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A breakout for FMG?

It’s a breakout. Not an orange suited prisoner, barbed wired, bullets whizzing, breakout. But a share price breakout trumpeting further paradigm portfolio investment shifts.

Yield hunt is the leash straining, point sniffer dog. And criss cross spotlight pinpointing is on Fortescue Metals (FMG). 

FMG busted through previous highs, almost at $14 and possibly has a target price with a 2 in front.

Price Is driven by growing investor realization that most bank dividends are being scuppered or suspended. And resources are the only salvation, meantime, to fill the income void.

Banks are looking down a barrel of unprecedented Covid losses estimated as much as $30 billion.

Collectively $5 billion of provisioning has only been made so far. So cashless may take on a new meaning for bank shareholders.

China relies on Australia for 60% of its iron ore supply, and with Brazilian ore exports down 12%, suggests the Platts ore price (the industry price benchmark), is likely to remain north of $80 a tonne for most of this year and possibly next. 

China can pivot towards South Africa and Brazil for alternate supplies, but meantime Chinese port ore stocks are declining. And with an economic stimulus package due from the PROC in the next week, the market is furiously reworking forward revenue and profit figures for the big three local miners. 

There is growing concern that Brazil will have to go into lockdown due to COVID-19 escalation and it takes 40-45 days for exports from Brazil to arrive in China versus 12 days from Australia.

While there is much diplomatic finger pointing, pragmatic Chinese steel mills know the Australian nameplates are the only consistent ore supply source they have for the foreseeable future.  

FMG in my opinion has the alpha dividend investors want. Dividend payout ratio is 50-80% of NPAT, and with two months left this financial year, and iron ore prices tracking towards $100 a tonne, a full year dividend payout, dependent on the final, could be anything between $1.60 and $1.80 a share.

December’s half yearly payout was 76 cents a share. At these prices still a healthy forecast 11% yield. Last year’s payout ratio was 78% and with a relatively low debt to equity ratio there is little need for FMG to keep excess cash on the balance sheet.  The forecast price earnings is less than 6 times.

Which suggests to me there is plenty of price upside still to come.

While it pays not to get too far ahead of the curve it’s a fair bet FMG‘s next financial year could be a similar run to this. Looking down the rabbit hole, FMG’s return on equity is approaching 40%. And that underscores the disciplined operations FMG CEO Elizabeth Gaines is running.

Ore production this year is set to be a record of 175-177 million tonnes shipped – at reduced Platts discounts reflecting FMG’s ore blending operations. And that scenario sees FMG sweating the assets just as hard in 2021 to get C1 costs down further from around $13 a wet metric tonne. Average waste to ore strip ratio of 1.5 which could be considered a little on the high side with improvements to be made. 

FMG has deferred capex by some $300 million, but this is an industry wide phenomenon and generally is considered prudent. 

We are continuing to back our call of the past two years of switching banks to resources. And the doppler effect of that claxon is all the more louder because of headwinds facing the banks. Those of you who heeded our suggestions, happiness is the resource wind in your sails.

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