Why the booming Fortescue still offers value

Elizabeth Gaines has been acknowledged for guiding Fortescue Metals Group through a bumper 12 months, but there is still a lot to come for investors, according to analysts.

Dec 10, 2020 – 12.00am

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When Fortune magazine this week named Fortescue Metals Group chief executive Elizabeth Gaines No. 5 in its list of the top 20 business people of the year, it noted FMG's 137 per cent total return over the past 12 months.

Gaines was ranked in Fortune's global list just behind Netflix CEO Reed Hastings, and two spots ahead of Amazon founder Jeff Bezos at No. 7.

Elizabeth Gaines is running one of the highest yielding stocks in the market. David Rowe

FMG had a higher gross profit margin (55 per cent) over the past 12 months than either Netflix (39 per cent) or Amazon (40 per cent), according to S&P Global Market Intelligence.

Also, FMG's return on equity in 2020 was 40 per cent, compared with 32.6 per cent at Netflix and 25 per cent at Amazon.

But for many Australian investors, the single most important aspect of FMG's performance has been the payment of a market-leading dividend yield.

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FMGFortescue Metals Group

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Dec 19Jun 20Dec 208.00016.00024.000

Updated: Dec 10, 2020 – 7.54am. Data is 20 mins delayed.

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Gaines confirmed during an investor day on Wednesday that FMG would stick with its dividend payout range of between 50 and 80 per cent of net profit after tax, despite some hefty capital expenditure commitments over the next few years as it expands the Eliwana and Iron Bridge projects.

Despite the soaring FMG share price – it has doubled since the COVID-19 lows in March – the dividend yield remains one of the highest in the market based on consensus broker dividend forecasts.

Dividend yield

FMG is tipped to pay out $2.34 a share in dividends in 2020 and $1.63 a share in 2022, according to consensus numbers published by FNArena. This points to a 2021 dividend yield of about 10.7 per cent for those who buy the stock now.

This does not include the 100 per cent franking attached to the dividend to cover tax already paid by the company.

After 17 years in the business, FMG is a well-oiled machine with an industry-leading cost of production, consistently improved safety performance and a proven commitment to Indigenous employment.

It has managed to avoid the sort of damaging cultural disaster that Rio Tinto brought upon itself. Gaines said on Wednesday she did not want to see a regulatory overreaction to what happened at Rio.

The Rio incident was proof that mining companies must take the licence to operate extremely seriously.

The highlight of the FMG investor day was the commentary about China from director of sales and marketing Danny Goeman, who focused on the declining iron ore stockpile in that country.

Goeman said that because of several factors, including strong demand from steel mills and downgrading of supply from Vale in Brazil, the stockpile was likely to fall below 100 million tonnes in the first quarter of 2021. This would be the lowest level in 4½ years.

Conspiracy theory

This blows away the conspiracy theory that Chanticleer heard floating around last month that China was building its inventories as a precursor to harming Australia's iron ore miners.

The opposite appears to be true. There seems to be no medium-term decline in China's demand for iron ore.

The outlook for the broader Chinese economy is strong, according to forecasts published on Wednesday by Japanese broker Nomura. It is forecasting real GDP growth in 2021 of 9 per cent.

This is well above the market consensus for 2021 of 7.9 per cent. But Nomura says China's economy will surprise on the upside, thanks to higher investments and consumption.

The broker is tipping a "normalisation" in China's government stimulus and a truce in the US-China trade war.

"US-China relations may be more predictable and less disruptive under the incoming Biden presidency, as career diplomats that favour a systematic and multilateral approach to China will return," Nomura's economists said.

"Biden’s team may even look for opportunities to work constructively with China on some issues, including climate change and public health."

This week, Goldman Sachs lifted its near-term iron ore price forecasts by about 30 per cent to $US120 a tonne for 2021 and $95 a tonne for 2022 following revised supply/demand balances.

It increased its fiscal 2021 earnings forecast for FMG by 35 per cent and its fiscal 2022 earnings by 71 per cent. It also stepped up its share price target by 18 per cent to $20, but kept a "neutral" rating on the stock.

FMG forecasts increased demand of 170 million tonnes in iron ore in 2021 from global steel mills, which consumed 1.8 billion tonnes this year. It will have about $US3.4 billion in capex in 2021, including $US1 billion in sustaining and development capital.

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This week, the company marked the first ore put through the ore processing facility at the Eliwana mine and rail project in Western Australia, which has a 30-tonne capacity and 143 kilometres of rail in the final stages of construction.

The project that has analysts worried, judging from questions during the investor day, is Fortescue Future Industries, which is developing its renewable energy business.

Gaines reassured analysts that FMG would not abandon its disciplined approach to capital investment. Its conservatism was evident in the use of a separate subsidiary accessing debt through non-recourse project financing.

She said a lot more work had to be done before the company would make a decision on the project.

It is doubtful Gaines can repeat the 2020 performance in the next 12 months. But all the signs are pointing to solid earnings growth and market-leading dividend payments, as the world's most efficient iron ore miner rides China's economic recovery.