Fortescue shares sink 9% on massive block trade – should you buy the dip?

Fortescue (ASX: FMG) shares are caught in a downward spiral as major institutional investors seek to exit the stock amid a range of issues including weak iron ore prices, cost management challenges and costly renewable energy ambitions.

On Tuesday morning, a significant $1.85 billion block trade crossed at $18.55 per share. The Financial Review reported that fund managers were seeking buyers within a range of $18.55 to $19.10 per share, representing an 8.8% to 6.1% discount to Monday's closing price. The fact that the block trade occurred at the floor price suggests weak demand for Fortescue shares.

Fortescue's stock opened at $18.53 on Tuesday, down 8.9% to its lowest level since November 2022. Over the past six months, the stock has declined by 37%.

FMG's 1-yr Price Chart. Source: Market Index

Block after block

A block trade is an agreement between two parties to sell a large volume of shares at a set price. This latest block trade is particularly noteworthy when compared to a previous selldown on Tuesday, June 18, as today's trade was almost double the size of the earlier $1.1 billion transaction and came at a steeper discount. The June trade had a fixed 6% discount at $21.60 per share.

The market's reaction to these trades has also shifted. Following the June 18 trade, Fortescue shares opened 2.7% lower at $22.35 and closed 5.2% down at $21.79, with the selldown impact becoming apparent only after the market opened. In contrast, today's trade was immediately priced in, reflecting heightened investor caution.

Value or trap?

Fortescue FY22 vs. FY24: While Fortescue's share price hasn't been this low since November 2022, investors should exercise caution before viewing this as a buying opportunity. From a fundamental perspective, the company's financials were stronger in FY22 compared to Macquarie's FY24 estimates.

Here are some FY22 vs. FY24e comparisons:

• Revenue: US$17.4bn vs. US$18.1bn

• EBITDA: US$10.5bn vs. US$10.2bn

• Reported NPAT: US$6.19bn vs. US$5.73bn

• Dividend yield: 10.3% vs. 8.9%

The latest quarterly (25-Jul): Macquarie says Fortescue achieved what they thought was impossible – A last minute sprint to hit its FY24 guidance following a derailment incident last December. The company reported full-year shipments of 191.6 million tonnes, just shy of its 192 million tonne guidance. The quarterly contained mostly negative takeaways, including:

• FY25 capex guidance of US$3.7 billion to US$4.3 billion is 14% above consensus expectations of US$3.5 billion

• FY25 shipment guidance of 190-200Mt was 2% below consensus expectations

• C1 cost for Pilbara Hematite of US$18.50 to US$19.75/wmt was 5% above consensus

• FY25 Iron Bridge production of 7.5Mt is 12% below consensus expectations of 8.5Mt

Earnings forecasts: "Whilst management spoke of a lean focus and 700 jobs were cut across the business, under our price forecasts, Fortescue's minimum 50% pay-out ratio comes under pressure. To sustain the dividend policy, we believe Fortescue may need to increase gearing," Macquarie said in a note last week.

The analysts downgraded the company's FY25 and FY26 earnings assumptions by 7% and 5% respectively to reflect the weaker-than-expected guidance and lower iron ore price assumptions.

Macquarie retained an Underperform rating for Fortescue, with a $14.25 target price.

Closing thoughts

Fortescue was once a simple business – it dug stuff out of the ground at low costs, shipped it and paid out market-leading dividends to shareholders. The company is now experiencing what some might call an existential crisis.

Fortescue has historically traded at a 20% multiple discount to iron ore peers BHP and Rio Tinto, according to Macquarie. Over the past five years, the company managed to narrow this valuation gap, largely due to its commitment to renewable energy and green hydrogen projects. However, the recent shift away from green hydrogen could potentially reopen this valuation disparity, pushing it back towards historical levels.

FMG's Multiple Gap. Source: Macquarie Research July 2024

While the energy sector transformation is a significant factor, it's not the only challenge Fortescue faces. Goldman Sachs maintains a Sell rating on Fortescue, citing several concerns unrelated to the company's energy business:

• Relative valuation vs. peers: Fortescue currently trades at 1.3 times NAV, compared to BHP and Rio Tinto, both at 0.9 times.

• Low grade iron ore: Analysts anticipate widening price differentials for low-grade 58% Fe iron ore. This is due to increasing supply from low-grade projects such as MinRes' Ashburton and high coking coal prices.

• Execution risks: There are concerns about the company's Iron Bridge project, particularly regarding water availability and the performance of key processing equipment.

The last thing to note is the all-important iron ore price, which is down almost 30% since January and not far off November 2022 levels.

Singapore iron ore price chart (Source: TradingView)