Materials, IPO & Equity Analyst

Venkat Ramana Nandyal

Equity Bottom-Up

<a href="https://www.smartkarma.com/entities/41" target="_blank" data-smartkarma-citation="entities:41:1">Fortescue Metals Group Ltd (FMG AU)</a>  has been reducing its net debt position thus providing flexibility for the management to pursue expansion, new exploration and capital return to shareholders. Although 62% iron ore fines index continues to oscillate between US$60-US$70/t range, management must be cautious as headwinds persist whilst China continues to reduce its inefficient steel capacity.Investment Thesis<ol class=""><li>Margins have been improving as the company managed to reduce its C1 cash cost to US$11-12/t, whilst iron ore prices hover between US$60-US$70/t range</li><li>Improvements in margins have provided management with flexibility to focus on improving the balance sheet. We expect the net debt/EBITDA to be below 1x.</li><li>The management has announced that it will return 50% to 80% of its earnings to shareholders, indicating that there are no major projects worth investing in the near term.</li><li>The stock is trading at FY18 P/E multiple of ~8x and EV/EBITDA of 4x well below its peers (14x and 6x respectively) and its long-term mean of 12x and 6x respectively. Based on these comparable and long-term means, we believe the stock could be priced between A$6-7.5/share.</li><li>Consensus FY18 dividend yield is expected to be 7% resulting in a total base case expected returns of &gt;20%.</li><li>Although iron ore benchmark prices have been holding steady at US$70/t, a slowdown in China and drop in demand for seaborne iron ore could significantly impact FMG’s earnings.  </li></ol>

Fortescue Metals Group Ltd (FMG AU)  has been reducing its net debt position thus providing flexibility for the management to pursue expansion, new exploration and capital return to shareholders. Although 62% iron ore fines index continues to oscillate between US$60-US$70/t range, management must be cautious as headwinds persist whilst China continues to reduce its inefficient steel capacity.Investment ThesisMargins have been improving as the company managed to reduce its C1 cash cost to US$11-12/t, whilst iron ore prices hover between US$60-US$70/t rangeImprovements in margins have provided management with flexibility to focus on improving the balance sheet. We expect the net debt/EBITDA to be below 1x.The management has announced that it will return 50% to 80% of its earnings to shareholders, indicating that there are no major projects worth investing in the near term.The stock is trading at FY18 P/E multiple of ~8x and EV/EBITDA of 4x well below its peers (14x and 6x respectively) and its long-term mean of 12x and 6x respectively. Based on these comparable and long-term means, we believe the stock could be priced between A$6-7.5/share.Consensus FY18 dividend yield is expected to be 7% resulting in a total base case expected returns of &gt;20%.Although iron ore benchmark prices have been holding steady at US$70/t, a slowdown in China and drop in demand for seaborne iron ore could significantly impact FMG’s earnings.  

FMG: Strong Balance Sheet Provides Flexibility for Capital Returns; Stock Mispriced