Amateur investors bet on Andrew Forrest despite professional doubts
Amateurs are investing a lot of faith in the belief that Andrew Forrest can keep delivering generous dividends from his iron ore business, Fortescue Metals Group (ASX: FMG), just as professionals warn that risks are rising in a company which isn’t quite sure what it is.
The disconnect is the most remarkable event on the Australian stock market today because it appears to be showing that fundamental measures of value can be beaten by a powerful personality, and a company can be one thing while promoting itself as something else.
Whether it can last is the first question which needs to be asked of FMG, but it’s not the only issue because a sudden correction in its share price would send shockwaves through the wider mining market.
There is no straightforward answer to the “can-it-last” question because FMG, despite just celebrating 20 years of highly profitable iron ore mining in Western Australia, remains a personal work in progress as Forrest attempts to reshape a business which can only be called a resources hybrid.
Challenges in shifting focus
Mixing the assured cash flows from selling iron ore to China with a courageous attempt to become a world-beating renewable energy business with a focus on hydrogen is proving harder than even the mercurial Forrest could have imagined.
The latest change of direction, which includes limiting investment in Fortescue Future Industries (FFI), the company’s renewable energy division, has coincided with rapid changes in the ranks of company management and a split among the major shareholders, Forrest and his wife Nicola.
Layered over all that are hints of a slowdown in China which will have an effect on demand for steel and iron ore which means it is likely that FMG is entering a phase in its life which the Chinese call ‘interesting times’.
Forrest, who has travelled the world to promote FMG’s environmental credentials, has been forced to limit investment in what had become a bottomless pit for iron ore profits.
A compromise on green goals
Rather than commit 10% of net profit after tax to FFI’s green goals the new plan is to only invest in projects “of merit” which also fit into FMG’s capital allocation framework.
Deciphered, that could mean that Forrest’s personal objective of saving the planet from the effects of climate change will, in future, play second fiddle to earning profits from iron ore and paying handsome dividends to shareholders.
If Forrest really has jumped in a Tesla for a trip back to the future then the recent rise in the company’s share price, even as doubts have grown about Chinese iron ore demand, can be better understood because the return to basics should mean a continuation of the handsome profits and dividends to which investors have become accustomed.
Uncertain future and management changes
The problem with that optimistic assessment is that no-one other than Forrest seems to have a clear view of where the company is going, certainly not the chief executive of six-months, Fiona Hick, who last week joined a long line of departing FMG executives.
The fact that Hicks’ exit was so abrupt is a worry for investors in FMG, as is the about face on renewables.
Investment bank analysts have been growing increasingly wary of FMG and this week’s announcement of a solid US$5.5 billion net profit for the year to June 30, and A$1 per share final dividend did nothing to sway a common view that the stock is over-priced and poised for a significant correction.
Goldman Sachs, which has led the FMG doubters’ clubs for the past year, reckons FMG could fall by 31.5% from the latest price of $21.15 to $14.50 with one of its analysts, Paul Young, saying at a results conference this week that “shareholders need a better explanation” about Hick and why she quit.
Morgan Stanley, which has a price target of $16.45, said it remained underweight because of heightened capital expenditure risk in FFI and continued management changes.
“This could affect company free cash flow and yields in addition to the potential softening in the iron ore price, alongside a widening of the [company’s] low-grade discount,” Morgan Stanley said.
General market consensus
Remarkably, or perhaps not so remarkably, every other investment bank and stockbroker has FMG as a sell or hold. There are no buy recommendations.
The most optimistic view comes from Barrenjoey which in a post-results note this week repeated an underweight (sell) tip along with a 50c reduction in the target to $19.50 with its major worry being that FFI capital spending could jeopardise FMG’s future dividends.
Citi warned that forecasting future FMG earnings was highly uncertain because of potential outlays on energy projects, leading to a $1.20 reduction in its price target to $18.20.
Morgans said sell with a price target of $16.20 and UBS rubbed 90c off its target to $15.20 and warned that Chinese steel production caps would soon be rolled out.
Bell Potter described recent events at the company as “another wobble in the wheels” which led to a repeat of its sell tip and 44c price target reduction to $15.53, as well as raising critical points about FMG, including the Hicks exits, a U$1 billion impairment charge against the new Iron Bridge mine, and a declining dividend payout ratio.
The future financial picture
By now you get the picture. Most professional analysts have deep-seated doubts about the future performance of FMG best seen in Morgan Stanley’s profit forecasts for the next two years with this year’s net profit likely to be US$3 billion (down from last year’s $5.5 billion) and then down another rung to US$2.3 billion in 2025.
The annual dividend, according to Morgan Stanley will fall from the $1.26 per share paid from last year’s earnings to 60 cents this year and then down to 43c in 2025.
Presented any way you like it’s not an encouraging financial picture which comes back to the original question: why do amateur investors keep buying when the professionals say sell?
There are three possible answers to that question: amateurs love Forrest and his outlandish and outspoken style, they don’t trust professional investment advice, or they truly believe that Forrest can deliver a world-class hydrogen business and save the planet from climate change.
Essentially, FMG is not just a hybrid mix of old-world iron ore and (potentially) new world alternative energy its followers show all the signs of being true believers in whatever Forrest says because he’s done it once and that surely means he can do it again (doesn’t it?).