Fortescue hungry for hydrogen results

Rising input costs and falling revenue could make the next 12 months a little squeezy for billionaire iron ore miner and renewable energy enthusiast Andrew Forrest.

At best Fortescue, his primary mining business, will suffer a profit fall and pay a reduced dividend.

At worst, Fortescue’s profit could be severely crimped, especially if the Australian government’s iron ore price forecast of $US60 a tonne – roughly half last month’s price – is on the money (not that any government is good at tipping commodity prices).

As the major shareholders in the business, Mr Forrest and his wife, Nicola, will barely notice the change, even if their shared annual dividend cheque drops from $2 billion to $1 billion.

But the hit to its profit, which seems likely to occur amid a fall in the iron ore price from $US145/t at the start of the year to $US107/t earlier this month, will influence Fortescue’s other shareholders and the company’s growth plans.

Funding for the company’s ambitious hydrogen projects comes from iron ore sales. But the timing of an expected return on its investment in hydrogen appears to be shifting further into the future, because projects are yet to be built and hydrogen buyers hard to find.

The pincer effect of rising costs and falling revenue will be keeping Fortescue’s bean counters awake at night, because they have the added pressure of a demanding boss who is on a mission to wean the world off fossil fuels onto a diet of renewable energy, especially hydrogen.

Last year, there was limited questioning about whether Fortescue could do it all – generate handsome iron ore profits and fund a series of hydrogen projects – because the iron ore price was rising: from $US98/t in May to $US143/t in late December, and then up a further $US2/t to $US145/t in early January.

The strong rise over the last six months of 2023 enabled Fortescue to report a pre-tax (EBITDA) profit of $US5.9 billion in the half year to December 31 from revenue of $US9.5 billion. An enviable profit margin of 62 per cent on sales.

Looked at another way, underlying earnings amounted to $US73/t of iron ore. And that’s when the future starts to close in on Fortescue, because even if the government’s price forecast of US$60/t is wildly wrong, there are early signs of a squeeze developing, with $US80/t a popular price tip for iron ore later this year.

Former Goldman Sachs executive Dan Hershan is currently the biggest bear in the iron ore market. He’s tipping a fall to $US80/t (Business News, March 11, ‘Tricky read on tea leaves from China’), while also tossing in an inflammatory prediction that an iron ore supply glut will cause carnage among iron ore miners.

Fortescue has faced tough times before. It’s the nature of commodity markets that prices rise and fall with movement in supply and demand. Ten years ago, the iron ore price briefly dipped below $US40/t but Fortescue survived to prosper even though its share price dropped to $1.88, a faction of the all-time high of $29.95 reached in February.

This time there is a difference, and that can be found in Fortescue’s estimate $US800 million annual net operating expenditure on energy assets and $US500 million capital expenditure on energy assets and investments: a $US1.3 billion commitment on a business yet to generate profits.

It’s the drive to diversify into renewable energy that makes the latest squeeze on iron ore profits different this time, largely because doubts continue to grow about the profitability of renewable energy, especially hydrogen, which is yet to attract many users.

Two recent examples highlight the financial challenge of hydrogen.

The first was a comment from Fortescue Energy boss Mark Hutchinson that Australian power prices needed to be halved for green hydrogen produced by the electrolysis of water to be profitable.

Halving power prices in Australia will not be easy in an environment of sticky inflation and rising costs, especially for labour.

The second example of hydrogen’s problems was a comment from Woodside Energy boss Meg O’Neill that potential hydrogen buyers in its H2OK project in Oklahoma had been slower to emerge than anticipated.

Hydrogen, it seems, is facing similar challenges to iron ore. Costs are higher than expected and demand is weaker, which means revenue is going to be harder to generate. Like other iron ore miners Fortescue has suffered a sharp share price correction since the iron ore price started to fall, but its 16 per cent drop is roughly double that of primary rivals BHP and Rio Tinto, which have a cushion under their earnings in the form of major copper interests, which are benefiting from a rising copper price.

Another significant difference is that Fortescue is the only iron ore miner attempting to launch a radical new business in hydrogen as iron ore revenue contracts.

Most investment bank analysts are wary of Fortescue’s ambitious hydrogen plans [and are] waiting to see what the final costs are and when the new business might be profitable.

Macquarie Bank summed up the mood of the market in its comments published after the release of the company’s half-year profit last month, warning that “with uncertainty over the capital commitment to FFI (Fortescue Future Industries) we maintain a cautious outlook”.

Like most other banks, Macquarie is sticking with a ‘sell’ recommendation and a forecast that Fortescue’s share price will continue to fall, down as far as $18.50, which would take the stock’s drop this year to 37 per cent.

The Forrest family, with its huge annual dividend, will not be concerned about Fortescue’s adventures in hydrogen. Small shareholders and fund managers are not so confident. They’re worried whether their company is biting off more than it can chew.

Two lithium tales

AUSTRALIA’S lithium miners are not out of the woods, yet, but it is possible to see a demarcation developing between those companies likely to survive the current low-price environment and those that will struggle.

A perfect illustration was obvious earlier this month when Liontown Resources, a company controlled by Gina Rinehart, secured a project development loan to replace one that had earlier been withdrawn.

If push comes to shove for Liontown, Mrs Rinehart could pay for its Kathleen Valley lithium mine in Western Australia with her spare change. That won’t be necessary, however, as banks queue up to provide debt for a business with the Rinehart name attached.

Core Lithium is going the other way, with its Finniss project in mothballs and directors heading out the door, led by exiting chief executive Gareth Manderson.