Under the Spotlight AUS: Fortescue (FMG)

Fortescue ($FMG) chairman Andrew Forrest recently went into apocalyptic mode and warned the Pilbara region risked becoming a ‘wasteland.’ 

It was a stunning statement from the Rich Lister whose $12.68b fortune is built on iron ore mined from the industry’s heartland in northern WA. He claimed China’s move towards greener steel production and the Pilbara’s falling iron ore grades spelled hard times for Australia’s largest export. 

Forrest’s gloomy forecast highlights China’s influence on the industry – Fortescue included – now and in the future. The Asian giant casts a long shadow at the moment: its property slump that’s sapped steel demand and concerns about its trade war with the U.S. have pushed iron ore prices below US$100 a tonne. That’s hurt Fortescue’s bottom line and its shares: the stock is down 15% this year and has halved from its 2024 peak. 

The decline has cast a spotlight on Fortescue’s lack of diversification, given its green energy ambitions remain unfulfilled. The crunch on revenues from lower iron ore prices has forced a rethink on its plans to become a leader in new energy sources like hydrogen. Despite the challenges, FMG shares are among the most traded on Stake.   

Great Wall of Worry

China accounts for more than 70% of global demand for iron ore. China’s steel mills have been under pressure from a protracted slump in the nation’s property market: real estate accounts for 26% of China’s steel demand. 

So how bad is it? Prices for steel rebar, which is used in construction, fell to an eight-year low in Shanghai last week. So it’s little surprise that iron ore now fetches US$95 a tonne, down from US$140 at the start of 2024. Beijing has unveiled policies that may stabilise the property market and provide some support for iron ore prices. 

Forrest’s comments point to coming headwinds. China plans to transition to greener steel making. Green steel involves the use of electric arc furnaces (which use scrap metal) or the use of higher grade ores that contain less impurities. This is a problem for Australian producers: Rio Tinto ($RIO) recently informed customers that its average iron ore grade would fall. The rub for Fortescue is that it produces lower grade ores. However, some Aussie miners are investing in new mines with high grades. 

But will the Pilbara become a wasteland? We riffed on the end of iron ore’s golden age last year. Rio Tinto’s iron ore boss Simon Trott said he’s heard warnings of the Pilbara’s demise before. However, there are new sources of supply emerging: the Simandou project in Guinea is expected to start production of higher grade ore later this year. BHP ($BHP) CEO Mike Henry reckons that, despite more supply, iron ore prices could be resilient given China will maintain one billion tonnes of annual steel production for several years. If he’s wrong and prices fall further… There is 180m tonnes’ worth of high cost ore supply that will come under pressure.

Metal fatigue

Fortescue’s financials reflect the weakness in iron ore prices. H1 revenue fell to US$7.63b, down from US$9.15b in H1 FY24. Underlying NPAT declined to US$1.55b from US$3.33b over the same period. 

But let’s be clear: Fortescue still makes good money with iron ore prices at US$95 a tonne, even when including a discount for the quality of its ore. Fortescue, and its Australian rivals, are low-cost producers. Fortescue’s C1 cost (or direct cost) of producing iron ore was just above US$19 a tonne in H1. It was US$17.53 in the March quarter. Full year guidance is for a C1 cost of US$18.50-US$19.75 a tonne. The miner continues to pay dividends, though they were more than halved year-on-year (YoY) to $0.50 a share in H1. 

Low costs allow the miner to keep the pedal to the metal when it comes to production. Fortescue’s iron ore shipments of 46.1m tonnes in the March quarter contributed to a record 143.2m tonnes shipped in the nine months to the end of March. The company’s full year guidance is for shipments of 190m-200m tonnes. That includes 5m-9m tonnes from its troubled Iron Bridge operation, which processes lower grade ore into a higher grade product.

Low energy

Forrest is an advocate for decarbonisation and a critic of fossil fuels. He once said fossil fuel CEOs’ heads should be ‘put on spikes.’ 

But Fortescue’s attempts to create a green energy business – focused on green hydrogen – have faltered. Donald Trump’s election forced the company to abandon some of its U.S. hydrogen plans. Capex for its energy division was slashed from US$500m to US$400m earlier this year. It recently cut 90 hydrogen jobs, but said it was committed to research and development of new green energy technologies. Fortescue plans to build a wind farm to power its mines.

Unfulfilled green energy ambitions have left Fortescue without the diversification enjoyed by other miners at a time of weak iron ore prices. BHP has grown its copper earnings through the acquisition of OZ Minerals and Filo Corp, while Rio Tinto has expanded into lithium through the acquisition of Arcadium Lithium. 

Hard rock

Fortescue offers pure exposure to iron ore. That’s a tough ask when prices are under pressure from China’s property slump, even though Beijing is doing its best to stabilise the housing market.

Low costs ensure Fortescue will continue to make money from its Pilbara operations and ride any recovery in prices. It’s whether the miner can turn its green energy rhetoric into reality that will determine whether it’s steeled for the future.  

This is not financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.