Fortescue loses another CEO (and that might not be the worst of it)

August may be drawing to a close but those of us who thought the reporting season drama was over were proven wrong this morning, as Fortescue Metals Group (ASX: FMG) released its annual results.

Management spoke of both revenue and adjusted EBITDA, which exceeded analyst expectations at $US16.87bn and $US9.6bn apiece. 

That didn't stop the stock from trading down 5% though, as investors' eyes were drawn to yet another change to the executive team, with CEO Fiona Hicks announcing her departure after just six months in the big chair. Hicks is the tenth senior executive to leave Fortescue over the past three years. 

Also weighing was an announcement that Fortescue's "Iron Bridge" project has suffered a $US723m impairment, just as it begins to ramp up production.

This isn't the full extent of the bad news for the miner however, according to Martin Currie's Michael Slack. Elevated costs from the FMG energy business, as well as macroeconomic pressure on steel demand, may bring future pain for investors.

"Currently, steel production is up 2 or 3% over 2022, but Chinese policy has dictated that it should be flat over 2022. If you look at all the economic data it indicates that steel production will have to fall over the last four months of the year, in order to stay flat over the year and fall in line with policy rhetoric."

In this wire, Slack outlines some of the biggest surprises from Fortescue Metals' latest result as well as his outlook on the miner, and its sector over the year ahead. Plus, he shares his view on whether or not there is value to be found in the ASX today.

 Note: This interview took place on 28 August 2023.

Fortescue Metal's key FY23 results

• Revenue of US$16.87 billion, ahead of the consensus of US$16.79B
• Adjusted EBITDA of US$9.96B ahead of analyst expectations of US$9.88B
• Underlying NPAT US$5.52B missed analyst expectations of US$5.60, down 11% on FY22
• Statutory NPAT was 25% down on FY22, “reflecting the decrease in underlying EBITDA and a US$726 million impairment charge relating to Iron Bridge,” management said.
• Free cash of US$4.3 billion and net debt of US$1 billion as of 30 June 2023.
• Final dividend of $1.00 a share, in line with its 65% payout ratio as a proportion of underlying NPAT. This was down 15% on last year.

Key company data for Fortescue Metals

1. In one sentence, what was the key takeaway from this result?

The key news out of the result was that cost inflation has taken hold of some of FMG's capital projects.

2. What was the market’s reaction to this result? In your view, was it an overreaction, an under-reaction or appropriate?

FMG has fallen around 5% on the market this morning, and that's not unexpected. There was a write-down of the Iron Bridge magnetite asset, which is just at the end of its construction and is coming into serious production shortly. FMG has faced a 30% increase in opex at Iron Bridge. They've also had a 100% increase in FMG Energy, capex for FY24.

They've also now delinked FMG energy from being funded by 10% of FMG metal. This reduces clarity of shareholder returns from FMG.

3. Were there any major surprises in this result that you think investors should be aware of?

Yes, I think there were a couple of major surprises. One was the magnitude of the increase in the cost of FMG energy. FMG is leading the world in renewable energy provision and future energy construction and the increasing costs from $400 to $800 million to run that business was a surprise. We also saw an increase in CapEx for next year from $300 to $400 million. Now that's not as much of a surprise because the market knew FMG had projects in the pipeline, but nonetheless, it's higher on a like-for-like basis. 

The other surprise in the result was the change of management. FMG has replaced their CEO after only six months in the chair, giving the company it's third CEO in six months. They have also seen 10 Senior Executive departures in the last three years, which would be quite destabilising.

4. Would you buy, hold or sell Fortescue Metals on the back of these results?

Rating: SELL

I would be a seller. I think the results highlight the lack of clarity around the investment proposition for FMG energy, and highlight that it's potentially a large capital drain on the company. For it to increase so much in terms of OPEX for the next 12 months is certainly a surprise. This has the effect of reducing the flow of dividends from the iron ore business back to shareholders, even though the iron ore business itself is quite strong.

5. What’s your outlook on Fortescue Metals Group and its sector over the year ahead? Are there any risks to this company and its sector that investors should be aware of?

FMG's fortunes in the next 12 months are really dominated by the iron ore market, namely the price and activity in China. We are seeing a slowdown in steel production coming out of China, which will undoubtedly have an effect on iron ore prices going forward and will reduce the earnings of FMG. 

Coupling that with the increase in the capital demands on the FMG energy side, and returns to shareholders in the next 12 months should be well down on what we've seen in the last 12 months. When thinking about the outlook for the next 12 months I would therefore be quite cautious.

Currently in China, steel production is up 2 or 3% over 2022, but Chinese policy has dictated that it should be flat over 2022. If you look at all the economic data it indicates that steel production will have to fall over the last four months of the year, in order to stay flat over the year and fall in line with policy rhetoric.

China is also not getting any benefit from increased demand out of the property sector, or the machinery sector, which are keen users of steel. As a result, the outlook beyond September this year is pretty poor for iron ore as it faces declining demand from the Chinese steel sector.

6. From 1-5, where 1 is cheap and 5 is expensive, how much value are you seeing in the market right now? Are you excited or are you cautious on the market in general?

Rating: 5

We're quite cautious on the market. If you look at pricing at the moment, notwithstanding the few percent the market is down this month to date, it's within a few percent of all-time highs. Throughout the results period, we have been hearing a variety of cautious outlook statements, whether it be from companies in the consumer space or in the industrial space. As a result, we are very cautious on the market in general for the coming 12 months.

Within that, we'd be even more cautious on the iron ore sector, and many of the iron mining names.

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