The recent market downturn has filled most investors’ portfolios with red arrows. Fortunately, it has also provided some outstanding value investing opportunities.
H1 earnings season has bought admissions from Qantas Airways Limited (ASX: QAN), Treasury Wine Estates Ltd (ASX: TWE) and Bluescope Steel Limited (ASX: BSL) (among others) surrounding the impact on full year earnings of the ongoing coronavirus outbreak.
On the back of news like this the S&P/ASX 200 (INDEXASX: XJO) fell 1.6% on Tuesday. This was on top of a 2.5% fall on Monday. Many traders are also taking this opportunity to take profits, which was clearly displayed by the 2-day rise and fall of gold mining shares.
The value investing opportunity
When the market moves as one, it always uncovers great opportunities for value investing. Fortescue Metals Group Limited (ASX: FMG) is suddenly available at a price-to-earnings (P/E) ratio of 4.7 and a price-to-book ratio of 2.67.
On a recent earnings call, Fortescue CEO Elizabeth Gaines stated “Our shipments are proceeding on schedule. We are confident in the strength of the Chinese economy.”
Fortescue has been going strong all year. Partly this is due to ongoing issues facing Vale SA, the world’s number one iron ore producer and exporter. A lot of credit also goes to its new high grade iron ore blend, which the company has been selling successfully into China.
The result has turned Fortescue into a cash compounding machine. Its recent H1 results showcased the company as a consistent low cost producer with quarter on quarter increases in revenue. It spent $852 million expanding production capacity. It also smashed expectations with $3.66 billion profit and has $2.5 billion free cash flow.
Fortescue announced a $0.76 interim dividend on 19 February. At Tuesday’s closing share price of $10.93, this means an interim payment of 7.4%. There are also indications of a higher full year payment.
This is what value investing is about. A well managed, cash gushing machine capable of generating greater revenues with every dollar of capital employed, and on sale at a reasonable price.
The company’s return on capital expended (ROCE) for FY19 was a massive 65%. This is 65 cents of earnings before interest and taxes (EBIT) for every dollar of capital unencumbered by liabilities. In comparison, BHP Group Ltd (ASX: BHP) forecast approximately 20% ROCE by FY22.
Additionally, Fortescue’s earnings yield for H1 stands at 11.9% compared with approximately 7% for BHP at the end of FY19.
Fortescue Metals Group is a very well managed company. It has a history of outperforming in compound annual growth rates (CAGR) across all financial performance indicators. It is a low cost producer that is able to wring large returns from every cent of capital employed.
Thanks to the market, it is also going cheap at a current earnings multiple of around 4.7. In my opinion, picking up Fortescue stock before the ex-dividend date of 2 March is a very good value investing opportunity, with the miner’s shares providing a 9.15% dividend yield (at the time of writing), as well as the high likelihood of capital growth in the short to medium term.
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Motley Fool contributor Daryl Mather owns shares of Fortescue Metals Group Limited. 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 Scott Phillips.
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