Another Initiation, Another Sell on Fortescue

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 Greg Peel

Shares in iron ore darling Fortescue Metals ((FMG)) have rocketed from $1 less than two years ago (in capital adjusted terms) to around $8 today. Like most stocks, there was a blip in January, but talk of potential 65% increase in seaborne iron ore contract prices has helped push the cowboy (I mean that in the nicest way) miner to new highs.

Fortescue is yet to sell one rock, but plans are running on or ahead of schedule to have that first rock tied with a ribbon and placed gently on a boat at Port Hedland by at least May. Fortescue plans to follow that one up with another 45-55Mtpa of the stuff and then onto 100Mtpa in 2012 or maybe even as much as 200Mtpa. The price Fortescue will get for its precious cargo will depend on whether BHP Billiton ((BHP)) and Rio Tinto ((RIO)) can face off with the Chinese and secure a 65% rise just like the Brazilians have. Realistically, they’d be pushing for 100% as Aussie iron ore has been fetching a discount to Brazil on a longstanding arrangement now being challenged.

It’s  a long way to Port Hedland from Fortescue’s mines out in the Pilbara, and so a railway line is still under construction, although progressing nicely. It won’t be finished by May, and so the last leg of delivery will be by truck. Indeed, the company needs to get some cash flow going so it can pay for its railway and any other railway lines it may yet be forced to build, not to mention finance the expansion of its mines.

Fortescue’s legendary CEO Twiggy Forest is trying to make BHP give up time on its own private line by taking the miner to court. Rio is another option. As BHP is already building a second, adjacent line (to allow simultaneous up and back) because it can’t get it’s own iron ore out to market fast enough, let alone anyone else’s, then it seems like a tough case to win. But if the government goes all socialist BHP can still set a price for using the line(s) which may yet make building one look cheap.

And building railway lines out in the boondocks is, at present, anything other than cheap. Rose Porteous politely asked Rio for a price not long ago and then decided to build her own line instead. By now, Rio Tinto is her major partner and shareholder.

So like every other commodity, getting the goods to market is the big challenge. Not just in Australia, but in the world. And there is the same problem at the other end. Not every factory in Asia is next to a port. That’s the supply-side reason why iron ore prices have gone through the roof. If everyone could get their iron ore to market quickly and easily, as they hope to do, the price would come down accordingly unless demand for steel just kept on growing exponentially forever.

Twiggy has been delighting his shareholders by constantly upgrading Fortescue’s iron ore reserves. But then as one WA resource analysts put it, the Pilbara is made of iron ore. The challenge is not to find it, the challenge is to profit from it.

This hasn’t stopped the share price from continually rising however, and as such it hasn’t stopped more brokers initiating coverage of the stock with a Sell. Citi became the latest this morning, having set a $7.00 price target (last trade $7.80). That brings the B/H/S ratio in the FNArena database to 0/1/3 with an average target of $5.92. That’s right – Citi’s target is at the high end.

GSJB Were (Hold) wins with $7.60, as the analysts are looking at the grandiose wider picture of Fortescue’s globally significant iron ore assets. But JP Morgan (Underweight) has set a more sobering $5.00 and Macquarie a rather depressing $4.07.

Citi, like its colleagues, suggests the current price is making no allowances for risk in both construction and ultimately production. Moreover, Fortescue’s extraction method applies unproven technology (Fortescue’s ore is of a lower grade than its compatriots’). Citi’s Sell comes despite the analysts arguing they are probably the biggest iron ore bulls in the market at present, predicting another 30% rise in prices next year on top of this one.

Six out of ten brokers/researchers in the FNArena base are yet to find Fortescue worthy of their attention.

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