Brokers remain acutely bearish on Fortescue despite “strong” result

Fortescue (ASX: FMG) has become a staple in many investors' portfolios over the past few years, driven by its impressive dividend yield in the post-pandemic era. This period saw a surge in iron ore prices, granting Fortescue, along with BHP Group and RIO Tinto, a short-lived era of extraordinary profits.

By late 2021, Fortescue’s dividend yield was just shy of 20% p.a.

Since then, the iron ore price has more than halved from its all-time peak of US$233/tonne. Despite this, Fortescue’s shares are trading above the price it attained at its dividend zenith, largely helped by a 50% surge from its September 2023 lows to peak just under $30 in January.

Fortescue has performed well despite the iron ore price more than halving from its post-pandemic peak

Fortescue’s dividend yield is back to a still respectable 7.4% (fully franked), and its stock price appears to be consolidating. With Fortescue reporting first-half FY24 results last week, now is the perfect time to check up on how the big brokers view Fortescue’s outlook and value proposition. Let’s begin with a quick recap of those results.

Fortescue H1 FY24 results

Key numbers

• 1H FY24 underlying EBITDA/NPAT of US$5.9B/US$3.3B (Consensus US$5.6B/US$3.3B)

• Net debt US$569M (Consensus US$640M)

• Free Cash Flow (FCF) US$2.7B (Consensus US$2.57B)

• Dividend A$1.08 (65% payout) (Consensus A$1.04)

Key takeaways

• Iron Bridge update: Work underway to replace 65km of high-pressure water pipeline to de-risk and improve performance. Scheduled completion mid-2025, not expected to materially impact Iron Bridge ramp-up

• December rail derailment issues resolved, facilitates some production catch-up in the second half

• 2 green hydrogen projects approved in H1 (including Phoenix Hydrogen Hub, USA), with Holmaneset green ammonia (Norway) and Pecem green hydrogen (Brazil) likely to be approved in H2

• Decarbonisation spend will accelerate in H2

Guidance

• Shipments guidance (192-197Mt) (i.e., no change), includes: 2–4mt for Iron Bridge

• C1 cost US$18.00–$19.00/wmt.

• Metals capex of US$2.8B–$3.2B.

• Energy capex and investments of US$500M, net operating expenditure around US$800M

Broker response

If I could sum up the big broker’s responses in one sentence, it would be: “Good result, but not good value in the stock”.

UBS Rating: SELL; Price Target increased to $24.10 from $24.60

“FMG delivered a strong and clean result in 1H-FY24, but with iron ore prices to ease lower and capex stepping up, FCF falls FY25/FY26E and we remain Sell rated.”

Citi Rating SELL; Price Target increased to $24 from $23

“Modest earnings upgrades in FY24/25…We raise our TP from A$23 to A$24 and stay Sell rated on valuation grounds”

Macquarie: Rating UNDERPERFORM; Price Target $18.50

“FMG is trading on modest free cash flow yields (by its own standards) of 5-8%. With uncertainty over FFI capital, we retain our Underperform rating.”

Goldman Sachs: Rating SELL; Price Target $19.60 from $19.80

“We continue to rate FMG a Sell on: 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: Rating UNDERWEIGHT; Price Target $18.80

“Earnings largely in-line. Dividend beat. Risks to Downside: Increased capex guidance at FMG's Iron Bridge or Pilbara Energy connect projects. Weaker-than-expected price realisation for FMG's product mix”

Bell Potter: Rating SELL; Price Target $21.51 from $21.39

“While we have recently upgraded our iron ore price forecast, we still see low growth in global steel demand and a deteriorating pricing environment. Dividend yield as a price support is coming back into play but we retain our Sell recommendation.”

Consensus

Taking into account the responses from brokers, Fortescue's consensus rating has been categorised as "Sell/Underperform/Underweight", with an average price target of $21.09. This represents a slight decrease of 0.6% from the average target set before the first half of FY24 results, and a significant 23% discount compared to the stock's trading price at the time of writing, which stands at $27.21.

Whether the big brokers love it or hate it, so far, Fortescue has delivered investors a combination of share price gains and a solid fully franked dividend yield. It’s defied broker expectations for at least the last 12-months, so why should anything change now?

*Consensus View rating is calculated by assigning a value of 1 to any rating better than neutral, 0 to a neutral rating, and -1 to any rating worse than neutral. The average of the numerical ratings is calculated and a value of 0.5 or greater is considered a consensus BUY/OUTPERFORM/OVERWEIGHT rating, a value of less than -0.5 is considered a consensus SELL/UNDERPERFORM/UNDERWEIGHT rating, and a value in between is considered a consensus NEUTRAL/HOLD/EQUAL-WEIGHT rating.