Fortescue share price lower after bearish broker note warns of dividend cuts

Fortescue shares are under pressure on Friday…

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Key points

  • Fortescue's shares are falling on Friday after brokers responded negatively to its quarterly update
  • Goldman Sachs has warned that the company's Fortescue Future Industries business could hit dividend payments
  • The broker expects yields to fall to as low as 2% by FY 2025

The Fortescue Metals Group Limited (ASX: FMG) share price is trading lower on Friday.

In afternoon trade, the mining giant’s shares are down 0.5% to $21.55.

Why is the Fortescue share price dropping?

Today’s weakness in the Fortescue share price could have been driven by a negative response to the miner’s quarterly update from a number of brokers.

This morning Credit Suisse, Goldman Sachs, and Morgan Stanley have all retained the equivalent of sell ratings on the company’s shares with price targets implying meaningful downside risk.

For example, the note out of Goldman Sachs reveals that its analysts have trimmed their price target to $14.90.

Based on the current Fortescue share price, this implies potential downside of 31% for investors over the next 12 months.

What did the broker say?

Goldman acknowledges that Fortescue’s shipments of 46.5Mt were well-ahead of its estimate of 43Mt. It also notes that the company’s price realisations were a touch ahead of its expectations and believes further improvements are coming in the current quarter.

However, this isn’t enough for a more positive view on the Fortescue share price.

This is due to a number of concerns relating to its valuation, the Fortescue Future Industries (FFI) business, and ramp-up risks with the Iron Bridge project.

In respect to its valuation, Goldman highlights that Rio Tinto Limited (ASX: RIO) shares are trading at 0.9x net asset value (NAV), whereas Fortescue’s shares trade at a lofty 1.7x NAV.

As for the FFI business, the broker has warned that its decarbonisation plans could come with significant costs and impact future dividend payments.

Goldman explained: “We think decarbonising the Pilbara could cost FMG over US$7bn (spend not in our numbers) and requires +US$50/t carbon or a iron ore green premia to be NPV positive. We think FMG is at an inflection point on capital allocation, and to fund the ambitious new strategy, we assume the dividend payout ratio falls from the current 80% to 50% from 2022 onwards.”

In light of this, the broker is forecasting dividend yields of 5% in FY 2023, 3% in FY 2024, and then just 2% in FY 2025.

This could mean the days of bumper yields will soon be coming to an end.

Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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