ords view of io and fmg. relate this to ago?

Fortescue Metals Group Ltd
Recommendation: Accumulate
Risk: Higher
Previous: Lighten
FMG.AX
Valuation compelling
$3.81
Price Target: $4.70
Previous: $4.95
Research 27 March 2013

Fortescue Metals Group share price bounced over 80% from its low in September 2012, but has since retreated around 30% from its February 2013 highs. This compares to a 14% drop in the iron ore price since the February 2013 highs. In recent years, FMG's share price has been highly correlated with the iron ore price, but the recent disconnect highlights it has potentially been oversold based on fears of a collapse in iron ore. Our view is that further weakness in the iron ore price will not last for an extended period.

At $3.81 per share, the stock has 23% potential upside to our net present value(based on a US$80/t long run iron ore price). Near-term price/earnings multiples are around 6.6x in the 2014 full year, and 5.9x in the 2015 full year, which doesn’t look stretched, in our view. Finally, the stock is implying US$92/t iron ore and parity AUD to perpetuity from today, which looks overly bearish to us.

While we acknowledge the risk that further sentiment-driven iron ore price weakness in the near term could be a headwind for the stock, we believe the market will start focusing more on the compelling valuation support that has emerged.

Further, we note the stock has already overshot on the downside vs iron ore. Upgrade to Accumulate. Based on underperformance relative to iron ore, and what are now compelling valuation metrics, we upgrade our recommendation to Accumulate. We also note in the past six months, the company has de-risked operationally as the Solomon rail spur, Firetail mine and Christmas Creek expansion has come on-stream. Finally, the sell down of a minority stake in the company’s port and rail infrastructure has the potential to provide a cash injection to significantly improve FMG's capital structure, without a material valuation impact (assuming favourable terms). Ord Minnett investment thesis - Significant valuation upside. With a number of operations coming on stream, risks for Fortescue have receded. The sale of port and rail infrastructure would provide additional cash injection.