FMG share price: Is the stock overvalued at $20.15?

Keep reading to discover:

• FMG’s recent share price performance
• Chinese iron ore trade data
• The rationale behind the Goldman Sach Sell thesis

FMG share price ↑

Fortescue Metals Group (ticker: FMG) has been one of the best performing large-caps on the ASX over the last year. In that period, the pure play miner is up about 75%.

Key Point: With the stock trading around the $20 handle, the company boasts a market capitalisation in excess of $60 billion. That makes it the 8th largest publicly listed company in Australia.

Despite that, in the last three months the stock has failed to gain much traction.

Over the last three months the stock is down 18%, over the last 1 month its down 5%, and over the last five days it has dropped 1.32%. FMG opened at $20.15 per share on Wednesday and remained in the red for the entirety of the session.

This all comes as equities have generally trended higher over the last year and iron ore prices remain at multi-year highs.

Let's take a quick look at some key trade data.

For the week ending April 9, iron ore inventory at Chinese ports fell 0.32% to 124.69 million tonnes. Steel inventories fell by an even greater degree, dropping 6.09% to 22.18 million tonnes.

As inventories fall, futures markets continue to trade at elevated levels. CME’s front month, 62% iron ore futures contract last traded at US$171.04 per tonne. Further out, futures contracts remain above $100 per tonne until September 2023.

The following is from the MMi's Daily Iron Ore Index Report, dated April 13:

‘Arrivals of iron ore at port continued to rise, while shipments that departed Australian and Brazilian port decreased sharply month on month. As the profits of steel mills continued to expand, the demand for mainstream medium and high-quality ore improved, while spot inventories at port also showed a downward trend, which still supported the spot prices of imported iron ore.’

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Goldman View

Getting back to FMG in particular, with iron ore prices still high and the stock itself trading at multi-year highs, one is left wondering if the company is overvalued.

Goldman Sachs thinks the answer is yes. The investment bank this week slapped a Sell rating (from Neutral) on FMG and lowered their price target to $18.9 per share (down from $20.4 per share).

What was their rationale?

Macro View: Centrally, Goldman has a negative view on the outlook for iron ore, arguing that the expectation is for the: ‘Market to enter a surplus in 2H21 on higher Brazilian exports and see the price falling back to US$110/t by 4Q even with a 4-5% increase in global steel production, and to below US$100/t in 2022.’

The investment bank also believes that China’s recent push to curb emissions within its steel industry will be a negative for lower grade producers, such as FMG.

More specifically, the Sell thesis has a few components:

Valuation: Based on its net asset value (NAV), FMG trades at a pronounced premium to its large-cap counterparts RIO and BHP: 1.4x NAV compared to 0.95x NAV, respectively.

Besides that, the price realisations from FMG’s lower grade products, timing risks (associated with the Iron Bridge project) and potential capital expenditure issues.

There was a pretty important qualification to this rating however, with it being noted:

‘With our view that FMG will report a strong March and June Q production report and a record final dividend in August with the FY22 results, our Sell rating is predicated on our thesis playing out in the Dec H.’

Revisiting FMG’s interim results

Bearishness aside, FMG continues to be a beacon of operational excellence, with the miner saying that shipments, earnings and operating cashflow where higher during the last half than at any other point in the company’s history.

Overall, for that half, FMG reported underlying earnings (EBITDA) of US$6.6 billion (+57%) and an EBITDA margin of 71%, for the half ending 31 December 2020.

This translated into net profits of US$4.1 billion. The miner paid out 80% of its net profits in dividends, reporting an interim dividend of AUD$1.47 per share.

From an operational standpoint, FMG mined 108.4 million wet metric tonnes of ore during the half, shipped 90.7 million wet metric tonnes, and achieved a realised price of US$114.02 per dry metric tonne. C1 costs came in at USD$12.78 per wet metric tonne during the half.

Positively, Fortescue upgraded its full-year production guidance as part of these results, saying it now expected full-year shipments to come in at 178-182 million tonnes. FY21 cost guidance was also raised, while CAPEX is now expected in the upper ending of the US$3.0-3.4 billion range.

The miner also recently closed a US$1.5 billion high yield bond offering, as FMG continues to tout the flexibility of its balance sheet. FMG had net debt of just US$110 million by the close of the December half, against cash on hand of US$4.0 billion.