Questions For Fortescue After FY Result

This story features FORTESCUE LIMITED, and other companies. For more info SHARE ANALYSIS: FMG

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Chris Shaw

Fortescue Metals Group ((FMG)) has reported a loss of $2.5 billion for FY08, but before investors panic, broker GSJB Were points out the number is based on a revaluation of Leucedia royalties, which is based on future revenue assumptions. Taking this out, the company reported an operating profit of $72 million, an outcome slightly below the broker’s number, but likely due to slightly lower grades or some donated ore following the Chinese earthquake of a few months ago.

As well, the broker points out the result was only on initial tonnage of 1.66 million, which is not really enough to form an accurate view of earnings performance given the company plans to expand output to 80 million tonnes per year by 2009. This expansion is to be financed from internal cash flows, but the broker sees achieving this output level as a challenge and expects the company to be producing at only 75 million tonnes annually in 2010.

Citi points out the revised production expansion is lower than previous targets, but this can be explained by additional debt covenants on the company in relation to the bonds it has issued in the US. On the plus side, the broker notes reserves at Cloud Break and Christmas Creek have increased by 54% to 1.625bn tonnes over the year, which is enough for a mine life of 20 years at an output of 80 million tonnes annually.

Macquarie regards the decision to slow the rate of expansion as a prudent one given the current economic climate, though it does result in the broker lowering its earnings estimates for the company by 9% in FY09 and by 21% in FY10.

This leaves it forecasting earnings per share (EPS) of 41.6c in FY09 and 83.9c in FY10, while Citi is at 29.8c in FY09 and 90.0c in FY10 and GSJB Were is forecasting EPS of 62.7c and 100.7c respectively. With such an earnings outlook and given the recent share price correction, Macquarie sees enough value to upgrade its rating to Neutral, which matches Citi but falls short of the Buy recommendation of GSJB Were.

One reason Macquarie is more cautious is because it believes the market is presently unwilling to give full value to future growth options, while it also is factoring in some risk in the company’s expansion program going forward. As a result, the broker estimates the risk/reward ratio is more favourable in the global diversified miners, while for those seeking iron ore exposure specifically it prefers Mt Gibson ((MGX)).

GSJB Were counters by arguing the company is ideally placed to supply China and while it notes the production expansion program makes it higher risk than its peers, the broker suggests if management can deliver shareholders will enjoy the rewards.

Overall, the FNArena database shows three Hold ratings (JP Morgan is the other) and GSJB Were at Buy, with an average price target of $9.49, down slightly from $9.67 prior to the profit result. It is worthy of note the GSJB Were target is well above the rest of the market at $12.27, so taking this out would give an average price target of a little more than $8.50.

Today, shares in Fortescue are weaker in line with the broader market and as at 11.00am the stock was down 41c or just under 6% at $6.74.

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