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Fortescue Metals Shares (ASX:FMG) is an Undervalued Stock to Buy

This article was originally published at: MF & Co. Asset Management.

Fortescue Metals Group (FMG: ASX) is one of the largest mining companies in Australia. With a low price to earnings (PE) ratio compared to its peers and strong growth, Fortescue Metals Shares has a lot of upside to give.

Unfortunately, the company’s 3rd quarter performance has been poor and an overdependence on exporting to China (89% of exports go to China) has created a substantial risk that an overall fall in demand in the Chinese iron ore market could have an adverse effect on FMG.

About Fortescue Metals Group (FMG: ASX)

Fortescue Metals Group consists of three mines, mainly excavating and exporting iron ore in Pilbara, Western Australia. The company is regarded as the fourth-largest iron ore mining company in the world. With a focus on a low-cost strategy, FMG has become the lowest cost supplier of seaborne iron ore into China.

Fortescue Metals Shares Has Great Potential For Investors

FMG’s Solomon Hub mine experienced a 20% productivity increase as a result of CAT autonomous haulage technology (AHS) implementation. Following the increase in productivity, FMG decided to expand AHS to their other mines in FY17. The expansion of FMG’s autonomous fleet via retrofitting will help to improve safety and unlock significant productivity gains for the company.

It’s important to note that the recent announcement of a change in CEO and their subsequent remuneration package will link to the company’s future performance which could be a motivator for management. FMG has reported $3.6 billion in early debt repayments, which shows their confidence on the company’s balance sheet. The company is looking to buy four more ships that will be ready in 2019 for shipments, which shows great confidence in future performance.

On the negative side, FMG is undiversified with iron ore as its only product and the company relies predominately on the Chinese market reporting that China takes 89% of their total export product.

FMG’s Opportunity Locally And Globally

Macquarie Bank claims that big cities in Australia such as Sydney and Melbourne will experience rapid growth in infrastructure in upcoming years as a result of urbanisation and migration. This will be a great opportunity for FMG as the local demand for iron ore increases.

The exporting of iron ore to China is forecast to decrease as Chinese construction slows down. Major cities in China are promoting restriction orders on real estate to reach a stable housing price which could lead to less new construction sites in China which indicates a lower demand on iron ore compared to the last decade. As China takes 89% of FMG’s exported product, it might significantly affect FMG’s performance.

However, even though real estate speculation in China is falling as a result of government regulation, the demand for real estate is bound to increase as China gradually abandons the one-child policy and promotes a two-child policy to improve the balanced development of the Chinese population.

In 2016, 45% of the 17.86 million babies born in China was a second child. China is also embracing the rapid urbanization process, which means new infrastructure will require iron ore. This leads to the assumption that China will be in a strong position to require the importing of iron ore and demand is set to continue.

FMG Stock Is Undervalued With a Lower PE Ratio

One of the most noticeable quantitative factors that should be noted is ASX FMG shares low price to earnings ratio (PE Ratio). PE Ratio represents how much the market is willing to pay to the company for one dollar of the company’s earnings. This reflects the market expectation for the future of the company. Generally speaking, a lower PE Ratio compared to competitors and the market generally reflects that the company is undervalued and vice versa.

The table below highlights FMG’s PE Ratio compared to its two biggest competitors RIO Tinto (RIO: ASX), BHP Billiton (BHP: ASX), two relatively small capital competitors BlueScope Steel (BSL: ASX) and Sims Metal Management (SGM: ASX) and the industry benchmark.

Company FMG RIO BHP BSL SGM INDUSTRY
PE Ratio 7.77 12.730 28.540 11.840 14.980 14.50

SOURCE ASX

ASX FMG shares have the lowest PE Ratio among all the listed competitors and the industry. Just because FMG stock has a low PE Ratio does not mean it is a cheap share to buy. In contrast, a poor performance could result in a low PE Ratio.

Whether the company is running at a profit or loss could be found in its annual financial report. In FMG stock’s case, ASX FMG shares has had a strong year on year performance.

Gross Revenue Revenue Growth Net Profit Net Profit Growth
2017 8447m 19.26% 2093m 112.49%
2016 7083m 985m

Source: FMG 2017 Financial Report

Both the 19.26% gross revenue growth rate and the 112.49% net profit growth rate show strong growth for ASX FMG shares. Combined with FMG’s low PE Ratio, Fortescue Metals shares is undervalued.

FMG Stock Looks Strong And Undervalued

Fortescue Metals shares is undervalued as indicated in its low PE Ratio. The industry has high barrier costs effectively preventing new entries into the market and the industry will see increasing demand both locally and globally.

The qualitative and quantitative factors present a fantastic entry opportunity particularly for investors looking for exposure to the China growth story or iron ore.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.



Categories: Australian Stocks, Featured

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