Is Fortescue's 70% dividend payout sustainable?

A year ago, Fortescue celebrated its 20th anniversary with a blow-out party in the Pilbara, but do they have as much to celebrate today?

The miner started FY24 with three senior executive departures – CEO Fiona Hick, CFO Christine Morris and non-executive director Dr Guy Debelle. It also scaled back its green hydrogen projects and shed 700 jobs in July alone. Despite the pause, Chairman Andrew Forrest remains committed to green projects, with significant spending still planned towards these ambitions.

If these challenges weren’t enough, commodity prices (in particular, iron ore) took a hit across FY24 over concerns of weakening Chinese demand becoming more entrenched.

But despite these challenges, Fortescue still offered investors its third-highest earnings in company history.

According to Atlas Funds Management’s Hugh Dive, Fortescue’s performance was largely in line with market expectations, but he holds concerns for the company’s future given future supply growth in iron ore and expenditure on green projects.

In this interview, Dive takes us through the results and outlook. Let’s just say Fortescue might want to hold off popping the champagne for the time being.

FMG FY24 Key Results

• Revenue +3% to US$18.22 billion
• Underlying EBITDA +7% to US$10.71 billion
• Profit +18% to US$5.66 billion
• Earnings per share +3% to US$1.85/share
• Final dividend -11% to 89c/share (full-year payout of $1.97/share)
• Dividend payout ratio increases to 70%.

Note: The dividend figure is given in Australian dollars but the rest of the report's key financial metrics are delivered in US dollars.

FY25 guidance

• Iron ore shipments of 190 - 200Mt, including 5 - 9Mt for Iron Bridge (100% basis). 
• C1 cost for Hematite of US$18.50 - US$19.75/wmt. 
• Fortescue Metals capital expenditure of US$3.2 - US$3.8 billion. 
• Fortescue Energy's net operating expenditure of approximately US$700 million and capital expenditure of approximately US$500 million.

Guidance is based on an assumed FY25 average AUD/USD exchange rate of 0.68.

What was the key takeaway from this result?

The key takeaway was the dividend, which was higher than expected at a payout ratio of 70%, much higher than BHP and RIO. On the whole, it wasn’t a bad outcome, and volumes are pretty flat. There is an improvement in the revenue per tonne at US$103/tonne which is comparable to BHP. The balance sheet was really strong with only US$500 million in net debt.

Were there any surprises in this result that you think investors may have missed?

The market should be concerned about the discount blowing out in the fourth quarter which normally happens when the iron ore price falls.

Investors also have a lot of questions about green energy. It was US$659 million and has pretty significant ongoing capex requirements. Can this capex be slowed with the iron ore price falling? We believe it will need to so that it can maintain shareholder returns.

Another question about green hydrogen is whether customers are willing to pay a large premium for this in a world with excess steel – we’re expecting to see a substantial onset of supply from China, southeast Asia and Latin American markets.

Would you buy, hold or sell FMG off the back of this result?

Rating: SELL

I would sell it for a few key reasons.

Firstly, the iron ore price is going down. We’re seeing it fall from $120/tonne to $80/tonne. FMG are trying to discount to the benchmark and this always seems to blow out when there are market falls because steel mills shift to a higher grade.

Having followed the company for many years, the market always seems surprised when iron ore falls. We saw that in 2015 and again in 2021 when the discount really blew out. Fortescue doesn’t have the debt load it had during those other times so can probably handle it better – but it will surprise markets. People have very short memories.

The other concern is the green energy projects. They are much beloved by the Executive Chairman and it’s very unclear whether these will generate economic returns. 

Some in the market will question whether they should be privately funded by the FMG Chairman’s own investment vehicles.

Are there any other risks investors should be aware of?

The key things are the ongoing CAPEX commitments and whether these can be flexed in an environment of falling iron ore prices. 

Fortescue are looking to spend about $1.2 billion on green energy and there are a range of new projects in Brazil and Oman. There’s a backlog of activity there. Does that then eat into dividends in the future? They’ve taken a much more aggressive stance with dividends compared to BHP and RIO.

From 1 to 5, where 1 is cheap and 5 is expensive, how much value are you seeing on the ASX today?

Rating: 3

Overall it isn’t cheap. Wider markets are trading on 16 to 17x forward earnings, it’s a mixed market.

Financial, healthcare and consumer discretionary stocks have had strong price rises in the last year but are still delivering earnings growth. In the case of the banks, there was a fair bit of handwringing about the high share prices. You wouldn’t short them when they are actively buying up about 10% of the average daily volume of market buybacks. We saw last week's margins are pretty good in both Commonwealth Bank (ASX: CBA) and Westpac (ASX: WBC).

Energy and materials are looking cheap. If you look at Australian companies, Woodside (ASX: WDS) looks undervalued and has strategic high value in the event of a wider Middle Eastern conflict which has been recognised by Japanese and Korean utilities, but not Australia yet. Two Japanese utilities have paid $2.4 billion to buy stakes in the yet-to-be-developed Scarborough project.

Falling rates will help bond proxies like infrastructure assets do well too.