MARKETS SPECTATOR: All aboard the iron ore train
As the spot price continues its striking recovery brokers have begun the iron ore upgrade cycle, with Fortescue first cab off the rank.
In what could be the first in a series of iron ore upgrades, RBS Morgans have re-initiated coverage of Fortescue Metals Group with an outperform rating and a target price of $5.90 per share, some 17 per cent above Friday's closing price of $5.01.
"We believe Fortescue's strategy of selling non-core assets unlocks value, exploiting the relationship in the higher return rates required by equity investors in Fortescue versus those from infrastructure assets. We expect production upside surprises in financial year 2013 forecasts and financial year 2014 forecasts, and an infrastructure sell-down to drive the share price higher in the near term,” RBS Morgan said in an equity note.
The broker believes increasing production from Fortescue's Solomon mine will lower the group's cash costs and expand margins while the partial infrastructure sales will be used to pay down group debt and substantially reduce gearing.
RBS Morgans foresees significant share price upside. Its estimates are around 10 per cent and 50 per cent above Reuters consensus in financial year 2013 forecasts and financial year 2014 forecasts, respectively. Based on consensus revenue and price estimates, "we suspect our 125Mtpa financial year 2014 production assumption is 5 to 7 per cent above consensus, and that this, combined with possibly higher margin assumptions, leads to the substantial variance in our bottom-line forecasts. An EV/EBITDA multiple of 6.0x (in line with Fortescue's recent trading history) in financial year 2014 forecasts implies a share price around $8."
It's also worth noting that the current consensus forecast for the first quarter of 2013 is for spot iron prices to average $119 per tonne. Yet it's starting the quarter around the $150 per tonne mark! Over the next few weeks, as analysts return from holidays we're highly likely to see an earnings upgrade cycle for any company that procures iron ore.
The below chart of Fortescue shows the strong price momentum seen recently as spot iron ore has continued its miraculous recovery. The short to medium-term trend is definitely to the upside now as money continues to flow towards Chinese facing stocks and short sellers continue to buy back their positions.
Source: Iress
"We believe Fortescue's strategy of selling non-core assets unlocks value, exploiting the relationship in the higher return rates required by equity investors in Fortescue versus those from infrastructure assets. We expect production upside surprises in financial year 2013 forecasts and financial year 2014 forecasts, and an infrastructure sell-down to drive the share price higher in the near term,” RBS Morgan said in an equity note.
The broker believes increasing production from Fortescue's Solomon mine will lower the group's cash costs and expand margins while the partial infrastructure sales will be used to pay down group debt and substantially reduce gearing.
RBS Morgans foresees significant share price upside. Its estimates are around 10 per cent and 50 per cent above Reuters consensus in financial year 2013 forecasts and financial year 2014 forecasts, respectively. Based on consensus revenue and price estimates, "we suspect our 125Mtpa financial year 2014 production assumption is 5 to 7 per cent above consensus, and that this, combined with possibly higher margin assumptions, leads to the substantial variance in our bottom-line forecasts. An EV/EBITDA multiple of 6.0x (in line with Fortescue's recent trading history) in financial year 2014 forecasts implies a share price around $8."
It's also worth noting that the current consensus forecast for the first quarter of 2013 is for spot iron prices to average $119 per tonne. Yet it's starting the quarter around the $150 per tonne mark! Over the next few weeks, as analysts return from holidays we're highly likely to see an earnings upgrade cycle for any company that procures iron ore.
The below chart of Fortescue shows the strong price momentum seen recently as spot iron ore has continued its miraculous recovery. The short to medium-term trend is definitely to the upside now as money continues to flow towards Chinese facing stocks and short sellers continue to buy back their positions.
Source: Iress
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