Fortescue Metals Group released its March-quarter production report. Shipments of 38Mt were lower than we expected due mainly to the impact from cyclones. The top end of FY19 guidance was trimmed by 3Mt, with a new range of 165–170Mt. The lower shipments also led to higher unit costs of US$13.5/t, up 50c quarter-on-quarter and slightly above our estimate.
A 5Mt lift in inventory created a large build-up of working capital. This led to lower cash conversion, with net debt essentially remaining flat at US$2.9bn versus US$3bn at the end of the first half – a special dividend was paid in the quarter.
The highlight of the result, in our view, was the achieved price of US$71/t – the best level since CY14. The 14% discount to the benchmark price was the lowest since CY16, with Fortescue now benefiting from about 10% of its volume mix coming from the new West Pilbara fines product, which is 60% iron. Brazil shipments have slowed materially over the past month and we see a very supportive quarter ahead from a price perspective.
We acknowledge the restart of Vale’s Brucutu mine will likely take some of the positive sentiment out of the recent run in iron ore. The situation in Brazil remains fluid, however, and Vale hasn’t changed its 2019 guidance. Our base-case forecast is for achieved prices falling from the mid-US$70s over the next six months to the low US$60s by the end of FY20.
Overall, we remain positive on Fortescue from an investment perspective, given the stock is trading favourable valuation metrics with a forecast dividend yield of more than 10% over three years. We maintain our Buy recommendation, although we have trimmed our target price to $8.60 from $8.70.