Data Insights

Fortescue is the most oversold stock on the ASX 200 – Where does it go from here?

Tue 18 Jun 24, 3:46pm (AEST)
A train of ore carts extending into the horizon in an Australian setting
Source: iStock

Key Points

  • Fortescue shares are down almost 20% since late May, trading at oversold levels not seen since China's Evergrande crisis in 2021
  • Fortescue is down another 5.5% on Tuesday after a major shareholder offloaded $1.1 billion at a 6% discount
  • Fortescue's forward returns from extreme oversold levels tend to be positive but its transition to green energy may significantly alter its identity

Fortescue (ASX: FMG) is in the midst of an incredible losing streak, down 15 of the last 18 sessions and falling almost 20% since late May.

The selloff intensified on Tuesday after a large fund manager offloaded a $1.1 billion stake at a fixed price-trade of $21.60 per share - a 6% discount to Monday's close, the AFR reported.

This losing streak has dragged the stock's relative strength index (RSI) to 20.9 – a level of weakness for FMG only comparable to China's Evergrande collapse in 2021, the onset of the 2020 pandemic and a trough in iron ore prices in 2018.

This begs the question – Should you take a punt at such extremely oversold levels?

Historic Returns from Oversold Levels

Since 2008, Fortescue has recorded 88 instances of trading at an RSI of less than 28 – this number is chosen as it represents two standard deviations from the average. In other words, you rarely see Fortescue this oversold.

Most occurrences are centred around periods when iron ore prices experience a dramatic and sustained selloff. To smooth out the data, we consider only the first instance in each month when the RSI is below 28.

This leaves us with 26 instances and here are the averages and forward returns.

Source: Market Index

At a glance, the forward returns are relatively mixed over the one, three and six-month periods. While the averages improve significantly over time, major bounce-backs tend to offset the high frequency of negative returns.

For example, here's the breakdown for forward six-month returns:

  • Negative: 40% of the time, down an average -15.6%

  • Positive: 60% of the time, up an average 51.1%

There are many ways to look at this data so here's another perspective. Trading at an RSI of 20.5 is extremely rare. What do forward returns look like when Fortescue trades at such at RSI of less than 21?

Since 2008, there have only been eight instances. Interestingly, forward returns become quite compelling after the first month.

Source: Market Index

Five of the eight instances have come from China's Evergrande crisis in 2021. During this time, iron ore prices crashed almost 60%, from US$215 a tonne in July 2021, to lows of US$90 a tonne by mid-September 2021.

The one-year forward returns from this sits at just 4.2% and positive only 60% of the time. This is because iron ore experienced a sizeable bounce back, up to US$170 a tonne by March 2022 and an equally dramatic pullback to US$75 a tonne in October 2022.

Long-term returns appear compelling but ...

Fortescue was once a simple business – they dug stuff out of the ground at a low cost, shipped it and paid out market-leading dividends. But Fortescue's commitment to the green transition will dramatically change the company moving forward.

I had a look at some of Citi's modelling for Fortescue (dated 26 April 2024) and here are some of the data points that stand out:

  • Dividend payout ratio was 80%/75%/66% in FY21/FY22/FY23. This is forecast to fall to 65% in FY24 and 60% in FY25-26

  • Return on equity is forecast to fall from 58% in FY21 to 32%/25%/18% in FY24/FY25/FY26

  • Free cash flow yield was 15.7%/6.5%/8.8% in FY21/FY22/FY23. This is forecast to fall to 9.2%/5.4%/2.3% in FY24/FY25/FY26

Comparing historic forward returns could prove challenging if the underlying business is undergoing significant changes.

The other factor to consider is the world's largest consumer of iron ore – China.

China's home prices fell at a faster pace in May, with new-home prices in 70 cities down 0.71% month-on-month in April. This marks the largest decline since October 2014. The value of existing homes also fell 1.0%, the sharpest decline since at least 2011 when China started collecting the data.

2024-06-18 15 14 49-China Home Prices Slump Despite More Property Market Stimulus - Bloomberg
Source: Bloomberg

The bottom line – Fortescue is currently in deep oversold territory and due for a technical bounce. Forward-looking returns from such extreme oversold levels are generally positive, particularly over the 12 and 24-month periods. However, we might be dealing with a very different Fortescue moving forward. Could this be why the big fund decided to offload $1.1 billion at a discount?

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Written By

Kerry Sun

Content Strategist

Kerry holds a Bachelor of Commerce from Monash University. He is an avid swing trader, focused on technical set ups and breakouts. Outside of writing and trading, Kerry is a big UFC fan, loves poker and training Muay Thai. Connect via LinkedIn or email.

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