Citi cuts Fortescue’s outlook over unreasonal expectations for hydrogen arm
Brokers are slashing the outlook of Fortescue over its green hydrogen arm, with Citi saying its current share price run implies ‘unreasonable expectations’ of the division.
A substantial valuation gap compared to its peers and unreasonable expectations surrounding its green hydrogen arm has prompted Citi to downgrade Fortescue Metals to a “sell” rating.
The broker noted on Wednesday that while iron ore prices surprised to the upside and dividend yields for miners remained robust, the West Australian-based company’s share price performance suggested unreasonable valuation expectations for its green hydrogen division, Fortescue Future Industries.
FFI was established in 2020 as a global green energy and product company owned by Fortescue. The business is working to produce zero-emission green hydrogen from 100 per cent renewable sources with a target of 15 million tonnes of green hydro by 2030.
It announced late last month that it had designed and constructed its own electrolyser to make hydrogen.
Citi said FFI would need a valuation of $US11.3bn ($15.6bn) to bridge the gap to its peers, but recent modelling for a normalised second-half project with capital expenditure of $US2bn and 12 per cent internal rate of return would only generate net present value of about $US550m.
“We don’t believe it’s possible for FFI to bridge the valuation gap – the maths is just too demanding,” Citi said.
“To fill a $US11bn valuation gap would require 20 such projects and total capital spend of $US40bn. At this early stage and with no visibility, this seems a bridge too far.”
Citi said that, in the past three months, Fortescue’s shares had risen by 46 per cent, while the price of iron ore was up 8 per cent and other iron ore producers’s stocks had increased by about 6 per cent on average.
Shares in Fortescue, which has a $64.38bn market cap, closed 1.1 per cent lower on Wednesday at $20.88. Despite a 46 per cent increase in the past three months, the share price was 17 per cent lower than a peak in July.
Citi has set a target price of $17.20 derived from a 50-50 blend of 5.5 times 2023 financial year earnings/EBITDA and net present value less expected dividends.
The downgrade by Citi is the latest bleak outlook for Fortescue, with multiple brokers slashing expectations on the company in the past week.
Goldman Sachs has one of the most bearish values at $11 a share, whereas Morgan Stanley has Fortescue as a sell at $14.05.
Morningstar Quantitative said the stock was overvalued and had a $16.31 target price, while analysts at Macquarie and Bell Potter still recommend the stock as a buy.
Citi said the key risk to its target price was that Fortescue was exposed to a single commodity with two mines, which left it highly exposes to operational and commissioning delays.
“Fortescue is highly leveraged to the iron ore price and a lower Australian dollar is beneficial to earnings,” the broker said.
“If the impact on the company from any of these factors proves to be greater than we anticipate, the stock will likely have difficulty achieving our financial and price targets.”
Citi said it was hard to overlook the large valuation gap.
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