Fortescue Metals Group Limited triples net profit, is it a buy?

Credit: Chatham House

Australia’s third largest miner, Fortescue Metals Group Limited (ASX :FMG) reported its full-year results to the market this morning. Despite a highly successful year of cost cutting that saw profits skyrocket, shares were down 1% at the time of writing.

Here’s what you need to know:

(All figures are in US Dollars)

  • Revenues fell 17% to $7,083 million
  • Net Profit After Tax (NPAT) rose 210% to $984 million
  • Earnings per share tripled from 10.2 cents per share to 31.6 cents per share
  • Dividends per share up from 5 cents per share to 15 cents per share
  • Production of 174 million tonnes, up 4% on prior year
  • Average realised price of $45/tonne, down from $57/tonne last year
  • Total delivered costs dropped 43% to $23/tonne
  • Strong cash flows with $2.9 billion of debt repaid, gearing now below 40%
  • ‘Positive’ outlook for 2017 due to Chinese infrastructure investment

Cutting the costs

Fortescue shares have significantly outperformed peers BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) because Fortescue’s operations were relatively less efficient in recent years. Thanks to a number of initiatives, mining costs have dropped like a stone.

It’s important to distinguish between C1 costs (‘cash costs’) which is the cost of getting the ore out of the ground, and ‘delivered costs’ which include the cost of shipping the ore to the customer. Fortescue also must add approximately $2 per tonne in ‘sustaining capital’ (ongoing maintenance) costs for its mines.

Investors must be sure to remember the positive impact of a weaker Australian dollar and lower oil prices (reducing shipping costs) on Fortescue’s operations. Forecasts for C1 costs of $12-$13 per tonne ($14.31 last year) for 2017 assume an AUD/USD exchange rate of $0.75 and West Texas Intermediate (WTI) crude prices of US$50/barrel.

The takeaway from these figures is that Fortescue doesn’t look able to significantly decrease costs in 2017. Although marginal improvements to C1 costs are forecast, sustaining capital will rise from $1.33 per tonne to $2 per tonne, offsetting part of the benefit – and that’s assuming exchange rates and oil prices stay constant, which they won’t.

What’s next?

Fortescue points out that it is responsible for 18% of China’s consumption of iron ore and that the outlook for 2017 is positive due to massive infrastructure investment in the ‘One Belt, One Road’ plan announced by the Chinese government. Turning this on its head, it might also be appropriate to point out that China is Fortescue’s biggest customer, and economic malaise here would hurt.

Fortescue is also assessing funding options for its Very Large Ore Carriers (VLOCs) and tugboats, with which it will ship ore itself, saving on transport costs. Company debt has decreased considerably throughout the year and management doesn’t seem keen on returning to former elevated levels, especially with ongoing uncertainty in global iron ore markets.

Management has done an outstanding job turning Fortescue’s situation around, but in my mind it appears as though much of the upside has already been priced into the stock, with cost cutting improvements getting successively smaller and sales depending heavily on market prices and Chinese demand. I wouldn’t be in a rush to buy Fortescue shares today.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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