Lower iron ore prices and a bigger average price discount have eaten into Fortescue’s interim profit compared to the lofty outcome last year. Full year guidance is unchanged but higher costs are beginning to niggle.
FMG’s 1H22 EBITDA of US$4,762 million was down 28% compared to last year. A combination of lower average realised prices and higher C1 production costs conspired to turn last year’s wizardry into this year’s muggle-like result.
FMG’s average realised price of US$96/dmt was just 70% of the average Platts 62% CFR Index of US$136/dmt. That 30% discount was much higher than the 10% discount in 1H21 and reflects the lower quality mix of product being shipped to China.
At the same time, FMG’s dream run of consistently lower C1 costs has abruptly ended with a 20% increase to US$15.28/wmt. Higher diesel and labour costs are mostly to blame.
FMG’s iron ore production remains on target for 180-185mt this financial year as the Eliwana project adds to the mix.
FMG’s balance sheet remains very efficient with net debt of US$1.7 billion as at 31 December 2021. Cashflow is becoming the more interesting aspect to monitor as capex heads towards a range of US$3.0-3.4 billion in FY22f (US$1.49 billion in 1H22). Up to US$1.4 billion is being spent at the problematic Iron Bridge magnetite project and a relatively minor US$100-200 million at Fortescue Future Industries (FFI).
FFI is consuming up to 10% of FMG annual net profit going forward (US$400-600 million expensed in FY22f) on a range of green energy projects and technology. For now, all it has to show is a grab bag of potential long-dated projects that could involve some disturbingly high price tags with no discussion on likely return on investment. A layman’s term for this might be a ‘sink hole’ but FMG is becoming evangelically determined to pursue its green agenda.
Investment view
Iron ore prices have fluctuated throughout the last 12 months but are gradually on the rise again as Chinese crude steel production regains momentum. China represents nearly 90% of FMG’s revenue and is therefore closely aligned with that country’s steel production.
Higher production costs are an industry factor, but this still takes some of the edge off the earnings outcome.
The on-going experiment at FFI does give cause for concern, particularly due to the lack of discussion on investment goals and parameters. It does not sit well with us that the increasing scale of investment in FFI could place a millstone around FMG’s earnings.
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.
