditure.
In the 1931 movie, Dr Frankenstein proclaimed of his monster, “It’s alive!”. What next for FFI’s quest to dominate world renewable energy utilising green hydrogen?
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.
Recommendation
We have retained our Hold recommendation.
Figure 1: Iron Ore Price Factor
Figure 2: Iron Ore Benchmark Price
