Fortescue shares: Bull vs. Bear

Multiple ASX share investors take on one another in a tug of war in a high rise building.Multiple ASX share investors take on one another in a tug of war in a high rise building.

Shares in S&P/ASX 200 Index (ASX: XJO) mining giant Fortescue Metals Group Ltd (ASX: FMG) have had a stellar run over the past five years, surging by more than 300%.

And during this time, the iron ore miner’s executive chair, Andrew ‘Twiggy’ Forrest, has never been far from the headlines.

Love him or loath him, most Aussies with even a passing interest in investing would likely agree that Twiggy is one of the local bourse’s highest-profile (and, arguably, divisive) leaders.

He established Fortescue just 20 years ago, building it up to become the $70 billion global behemoth it is today.

But what of Twiggy’s green hydrogen dreams? Will these ambitious plans be the making or the undoing of the ASX’s eighth-biggest company?

For their thoughts on whether Fortescue can continue delivering share price gains and decent dividends for its shareholders, we decided to ask two of our Foolish writers: one bull and one bear.

Here is what they said:

Bull thesis

By Tristan Harrison: The Fortescue share price has risen by 50% since 31 October 2022, with the iron ore price climbing to its current level of around US$129 per tonne (at the time of writing), according to Commsec.

In the short term, movements of the iron ore price will likely be the strongest influence on investor sentiment surrounding Fortescue. If the iron price drops, then Fortescue shares would likely fall too.

But, the Chinese economy isn’t firing on all cylinders (yet), according to CNBC reporting. With lockdowns largely over and economic ties with the West improving, there could be another period of heightened demand for iron ore (and, therefore stronger profits for Fortescue), particularly if the Chinese government implements more growth policies focused on infrastructure and construction.

Goldman Sachs has also predicted that the iron ore price could rise by 20% to reach US$150 per tonne over the next few months, according to reporting by the Australian Financial Review. This could provide another potential boost for the Fortescue share price moving forward.

Another potential tailwind for Fortescue is that it’s working on unlocking the huge Belinga iron ore project in Africa. This could help drive future earnings and add geographic diversification to the company’s iron portfolio.  

But iron isn’t my main reason for optimism about Fortescue shares.

I think that Fortscue Future Industries (FFI) is unlocking a very large avenue of growth for the company, which could already be worth many billions.

It’s aiming to produce 15mt of green hydrogen by 2030 which, according to management, is “very achievable”.

FFI already has customers lining up to buy some of that output, including European multinational utility operator E-ON, which could buy a third of the production by 2030. Once hydrogen production is up and running, I believe it will start generating meaningful earnings for Fortescue.

Decarbonising the planet could cost trillions of dollars according to various estimates. While this presents a cost for some, it creates a significant revenue opportunity for others. To this end, FFI is working on a global portfolio of green projects, on every populated continent.

Furthermore, heavy machinery, planes, and ships use vast amounts of fuel. This could be replaced by green hydrogen/green ammonia in the future, potentially unlocking a huge earnings stream for Fortescue over the coming decades.

FFI is also working on building a leading, global high-performance battery business with its WAE acquisition.

For these reasons, I believe Fortescue shares have a positive future, with the green side of the business potentially unlocking many billions of dollars in value. Whilst the shorter-term outlook could be volatile for the Fortescue share price, I’m staying focused on the long-term investment outlook.

Motley Fool contributor Tristan Harrison owns shares in Fortescue Metals Group Ltd.

Bear thesis

By James Mickleboro: Although Fortescue is undoubtedly a high-quality mining company, I believe its shares are vastly overvalued at current levels and could be about to begin a multi-year slide downwards.

The main reason for this is that the company’s noble but costly decarbonisation plans look set to consume large amounts of its free cash flow and put significant pressure on its dividend payments.

If I were to say that Fortescue shares will soon provide investors with a 2% dividend yield, I wonder how many would be willing to hold onto them at current levels. My bet is very few. Particularly when you can earn a greater risk-free return from term deposits.

Well, the bad news is that a number of brokers believe that this could be the case in just two short years.

For example, Goldman Sachs is forecasting dividends per share of 38 US cents in FY 2024, 31 US cents in FY 2025, and then 32 US cents through to FY 2027. Based on the current Fortescue share price and exchange rates, this will mean yields of 2.5%, 2%, and then 2.05%, respectively.

Elsewhere, Morgans is a little more upbeat and expects yields of 3.6% in FY 2024 and then 2.2% in FY 2025. Though, it warns that Fortescue could even struggle to pay these dividends if iron ore prices are softer than expected. This could see management forced to lower its target payout ratio to support the high capital intensity of the FFI business.

But it’s not just dividends that make me bearish on Fortescue’s shares. It is also the company’s valuation compared with more diversified peers.

While Fortescue may look like good buying based on its price-to-earnings (P/E) ratio of around 8 times, this multiple is not widely recommended for valuing mining shares as it tends to make them look cheap in comparison to shares in other sectors.

Instead, Goldman Sachs uses the price-to-net-asset-value (NAV) ratio for valuing mining shares. 

And despite the uncertain outlook for the miner, the broker notes that Fortescue trades at a sizeable 1.6 times NAV. As a comparison, BHP Group Ltd (ASX: BHP) trades at 1.1 times NAV and Rio Tinto Ltd (ASX: RIO) shares are changing hands at 0.9 times NAV.

Overall, I believe the risk/reward on offer with Fortescue shares is extremely unfavourable and, thus, I’d urge investors to stay clear of the ASX 200 miner.

Motley Fool contributor James Mickleboro does not own shares in Fortescue Metals Group Ltd.

The post Fortescue shares: Bull vs. Bear appeared first on The Motley Fool Australia.

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The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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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