Messy Fortescue Result Offers Little Clarity

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

By Chris Shaw

Fortescue Metals ((FMG)) yesterday announced its earnings and the most common response from stockbrokers covering the stock was the result was a messy one. JP Morgan notes the headline figure of a profit of US$508 million included a positive revaluation of the Leucadia subordinated note along with changes to accounting definitions and re-statements of earnings in previous periods.

As a result, the broker has decided to focus on normalised earnings, which on its calculation came in at a loss of US$320 million compared to its forecast of a loss of around US$187 million. The biggest disappointment in its view was higher unit costs, as the broker notes underlying revenues actually came in relatively close to its forecasts.

JP Morgan also notes the company suffered an average discount to benchmark prices of around 20% through FY09 and it has chosen to carry this forward in its numbers to reflect the company’s issues with moisture and aluminium content in its ore.

The result sees the broker make significant changes to its forecasts, cutting its FY10 earnings forecast in earnings per share (EPS) terms by 56%, while its later year estimates have been cut by 30-38%. The messy nature of the result sees the broker point out it is almost meaningless to compare the result to past years or to pre-result expectations.

Brokers forecasts also reflect this, as profit expectations for FY10 for example range from around US$153 million for JP Morgan to as much as $450 million for UBS, the wide range indicating there is little confidence with respect to the company’s earnings outlook.

Citi agrees the result was a messy one, but it saw signs of cost improvement, though this was offset by lower than expected prices and freight losses. On Citi’s numbers realised prices are more likely to be around benchmark at US$50 per tonne than spot prices of closer to US$100 per tonne, though it notes the company is not providing much in the way of clarity with respect to pricing of sales to China.

Regardless, the broker doesn’t see great value in the stock at current levels as it suggests the share price is implying an expansion of output to 95 million tonnes per year and a long-term iron ore price of US$70 per tonne. Given this, there is no change to Citi’s Sell rating, which matches the Underweight recommendation of JP Morgan.

UBS is similarly negative and has a Sell rating, taking the view the share price is factoring in an expansion to above nameplate capacity of 55 million tonnes annually or better pricing. While the company enjoys good leverage to rising iron ore prices, the broker simply doesn’t see enough upside at curent levels.

GSJB Were argues while the company is well placed by virtue of its operations being in the Pilbara region, it is hard to get too positive when the accounts are dificult to reconcile, debt levels remain high and production is still in the ramp-up stage. As well, the broker notes the company is forced to discount prices when market conditions are more difficult, something it expects will continue and which shows the weaker position of the company compared to the iron ore majors such as BHP Billiton ((BHP)) and Rio Tinto ((RIO)). Given these issues, the broker rates the stock as Hold.

While not all brokers to cover the stock have put out notes post the earnings result, the FNArena database currently shows one Hold and six Sell ratings, with an average price target of $2.63, little changed from $2.62 prior to the result announcement.

Shares in Fortescue today are weaker and as at 1.10pm the stock was down 14c or 3.4% at $4.02. This compares to a trading range over the past year of $1.16 to $8.20.

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