Fortescue FMG fiscal 2025 first-quarter iron ore shipments are solid, and guidance is reiterated. Shipments of 47 million metric tons are up 3% on a year ago, but 12% down on the prior quarter. Hematite unit cash costs of USD 20 per metric ton rose 12% on last year due to a higher strip ratio and inflation.

Why it matters: The first quarter is broadly in line with our expectations, and we make no change to our sales volumes and earnings forecasts. We still expect Fortescue's share of iron ore sales volumes to modestly increase, by 2%, to around 195 million metric tons in fiscal 2025. Average hematite prices of USD 83 per metric ton are a 17% discount to the 62% benchmark price. This discount is driven by its generally lower grade ore of around 57%-58% iron content. While the discount is 4% greater than a year ago, it is similar to the prior quarter and our expectations. First-quarter unit cash costs are 5% higher than our unchanged forecast for about USD 19 per metric ton—excluding Iron Bridge. But we expect unit costs to reduce over the rest of fiscal 2025 as the strip ratio normalizes to 1.8, down from 2.0 in the first quarter.

The bottom line: We keep our $15.30 per share fair value estimate for no-moat Fortescue. Higher near-term iron ore prices driven by optimism over increased steel demand from China stimulus are likely the main driver of the shares trading at a 25% premium to fair value.

Long view: Driven by 69%-owned Iron Bridge ramping up to full production, likely in fiscal 2026 or 2027, we expect the miner's share of iron ore sales to rise to about 210 million metric tons in fiscal 2028. This will likely modestly increase average iron ore grades, to between 58% and 59%, though this is still materially lower than grades at its larger competitors no-moat Vale, BHP, and Rio. We expect earnings to decline by 19% per year on average to midcycle in fiscal 2029, from fiscal 2024, driven by lower iron ore prices and greater discounts received on hematite ore sales.

Business strategy and outlook

Fortescue is the world's fourth-largest iron ore exporter. Margins are well below industry leaders BHP and Rio Tinto, and some way behind Vale, meaning Fortescue sits in the highest half of the cost curve. This is a primary driver of our no-moat rating. Lower margins primarily result from price discounts from selling a lower-grade (57% to 58% iron) product compared with the 62% iron ore benchmark.

The lower grade is effectively a cost for customers through a greater proportion of waste to transport and process, additional energy/coal per unit of steel and lower blast furnace productivity. This results in a lower realized price versus the benchmark. In the 10 years ended June 2024, the company realized an approximate 23% discount versus the 62% benchmark.

Fortescue increased production rapidly thanks to favorable iron ore prices, aggressive expansion, and historically low interest rates. Expansion from 55 million metric tons of capacity in fiscal 2012 to around 190 million metric tons by 2023 was unprecedented. It built much of its capacity around the China boom peak and baked in a higher capital base than peers. This means returns are likely to lag the industry leaders who benefited from building significant capacity when the capital cost per unit of output was lower.

Fortescue has done an admirable job of reducing cash costs materially versus peers. However, product discounts remain a competitive disadvantage. The addition of about 22 million metric tons a year of iron ore production from the 69%-owned Iron Bridge joint venture allows Fortescue blending options. Iron Bridge grades are much higher, around 67%, meaning Fortescue could blend most of its iron ore to increase its average grade to between 58% and 59%.

Fortescue is a China fixed-asset investment play, with practically all of the company's iron ore sold there. In the long term, we see demand for steel in China declining as the country's stock of infrastructure matures and with the rate of urbanization past its peak.

The company’s strategy is to transform into a diversified iron ore and clean energy company. Its green energy initiatives are at an early stage, but it has big ambitions in the space.

Fortescue bulls say

  • Fortescue provides strong leverage to the Chinese economy. If growth in steel consumption remains strong, it's also likely iron ore prices and volumes will, too.
  • Fortescue is the largest pure-play iron ore company in the world and offers strong leverage to emerging world growth.
  • When steel industry margins contract, it's likely that product discounts narrow significantly relative to historical averages, reducing Fortescue’s competitive disadvantage relative to the majors.

Fortescue bears say

  • We think that ultimately Chinese fixed-asset investment will slow, and future iron ore volume growth and prices are likely to be much less favorable.
  • Margins are significantly lower than those of diversified peers BHP, Rio Tinto, and Vale, and this could see Fortescue’s margins fall much more than peers if iron ore prices fall.
  • Fortescue produces an inferior, lower-iron-grade product, which attracts a discount to the benchmark 62% iron ore fines price. Lower-grade reserves mean this discount is likely to persist.

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