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Review: Fortescue Metals (19/20FY)

Fortescue Metals Group

Fortescue Metals is a single bet on China. And this is one bet that is now paying dividends!

Fortescue currently produces one product – iron ore; exports to one country – China; operates entirely from one area – the Pilbara; exports through one port – Port Headland; and is driven by one man – Twiggy Forrest.

And there’s something highly unusual about Fortescue’s balance sheet: it’s one of the world’s few large scale miners to be in a net cash position. A conservatively structured balance sheet enables Fortescue to work through the tough economic times and withstand a period of volatile iron ore prices and soft demand.  It also enables the Group to pay dividends to shareholders and to fund much of its growth without asking shareholders for money.

Floated in 2003 at 10 cents a share, Fortescue shares are now $14.90 and this year will pay 90 cents in fully franked dividends.

Fortescue is the world’s fourth largest iron ore producer and China is the world’s largest consumer of iron ore, accounting for 70% of global demand. Australia accounts for over 50% of the world’s iron ore exports, more than double our nearest rival, Brazil, with 20% of world export demand.

So Fortescue’s fortunes are inextricably hinged to China’s future economic growth prospects.

How’s China faring? This is the question that every Fortescue investor needs answered every day.

According to Fortescue’s chief executive, Elizabeth Gaines, demand for iron ore out of China is growing today as China rapidly recovers from the coronavirus lockdown and steel production is returning to pre-coronavirus levels. This is backed up by Rio chief executive Jean Sebastien Jacques who states that demand for iron ore out of China is ‘as strong as ever’. CEOs of global companies don’t make these comments lightly. Unlike journalists, public company CEOs are governed by strict laws around disclosure and public remarks, so considerable credence can be placed on this observation by Jacques.

But there is one question mark over Chinese demand for Australian sourced exports.

Australia’s trade relations with China are strained at present, as evidenced by China’s tariff impost on Australian barley amid claims of ‘dumping’ of barley by Australian farmers and the banning of meat exports from 4 Australian meat abattoirs. This is seemingly in retaliation for PM Scott Morrison’s recent criticism of China’s delayed release of coronavirus details that could have prevented the spread of the global coronavirus pandemic.

The question on Fortescue shareholders’ minds is whether this diplomatic spat will result in a Chinese ban on Australian iron ore.

China’s dependence on Australia for 62% of its iron ore imports strongly suggests that this is most unlikely to occur.

This is good news for Fortescue, given its sole dependence on Chinese steel mills for 100% of its revenue.  Gaines has hinted that Fortescue understand this exposure risk to Chinese demand and recently stated that “We have a multifaceted approach to engagement with China, which extends to procurement, financing and sponsorship”.

This suggests that Fortescue knows the value of having deep and close ties to Chinese officials and explains the recent incident at a press conference hosted by Health Minister Greg Hunt, which was hijacked by a senior Chinese official, who was specifically invited by Twiggy Forrest, without prior knowledge of the Health Minister. The Chinese official took to the podium and espoused the virtuous behaviour of China in its handling of the coronavirus, at the Australian Health Minister’s media conference!   

The iron ore price has spiked 20% since late May which supports the notion that the Chinese economic recovery post coronavirus is well underway.  

An investment in Fortescue is a bet on China.

And a bet on China right now is looking as if its going to continue to pay dividends for a long time into the future.

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