Can Fortescue shares defy broker expectations?

Fortescue is arguably one of the bellwethers of Australia’s mining industry. Recent half-year results has seen the miner deliver excellent results — but increasing potential capex costs and weakness in the iron ore market may be creating a difficult environment going forward.

For context, Fortescue shares have risen by more than 300% over the past five years to $26.21, but have corrected from a peak of $29.88 at the end of January. Where next?

Fortescue shares: half-year results

In the six months to 31 December 2023, iron ore shipments hit 94.6 million tonnes — the second highest in company history. Accordingly, underlying EBITDA rose by 36% compared to H123, while underlying EBITA margin rose to 62%.

Net profit after tax hit US$3.3 billion, while EPS rose by 41% to US$1.08. Consequentially, net cash flow from operating activities came in at US$4.2 billion, leaving free cash flow of US$2.7 billion after capital expenditure and investments. And the company delivered a fully franked AU$1.08 interim dividend, 44% higher than the dividend paid out from the same period a year ago.

And encouragingly in this higher rate environment, net debt stands at only US$600 million, inclusive of Fortescue’s cash balance of US$4.7 billion.

Operationally, the company hailed multiple positive developments in the half. It announced a Final Investment Decision on the Phoenix Hydrogen Hub in the USA alongside the Gladstone PEM50 Project in Australia. And it announced a Green Iron trial commercial plant in the Pilbara. These investments come to US$700 million of spending.

In its decarbonisation efforts, the ASX miner launched green energy investment accelerator Fortescue Capital, while also deploying its first electric hail truck and also the first operational electric excavator in the Pilbara region.

CEO Dino Otranto enthuses that ‘Fortescue’s performance in the first half of FY24 has been excellent, with the team achieving our second highest first half shipments while maintaining our strong focus on safety and keeping our costs low… we remain committed to creating value for all our stakeholders.’

Where next for Fortescue shares?

Importantly, previous guidance for full-year shipments, costs and capital expenditure remains in line with previous expectations. But despite the excellent numbers, multiple brokers remain bearish on Fortescue.

Goldman Sachs rates the stock a sell, with a price target of between $19.60 and $19.80. It notes three reasons for this rating:

‘1. Relative valuation: the stock is trading at a premium to RIO & BHP on our estimates.
2. Widening of low grade 58% Fe product realisations over the medium to long term.
3. Execution and ramp-up risks on the Iron Bridge project and Gabon iron ore over FY24 & FY25.’

Morgan Stanley notes that while earnings were roughly in line with expectations with a dividend beat, downside risks include ‘Increased capex guidance at FMG's Iron Bridge or Pilbara Energy connect projects. Weaker-than-expected price realisation for FMG's product mix.’

There are similar bearish attitudes at UBS, Citi, Macquarie and Bell Potter — with price targets ranging from $18.50 to $24.60. Three common threads run through their comments: the likelihood of falling iron ore prices, increasing capex estimates, and the difficulty in properly valuing the company’s burgeoning green business.

For context, Fortescue’s dividend hit nearly 20% in late 2021 — at a time when iron ore was trading at a record US$233/tonne. Iron ore has since halved in price, and yet Fortescue shares are changing hands for more than at this dividend peak, driven by a huge surge over the past few months.

But while Fortescue shares may appear to be overvalued, near record shipments and rocketing underlying EBITDA could continue to see share price strength in the mid-term.

Past performance is not an indicator of future returns.

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