The Fortescue Metals Group Limited (ASX: FMG) share price has jumped 14% since the start of the year but the stock could be poised for further gains next week if Morgan Stanley is on the money.
The FMG share price jumped 2% to $4.78 in the last hour of trade today while the BHP Group Ltd (ASX: BHP) share price fell 0.2% to $32.58 and Rio Tinto Limited (ASX: RIO) is hovering close to breakeven at $79.62.
The strong run in Fortescue's share price could extend in the short-term as the miner prepares to hand in its quarterly production update next Thursday.
Key catalyst
Morgan Stanley sees the update as a "key catalyst" for the stock following the recent recovery in the price of lower quality ore that Fortescue produces.
"Following the recent Platts article suggesting FMG further narrowed near-term contract discounts in Feb, we see FMG's 2QFY19 production report and its Q&A session as a potential catalyst, where the company could provide forward looking commentary on the currently improving price realization (in 3QFY19)," said the broker.
The Platts article that was published last week said that prices for Fortescue's traditional products are running higher than expected and is around 6% ahead of Morgan Stanley's 2HFY19 forecast.
The stock could be cum consensus upgrade if management confirmed that the good prices it was receiving for its lower-grade product is carrying over into the current quarter and could persist over the medium term.
Under this scenario, Morgan Stanley believes the Fortescue share price could jump to $5.23 and it believes this is the most likely outcome.
However, if Fortescue says the strong price realisation in the December quarter is a one-off and that the gap between the higher and lower grade ore was set to widen again, the stock could tumble more than 10% from its current level.
More upside than downside risks
Morgan Stanley rates this bearish scenario as only a 20% chance and I have to agree as Fortescue's management has never been shy about talking up the prospects of the miner.
Fortescue's ore tends to contain around 58% iron compared to 62% for Rio Tinto and BHP. Chinese steel mills lost appetite for the lower grade ore through most of 2018 and that caused the price gap between the two grades to blow out significantly.
The distaste for the higher polluting ore stemmed from China's pollution control regulations but the subsequent collapse in profit margins of steel producers have prompted many to start re-buying the cheaper ore.
Morgan Stanley has an "outperform" recommendation on Fortescue with a price target of $5.05 a share.
