Fortescue's selloff is overdone and a 6% yield still up for grabs

Fortescue (ASX: FMG) has plunged nearly 20% since its February half-year result, trading near levels not seen since October 2022. However, UBS says the recent selloff and underperformance vs. peers like BHP and Rio Tinto is overdone.

The decline first began with a disappointing half-year FY25 result, where net profit of $1.55 billion missed market forecasts by 8% due to higher shipping costs, royalties, forex losses, and depreciation. Its interim dividend of 50 cents per share also fell short of the expected 54 cents, despite a steady payout ratio.

Fortescue has lagged behind peers BHP and Rio Tinto in recent months, with UBS pointing to fears of Chinese steel production cuts as the culprit. These could widen discounts on Fortescue’s low-grade iron ore. Historically, discounts spiked during events like China’s 2021 Carbon Neutrality-driven cuts or the 2017-18 "War on Pollution," which slashed steel output, tightened spreads, and pushed mills to favor high-grade ore.

Fortescue (blue) vs. Rio Tinto (red) and BHP (orange) | Source: TradingView

Charting the Discount Trends

A decade-long view shows 58% iron ore trading at narrower discounts today against the 62% benchmark, reflecting tight steel spreads in China. UBS notes speculation of a 50-million-tonne steel cut in 2025, but doubts its likelihood. Still, any reduction could deepen iron ore discounts and widen steel spreads, depending on implementation.

UBS argues the market’s reaction is excessive. While expecting supply to outpace demand and create medium-term surpluses, they forecast iron ore prices to remain resilient:

• US$100 a tonne in 2025

• US$95 in 2026,

• US$90 in 2027

They also view low-grade discount fears as overblown, nudging their discount estimate to 16% (from 15%, vs. ~14% spot and ~18% consensus) to reflect potential steel cuts. This adjustment trimmed their target price to $16.70 (from $17.30), still offering a 5.7% upside from Friday’s $15.79 close, prompting a rating upgrade from Sell to Neutral.

Source: UBS

Earnings and Dividend Outlook

For FY25, UBS predicts a tough year, with Fortescue’s earnings dropping 45% from $5.6 billion to $3.0 billion and net debt ballooning nearly fourfold to $2.3 billion. Yet, they expect dividends to hold at 98 cents per share, delivering a solid 6.2% yield.