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Key points
- Fortescue has been rated as a sell by Goldman Sachs
- It believes its shares could fall 34% over the next 12 months
- Broker warns that dividends are at risk from Fortescue Future Industries plans
The Fortescue Metals Group Limited (ASX: FMG) share price is sliding on Tuesday.
In morning trade, the iron ore producer's shares are down 1% to $20.55.
Where next for the Fortescue share price?
One leading broker has been running the rule over the resources sector this month and unfortunately did not have anything positive to say about the Fortescue share price.
In fact, the team at Goldman Sachs has named four reasons why its shares are a sell at the current level.
The broker currently has a sell rating and $13.50 price target on the miner's shares, which implies potential downside of 34% for the Fortescue share price over the next 12 months.
Why is the broker so bearish?
The first reason that Goldman is bearish on the Fortescue share price is its valuation compared to rivals BHP Group Ltd (ASX: BHP) and Rio Tinto Limited (ASX: RIO).
It explained: "The stock is trading at c. 1.8x NAV vs. RIO at c. 0.9x NAV. FMG is pricing in c. US$84/t (real) long run iron ore vs. our US$67/t (real 2022 $) estimate. FMG is also trading at a significant premium to BHP & RIO on a EV/EBITDA basis (5.4x vs. BHP & RIO on c. 4x), which we think is unwarranted considering the lack of diversification."
Another reason is the low grade ore that Fortescue produces, which is falling out of favour with end users.
The broker commented: "Widening of low grade 58% Fe product realisations due to high coking coal prices and high steel mill margins (similar to the steel/iron ore market dynamics at the end of 2017). Based on the 58% Fe price, we see FMG's price realisations dropping to 68% in Dec Q (from 73% in the Sep Q)."
Goldman also has concerns over the Iron Bridge project, which it suspects will require higher capital expenditure than guided to.
It explained: "Execution and ramp-up risks on the Iron Bridge project: capex guided to US$3.3-3.5bn (100% basis) and first production in Dec 2022. We model capex of US$3.7bn and first ore in 1Q 2023, and an 18-24 month ramp up, but think there may be further capex increases and pressure on the project schedule due to contractor shortages inflation on key input costs (steel, concrete, labour, equipment, etc)."
A fourth reason Goldman Sachs sees downside risk to the Fortescue share price is its Fortescue Future Industries business and decarbonisation plans. Its analysts suspect these plans will come at a significant cost and force a reduction in future dividend payments.
The broker said: "Uncertainties around Fortescue Future Industries (FFI) diversification and Pilbara decarbonisation: FMG is targeting a 10% allocation of NPAT to FFI renewable energy projects (green hydrogen, solar, wind, etc) but only when a project is investment ready."
"We think decarbonising the Pilbara could cost FMG over US$7bn and requires +US$50/t carbon or a green premia to be NPV positive. FMG has outlined that the Pilbara decarbonisation project/assets would logically sit within FFI (although ultimately under a Power Purchasing Agreement (PPA) which would still be reflected on FMG's balance sheet). In order to fund FFI projects, we think FMG may have to reduce their dividend payout ratio from 80% to 50% in the coming years," it concluded.
