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Fortescue’s Decarbonisation Plan To Impact Dividends

ESG Focus | Sep 26 2022

This story features FORTESCUE LIMITED. For more info SHARE ANALYSIS: FMG

Brokers focus upon the dividend impact from Fortescue Metals decarbonisation strategy and crave more detail.

-Fortescue Metals reveals a roadmap to decarbonisation
-Brokers feel more questions have been raised than answered
-Will costs be funded from cash flow or debt?
-Forecasts are lowered for the dividend payout ratio
-Potential lift for the company’s ESG profile

By Mark Woodruff

For some time, brokers have been probing Fortescue Metals ((FMG)) for more colour around its decarbonisation ambitions. 

While some details were provided last Thursday, brokers generally thought more questions were raised than answered, while future capital allocation has now come into focus.

The company revealed first time guidance on costs to eliminate fossil fuel use and achieve zero scope 1 and 2 emissions targets by 2030 for its iron ore operation in the Pilbara.

The roadmap to achieve these targets includes the use of green power sources, battery/hydrogen trucks and trains powered by renewable energy. Electric and hydrogen drill rigs and excavators will also be used.

Management’s capital expenditure estimate of US$6.2bn represents the incremental spend over and above existing planned sustaining and fleet replacement capex. This spend is expected to provide significant environmental and economic returns by 2030.

Those returns include net operating cost savings of US$818m per year from 2030, calculated at prevailing market prices for diesel, gas and Australian Carbon Credit Units.

The investment includes the deployment of an additional 2-3 GW of renewable energy generation and battery storage, and incremental costs associated with a green mining fleet and locomotives.

The company has not specified whether funding will come from cash flow or debt. If the dividend is reduced by lower cash flows, Underweight-rated Morgan Stanley (target $15.15) estimates the absolute dividends for FY23-25 will fall to US89/47/20cps from US105/80/59cps.

The analyst also has concerns over the additional 2-3GW of renewable capacity that is required. Based on approximate figures for solar and wind, the broker estimates costs in the range of US$4.7bn-US$7.1bn, compared with company guidance for US$4.6bn.

Only three of the seven brokers that are updated daily in the FNArena database have refreshed research for Fortescue’s new detail on decarbonisation. 

However, some changes to forecasts may be afoot as Morgans points out consensus (unlike Morgans) doesn't appear to have allowed for decarbonisation capex.

As it stands, the average target price set by brokers in the database is $16.55, in line with the current share price.

Dividend payout ratio

Underperform-rated Macquarie also mentions funding requirements for both decarbonisation and Fortescue Future Industries (FFI) could compete with shareholder returns.

The company’s dividend policy is to pay out 50-80% of net profit after tax and the implied payout ratio in FY22 was 75%, which aligns with the historical payout ratio over the last five years.

Macquarie now sees a headwind for that dividend payout ratio and lowers its payout assumptions to 60% in the medium term. The broker’s 12-month target price falls by -1% to $14.30.

Goldman Sachs, not one of the seven brokers updated daily in the FNArena database, also believes Fortescue is at an inflection point on capital allocation. To fund the decarbonisation strategy, it’s assumed the dividend payout ratio will fall to around 50% from FY24 onwards.

The broker retains its Sell rating and $12.10 target price.

Broker criticism 

Hold-rated Shaw and Partners, also not one of the seven, supports the company’s decarbonisation drive though wishes for more near and medium-term detail from management to support the long-term targets.

The broker retains its $17.00 target price though tables a long list of unanswered questions including a lack of documentation to show potential government support from the EU or any other government. In addition, the cost per KWhr for any technologies used was not disclosed.

If decarbonisation is executed successfully, Morgans (Hold) acknowledges sustainable and material opex savings will occur and vastly lift Fortescue’s ESG profile. 

However, the analyst remains critical of the company’s trailblazing and aggressive push, which will restrict the company’s free cash flow profile and increase dependence on the iron ore price.

Morgans feels the need for world-leading energy and technological innovation is not playing to the company’s strengths in bulk mining.

After adjusting capex forecasts and increasing iron ore price forecasts, the broker lifts its target to $17.30 from $17.20.

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