All together now, buy FMG!

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It’s no secret that most sell-side analysts see Fortescue Metals as a buy. In fact, at my last count it 5 buys, 7 over-weights, 5 neutrals and two sells from Deutsche and Goldman Sachs.

JP Morgan is out today recommending buying on current weakness:

sdfs

We remain bullish on FMG, and view the recent pull back in share price as an attractive entry point. While recent Chinese steel / iron ore data points have been underwhelming, we continue to believe the balance of risks point to the upside for FMG on a 6-12 month view. In this report, we review the OW case for the stock and reiterate our recommendation.

  • 11 reasons we like the stock: 1) cheap valuation: ~30% potential upside to DCF, 4x/5x FY15/16E PE, and low US$90/t implied iron ore price, 2) recent fall in cash costs, 3) lower breakeven price, 4) strong EBITDA margins, 5) going ex-growth capex, 6) strong FCF yield, 7) balance sheetimprovement, 8) potential for higher dividends, 9) de-risking of production as expansions are completed over the next 1-2 months, 10) debottlenecking opportunities, and 11) long mine lives with resource upside.
  • Our house forecasts remain 7.4% GDP growth and 5% steel production growth in China over 2014, which is supportive of iron ore markets in our view (US$125/t in CY14 / US$110/t in 2015).

With respect, where is the evidence for this very bullish steel forecast? It’s all going the opposite way right now.

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I’m a big fan of Andrew Forrest and it saddens me to say it, but FMG is at risk of being the swing producer in the great iron ore reckoning. Yes, there are more expensive mines in China and elsewhere but the lesson of the coal shakeouts is that other jurisdictions do not react rationally to price pressures. They protect, cajole, manipulate, cost-out and hang on. That means that the first major producer on the supply curve ends up being roughly where the price settles during the shakeout.

As well as that, Mr Forrest has a giant competitor breathing down his neck in Gina Rinehart’s Roy Hill, which also does not appear likely to respond to market price signals.

Whether I end up being right about these things is really besides the point. They are unquestionably major risks in play and the sell side should not be ignoring them.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.