Fortescue: Quo Vadis The Dividend?

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A long-time source of income for investors, Fortescue’s challenges are leading to warnings from brokers the miner’s dividend yield is on the decline.

-Fortescue’s earnings result weaker than feared
-Policy uncertainty leads to a rethink on green investment
-Higher spending on iron ore; Iron Bridge delayed
-Dividend miss, with ongoing declines forecast

By Greg Peel

Australia’s number three iron ore producer and green energy aspirant Fortescue ((FMG)) reported first half FY25 revenue down -20% year on year, earnings down -39% and profit down -54%. An interim dividend of 50c was declared, while net gearing increased to 10% from 2% over the period.

Analysts were expecting weak numbers, but key metrics were still on the disappointing side. The 50c dividend fell short of a 57c consensus forecast. The implied earnings payout ratio of 65% was in line with expectation, but earnings were lower than forecast.

Earnings were impacted by higher shipping costs, royalties and D&A cost, on top of adverse forex movements. The earnings margin of 47% is the lowest reported by Fortescue since FY18.

Bridge too Far?

The good news is no major damage across Fortescue’s Pilbara iron ore assets despite a very active cyclone season. The miner shipped a record 97.1mt of iron ore in the half, up 3% year on year. It was a solid operational performance, Bell Potter declares, but H1 also reflected a tougher environment of higher costs and a lower iron ore price.

FY25 shipping guidance is unchanged at 190-200mt, including 5-9mt from problem child Iron Bridge (near Port Hedland). The Iron Bridge ramp-up has been for some time a matter of frustration.

Iron Bridge continued to ramp up in the half and is on track to achieve FY25 shipment guidance and cash operating expenditure excluding shipping and royalites of approximately US$500m.

However, the schedule for operating at nameplate capacity of 22mt per annum is under review, with an assessment underway to optimise the performance of the air classification circuit and downstream aerobelt conveyor. This assessment is anticipated to be completed in the June quarter.

The history of bringing Iron Bridge into production amounts to a long list of delays. Initially, this project was expected to ramp up full production by late 2023-mid-2024. UBS, for one, now assumes the June quarter FY26.

Management assured that in its opinion the ramp-up of Iron Bridge to nameplate was not a matter of “if” but “when”. Heavy rainfall was flagged as an impediment at the site but the ramp-up is flagged to be according to management’s expectation.

It’s Not Easy Being Green

Donald Trump’s return to the White House and his dismantling of green programs means Fortescue will review the projects under development in its nascent clean energy division. The Trump administration has paused grant payments under the former Biden administration’s Inflation Reduction Act, and is unashamedly pro-fossil, anti-green.

The upcoming Australian election is another source of policy uncertainty. A Dutton government will (presumably) focus on nuclear at the expense of renewables/green energy.

Fortescue will subsequently review its previous timelines for its green hydrogen facilities in Arizona and Gladstone (Queensland) and no further investment will be made at this time.

The company’s decarbonisation push nevertheless continues, with planning and approvals for solar/wind and battery storage projects ongoing, but will be “rephased”, leading to a reduction in capex to -US$500m from a prior -US$700-900m.

To date, Fortescue has introduced battery EV/fuel cell haul trucks, four electric excavators, and 6MW of charging points.

Andrew Forrest’s green aspirations have long been lauded by the climate-conscious but questioned by analysts on a pragmatic, stock valuation basis. Investment in unproven future-facing projects can only drag on Fortescue iron ore cash machine and subsequent returns to shareholders.

For some time, Macquarie has been sceptical of the company’s hydrogen and green-ammonia plans given the energy losses in conversion. Hence, management’s language supporting discipline is welcomed by the broker. Fortescue will trim its FY25 green capex guidance to -US$400m from -US$500m.

In terms of Jarden’s broader thesis – and whether the pursuit of Real Zero might need moderating to manage the balance sheet under base case assumptions, the broker views the decision to reduce capex guidance for the Energy division as potentially more telling than the -US$100m reduction itself.

At least in terms of the Energy division, Jarden was quietly left to consider that the overall pursuit of green energy solutions has not tempered, but the timelines may stretch.

Guidance Juggle

Fortescue’s FY25 capex guidance is unchanged, other than a tightening in range to US$3.9-4.2bn from a prior US$3.7-4.3bn. This despite an implied -US$300-500m reduction in green hydrogen/decarbonisation spending.

The gains are offset by increasing spending for Fortescue Metals (iron ore).

There remains the balance of HME fleet (heavy mobile equipment Tonka trucks) replacement, power generation, typical stay-in-business (sustaining) capex, and new mine development (Mindy South).

Spending also covers the inclusion of the recent Red Hawk Mining (WA) acquisition (-US$160m).

Jarden argues Fortescue’s otherwise arguably pristine balance sheet in recent times will be the subject of increasing interrogation as the capex calls ramp up over the remainder of the decade.

Which leads us to…

Capital Management

Fortescue has for many years been an attractive source of yield for investors seeking income. Can that last?

Ord Minnett highlights even though the number three iron ore producer will need to borrow to support its dividend payout policy of 50-80% of net profit, given free cash flow of circa US$660m was insufficient to fund the US$1bn interim payout, Fortescue’s balance sheet is robust enough to do this without any concerns.

Ord Minnett retains a Buy rating.

The maintenance of a good dividend distribution is a positive, however Bell Potter continues to forecast this to decline. Reduced capex on decarbonisation and Fortescue Energy projects may nevertheless potentially free up cash flow for dividends, and available dividend support helps keep Bell Potter on Hold.

Core iron ore operations are maintaining a steady performance, but the only real tailwind for Fortescue at the moment is a low exchange rate, Bell Potter believes. The iron ore price, Iron Bridge production and Fortescue Energy projects all have a subdued outlook.

Fortescue continues to base its US dollar guidance numbers on an assumed exchange rate of US68c. Recently the Aussie has been trading around US64c, having taken a trip below US62c.

Fortescue’s interim dividend of 50c missed consensus by -7%, which, importantly to Macquarie, given the company’s emerging retail shareholder base, was -46% lower half on half. The yield represented 5.2% annualised.

The result disappointed on earnings which flowed through to the dividend, Macquarie notes. The result may cast doubt for income-focussed investors on the sustainability of Fortescue’s dividend. Macquarie is on Underperform.

The relatively soft profit result meant the interim dividend was relatively disappointing, which would explain a weak share price performance on the result release, but Jarden suggests the intraday reaction possibly relates more to extrapolation of this disappointment.

Jarden’s core forecast for backwardated iron ore prices, combined with a rising capex profile, results in forecast yields diminishing to less than 4% in FY26-27 and to 1.6% for the remainder of the decade.

The consensus benchmark pricing outlook appears hopeful of further Chinese stimulus, Jarden suggests. This broker remains more circumspect as to what can be implemented to reverse waning demand for steel and its inputs, particularly when, in Rio Tinto’s ((RIO)) Simandou alone, supply does not look to be an issue. Price realisation through FY25 to date, combined with recent movements in dry bulk rates, seems supportive of this view, Jarden notes.

Jarden has an Underweight rating.

Goldman Sachs anticipates a widening of low-grade 58% Fe product realisations over the medium to long term due to expectations of increasing supply of low-grade iron ore from other projects, high coking coal prices, a normalisation and higher steel mill margins, and the global sector’s focus on decarbonisation and preference for higher grade iron ore.

Goldman notes Fortescue is trading at a premium to both Rio Tinto and BHP Group ((BHP)) on its estimates. The stock continues to trade at more than a 10% premium to Rio and BHP on an enterprise value to earnings basis, and at a more than 30% premium on a price to net asset valuation basis, despite being less diversified and having a lower margin and a lower free cash flow per tonne iron ore business.

Goldman Sachs has a Sell rating.

UBS’ Sell rating reflects the broker’s cautious iron ore outlook, resultant weaker earnings to free cash flow at a time of robust capex, and hence risk to returns.

First-look updates from both Citi and Morgan Stanley have those brokers retaining their Neutral (Citi) and Equal-weight (Morgan Stanely) ratings. Late-comer Morgans has equally retained its Hold rating.

Among the seven brokers monitored daily by FNArena there is one Buy or equivalent rating, against four Neutral/Holds and two Sells.

The consensus target among those brokers has fallen to $18.36 from $18.48, on a wide range from $15.00 (Macquarie) to $21.00 (Ord Minnett).

Jarden and Goldman Sachs also have Sell or equivalent ratings. Jarden’s target has fallen to $17.08 from $17.24, and Goldman’s drops -1% to $16.20.

Barrenjoey and RBC Capital have both sided with Ord Minnett, rating the stock Overweight-Outperform alongside a $21 price target.

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