Why the Fortescue (ASX:FMG) share price is underperforming its peers today

Mining stocks are following the S&P/ASX 200 Index (Index:^AXJO) lower this morning. But the Fortescue Metals Group Limited (ASX: FMG) share price is suffering a bigger blow.

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Mining stocks are following the S&P/ASX 200 Index (Index:^AXJO) lower this morning. But the Fortescue Metals Group Limited (ASX: FMG) share price is suffering a bigger blow.

Shares in the iron ore miner tumbled 3.7% to $16.70 at the time of writing. This compares to a 0.8% loss for the BHP Group Ltd (ASX: BHP) share price and 1.4% decline for the Rio Tinto Limited (ASX: RIO) share price.

The heavier sell-off in Fortescue coincides with a ratings downgrade by Morgan Stanley. The broker cut its recommendation on the stock to “underweight” and did the same to the Mineral Resources Limited (ASX: MIN) share price, which shed over 3% as well.

Positive outlook can’t save FMG share price from downgrade

The move comes despite the broker having a reasonably upbeat view of the iron ore market.

“A higher-for-longer iron ore price scenario is our new base case, driven by a slower unwinding of current tightness through 2021,” said Morgan Stanley.

“However, some miners have run ahead of these expectations, implying high iron ore prices.”

Here for good time, not long time

It isn’t the spot price assumption that’s the problem. Fortescue’s share price implies a spot price of US$76 a tonne when spot is around US$126 a tonne. The implied spot price for the Mineral Resources share price is US$88 a tonne.

The issue is the implied long-term price for the ore which is needed to justify the big run in Fortescue and Mineral Resources over the past year.

The long-term price will need to be at least US$107 a tonne for FMG, while the commodity will need to fetch US$117 a tonne for MIN, according to Morgan Stanley.

This stands in contrast to the broker’s long-term estimate of US$65 a tonne.

Top ASX stock to buy in sector

This also explains why BHP is Morgan Stanley’s top pick for the sector. The implied long-term ore price from BHP’s current share price is US$89 a tonne.

While that’s about the same for Rio Tinto, the broker prefers BHP for its better diversification to other commodities.

Morgan Stanley is recommending BHP as “overweight” (or “buy”) while Rio is rated as “equal-weight”.

Too early to throw in the towel?

But Morgan Stanley’s price assumption may prove to be too conservative. Just about all analysts have underestimated the iron ore price, even before COVID-19.

Also, the nearer-term outlook for the gravity-defying commodity is bright and there are signs the good times could last through 2021. This outcome will postpone the de-rating in the FMG share price and MIN share price for a while yet.

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Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd. 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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