Fortescue Metals' stock price and its results are almost negatively correlated.
There is a strong correlation between Fortescue Metals' stock price and the price of iron ore.
There is a good correlation between the price of iron ore and Chinese industrial production year over year.
Fortescue Metals Group Limited (OTCQX:FSUGY) is an Australian company that was incorporated in 2003 and is one of the major worldwide producers of iron ore. Fortescue's land holdings are located throughout the resource-rich Pilbara region of western Australia. Its customers are almost entirely Asian, primarily Chinese.
Its operational sites are as follows: Firetail and Kings (in the Solomon area), Cloudbreak and Christmas Creek (in the Chichester area) and Herb Elliott Port, while the Iron Bridge site is under construction. The company has also locally developed rail and sea port transport facilities.
I believe this company is quite interesting at this point. Let's start with the main financial ratios: The current P/E ratio (ttm) stands below 2. Just to give you an idea of what this means, assuming earnings remain unchanged (although this is quite an unrealistic hypothesis) for the next two years and the company offers a dividend payout of 100% (also unrealistic), one could entirely cover their investment into this company in the same length of time (two years).
The P/S and P/B ratios are equal to 0.4 and 0.7, respectively, compared with an average ratio of 1 and 1.1, respectively, for the main sector leaders (Vale, Rio Tinto, BHP Billiton, Glencore, and Anglo American).
Based on said ratios, Fortescue therefore looks undervalued.
If we look at the revenue growth of the company during the last five years (ending June 2014), the historic revenue CAGR is 38.2%. A similar path has been followed by net income (five-year CAGR = 47.2%) and the current dividend yield is as high as 8.7%. The company started to pay dividends only four years ago.
The overall indebtedness has been reduced consistently in the financial year ending June 2014, with a debt/equity ratio reaching 1.3 from 2.4 a year earlier. Total equity has further improved as well.
The exceptional outstanding performance of Fortescue financial results, at least during the last four years, is almost negatively correlated with the market performance of its stocks, down almost 68% during the same period. (click to enlarge)
To fully understand its performance, a comparison between Fortescue's stock price and the price of iron ore is also needed.
There is indeed a strong correlation (not far from one in the period from July 1999 to December 2014) between them; this means that when the iron ore price declines or increases, it seems as if the same thing happens to the stock price. (click to enlarge)
According to the latest release of the Word Bank's "Commodity Markets Outlook" quarterly report, iron ore is expected to decline the most in 2015 (-22%) and the key risk for metals prices is a sharp slowdown in the Chinese economy (referred to as a low-probability scenario at present).
Nevertheless, the World Bank forecasts point to a steady increase in iron ore prices for the next 10 years, as shown in the graph above.
The existing correlation between iron ore prices and Chinese industrial production year over year (the change in the total inflation-adjusted value of output produced by mines, manufacturers, and utilities) was computed by me and a rather high positive correlation resulted (0.5).
This means that to gain a sense of what is going to happen with iron ore prices in the forthcoming months, the stress must be placed on how Chinese industrial production will eventually evolve. (click to enlarge)
In my view, iron ore prices have just bottomed up at around 63.30 $/dmtu (as of Jan. 27, 2015), a level seen only before 2005. A rebound may soon happen as for the Chinese economy as a whole.
The company is expected to report its half yearly 2015 results on Feb. 17, 2015. On Jan. 29, 2015, the company disclosed its December 2014 quarter production report, whose main outcomes were the following:
Costs (US$28.48/wmt on average) have improved over the prior quarter, reflecting operational efficiencies, a lower Australian dollar, and lower fuel prices (12% of C1 costs); debt repayments have progressed during the quarter (redemption of US$500M) with consequential interest savings; and capital expenditure guidance for FY 2015 has been reduced to US$650 million from US$1.3 billion.
In addition, according to the company report, it had undertaken an impairment review as of Dec. 31, 2014, which confirmed recoverability of all of its assets at or above the underlying book values.
Based on my DCF analysis performed on 2014 full-year financial results (FY ending June 30, 2014), I found the company to be quite undervalued.
To re-assess the impact of iron ore price on company's results, I will wait until mid-February when the new figures will be released.
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