Is FMG worth $18.50 per share?

FMG share price remains elevated, though off all-time highs

The Fortescue Metals Group (FMG) share price has struggled over the last month – falling around 18% from the high it recorded in late August – trading at $16.11 per share as of 12:11 PM.

In spite of that recent share price weakness, enthusiasm around the stock has remained high, after FMG delivered a record set of FY20 production results in August. Here the miner reported record shipments, higher earnings and profits, as well as an impressive $1.00 final dividend – bringing the company’s full year payout to $1.76 per share.

Ultimately, elevated iron ore prices over the last year has seen both Fortescue’s free cash flow and revenues surge, with the market’s confidence in the miner seemingly growing in step. For example, in FY20 FMG saw its average realised price reach US$79 per dry metric tonne, ahead of the average 62% CFR Index.

We unpack FMG's FY20 results in more detail here.

The analyst view: FMG dividend outlook

With FMG’s above-market dividend yield and buoyant iron ore prices – FMG’s impressive YTD run-up, which has seen the stock surge nearly 50% – should come as little surprise to investors. What remains less certain however is the miner’s future – with many doubting that iron ore prices can remain elevated over the long-term.

Tellingly, of the 17 analysts covering the stock, 4 rate FMG a Buy, 9 a Hold and 4 a Sell – equating to a consensus rating of Hold, according to the Wall Street Journal.

Analysts from Morgan Stanley, for example, though recently upgrading their base-case iron ore forecasts, downgraded FMG to Underweight, saying:

‘A higher-for-longer iron ore price scenario is our new base case, driven by a slower unwinding of current tightness through 2021. However, some miners [such as FMG] have run ahead of these expectations, implying high iron ore prices.’

By comparison, UBS took a diametrically opposed view, this week upgrading FMG from Neutral to Buy and reiterating their $18.50 price target on the pure play miner.

Centrally, UBS analysts noted that global steel production has begun to recover, which should assist with both coal and iron ore demand. Moreover, while the investment bank noted that there may be a slowdown in Chinese iron demand across December and February, it was flagged that leading indicators 'point to ongoing strength in underlying/seasonally adjusted steel demand.'

As a result of this, the investment bank’s view on Chinese steel demand has become more optimistic, a view driven by the:

‘Continuation of credit easing and China's heavier reliance on domestic investment for GDP growth with property, infrastructure and automotive sectors remaining key pillars for China's economic growth.'

Looking forward, as a result of still-elevated iron ore prices, UBS analysts argued that at an 80% payout ratio, FMG should be able to support a AUD$2.05 per share dividend in FY21 and a AUD$1.31 per share dividend in FY22 – implying significantly above-market dividend yields of 13% and 8%, respectively.

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