From Goldies:
Solid result, costs to be sustained at sub-US$15/t
The result posted by FMG’s management today is a solid one, which reflects the strong operational performance of FMG. The company continues to do a good job in controlling controllables, in our view & its war on iron ore costs continues with guidance of US$12- 13/wmt for FY17E. The improvement in processing is a positive and highlights the ability of FMG to continue to beneficiate lower grade ore and maintain the low strip ratios. As such, we believe that the low mining costs remain sustainable at the sub-US$15/t for the foreseeable future.
Revisiting our Sell case
Ytd, FMG’s share price has performed exceptionally well (+158% ytd), outperforming the ASX200 (+4.1% ytd) & the ASX300 Metals & Mining index (+36.5% ytd). Concurrently, the level of short interest in the stock has also fallen from as high as 9.1% (on 22 January) vs 2.5% as at 16th August close (Source: ASIC). Whilst we believe that the increase in its share price is partly a reflection of (i) the better macro outlook for the iron ore markets in the short term, driven by China’s credit-led stimulus; (ii) cost-out initiatives carried out by FMG and (iii) the sustained strength in the CFR China Iron Ore price (+43% ytd), longer term we do not believe that this is sustainable. Ultimately, we believe the continued cost reduction iron ore majors are able to extract will drive prices lower. With weakening global demand for steel, and thus iron ore, we do not believe that it is a macro market where producers can keep the extra margin they extract by lowering costs. The cost out drive is a key component of our commodity teams’ view of iron ore moving to US$35/t over the next 12 months.
Why is our target price 60% below today’s close?
On spot Fe & FX, FMG’s NPV would be c.6.6x higher vs GSe at A$11.57, reflecting the more immediate pay down of its debt as a result of the extra free cash flow generated from sustained strength in the iron ore prices. However, our view of US$35/t iron ore environment erodes any value we see in the shares at current prices. As such we maintain our Sell recommendation.
Like MB, been wrong this year so far. But the analysis is right longer term.
