Why the Fortescue share price rallied over 40% to a record high in 2020

The Fortescue Metals Group Limited (ASX: FMG) share price hit a high a record high this afternoon and is among the top performers on the S&P/ASX 200 Index (Index:^AXJO) this year.

Shares in the iron ore miner jumped 2.6% to $15.24 in after lunch trade, which takes its gains for 2020 to 42%.

In contrast, the BHP Group Ltd (ASX: BHP) share price and the Rio Tinto Limited (ASX: RIO) share price shed 7% and 2%, respectively, over the period.

Good reporting season ahead

There are a few reasons for Fortescue’s outperformance. Firstly, the miner is tipped to be one of the August reporting season heroes.

There isn’t much risk of the miner disappointing on the profit front when the iron ore price remains stubbornly strong right through the COVID-19 market meltdown.

Further, the outlook for the commodity looks reasonably bright even as the global economy is hit by the proverbial coronavirus-recession bus.

Brazil’s inability to control the rampant outbreak means rival Vale SA’s iron ore production levels will stay depressed over the short- if not medium-term.

Fortescue’s temporary edge over BHP and RIO

What’s good for the goose is normally great for the gander too. This means BHP’ and Rio’s earnings should benefit from the same thematic.

The issue for BHP is that it’s diversified income stream, which is normally seen as a plus in managing single-commodity risk, is hurting sentiment. The group is exposed to oil production and the outlook for crude isn’t great.

Investors are also keener to support Fortescue over Rio Tinto because the former is more leveraged to buoyant iron ore prices. Fortescue’s production costs are higher than Rio Tinto and its ore is generally of lower quality.

When it pays to be the second fiddle

Given that profit margins of Chinese steel mills are reasonably high and there’s little chatter about the Chinese government imposing strict environmental pollution controls, these customers won’t mind buying the lower quality ore.

Historically, companies at the lower end of the quality scale tend to outperform when things are going well but underperform when the outlook turns.

ASX dividend outlook

Another reason why Fortescue is proving to be so popular is its dividend. There’s a big recent step-change in dividends from Fortescue, and even with the share price rally, I think the stock can generate an FY20 dividend yield of around 10%.

That’s more generous than BHP or Rio Tinto, even though their yields will put many others to shame.

The only thing is that Fortescue’s dividend payment is expected to peak in FY20 before turning lower in the next two years.

Despite this, I think the stock will continue to be well supported until steel margins come under pressure or when Vale returns to full production.

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• How does the Fortescue share price compare to its peers?

Motley Fool contributor Brendon Lau owns shares of BHP Billiton Limited and Rio Tinto Ltd.  Connect with me on Twitter @brenlau.

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. 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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