Is the Fortescue share price really the cheapest ASX 200 materials share on the market?

Are Fortescue's shares cheap or a value trap?

| More on:
A man wearing a shirt, tie and hard hat sits in an office and marks dates in his diary.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Key points

  • Fortescue's shares are changing hands for just 4.1x FY 2021 earnings
  • Investors may think this makes them among the cheapest shares around
  • However, they could actually be expensive and not cheap after all

The Fortescue Metals Group Limited (ASX: FMG) share price has come under pressure this month amid weakness in the iron ore price.

Since the start of June, the mining giant's shares are down 10%.

Is the Fortescue share price cheap?

Following this decline, the Fortescue share price is now trading at $18.00. Based on this and FY 2021's earnings per share of $4.43, this means that its shares are changing hands for just 4.1x earnings.

However, it is worth remembering that the market is more interested in what the future holds than in what happened in the past.

FY 2021 was an incredible year for Fortescue. And while FY 2022 will go down as a very good year, it won't stop the company from posting a big decline in its earnings.

Goldman Sachs is expecting earnings per share of US$2.00, which equates to $2.90 per share in local currency. This means that Fortescue's shares are trading at 6.2x forward earnings.

Let's now take a look at how this compares to other ASX 200 mining shares:

  • BHP Group Ltd (ASX: BHP) shares trade at 6.1x FY 2022 estimated earnings
  • Rio Tinto Limited (ASX: RIO) shares trade at 6.2x FY 2022 estimated earnings
  • South32 Ltd (ASX: S32) shares trade at 5.3x FY 2022 estimated earnings

As you can see above, based on price-to-earnings (PE) multiples, the Fortescue share price is no cheaper than the rest of its peers.

What about other multiples?

While PE multiples are a popular tool for investors to use for share market valuations, they're not used widely with mining shares. Instead, price to net asset value (NAV) and EBITDA/EV multiples are seen as better suited for mining valuations.

This is important, because if you rely on PE multiples to value mining shares, you may end up buying shares that you think are cheap, but the rest of the market thinks are expensive.

The Fortescue share price is actually a prime example of this.

Goldman Sachs recently explained why Fortescue shares are actually expensive compared to the likes of BHP and Rio Tinto. This is despite its outlook being much weaker than the others.

The stock is trading at a significant premium to BHP & RIO; c. 1.7x NAV vs. RIO & BHP at c. 0.9x NAV & 1.1, c. 6.5x EBITDA (vs. BHP & RIO on c. 4x), and c. 4% FCF vs. BHP & RIO on c. 11-13%.

In light of this, the widening of low grade 58% Fe product realisations, execution and ramp-up risks on the Iron Bridge project, and uncertainties around its Fortescue Future Industries (FFI) diversification and Pilbara decarbonisation plans, Goldman has a sell rating and $13.50 price target on Fortescue's shares.

This implies potential downside of 25% for investors over the next 12 months. Food for thought.

Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. 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.

More on Materials Shares

A man holds his hand under his chin as he concentrates on his laptop screen and reads about the ANZ share price
Materials Shares

Down 39% in a year, why IGO shares still look overpriced

A leading expert doesn’t believe IGO shares are out of the woods just yet.

Read more »

Man with rocket wings which have flames coming out of them.
Materials Shares

This ASX 300 stock is surging 25% on US defence deal

The announcement of a 'a pivotal milestone' is getting investors excited today.

Read more »

A happy construction worker or miner holds a fistful of Australian dollar notes.
Materials Shares

$5,000 invested in BHP shares 5 years ago is now worth…

Will its shareholders be happy with their investment? Let's find out.

Read more »

A young man punches the air in delight as he reacts to great news on his mobile phone.
Materials Shares

Guess which ASX 200 stock is ending the week with a bang thanks to Rio Tinto

This stock has won a major contract from the mining giant.

Read more »

A man wearing a hard hat and high visibility vest looks out over a vast plain where heavy mining equipment can be seen in the background.
Materials Shares

Is it time to buy ASX lithium shares?

Lithium prices continue to sink. Has this created a buying opportunity?

Read more »

A man sits in despair at his computer with his hands either side of his head, staring into the screen with a pained and anguished look on his face, in a home office setting.
Materials Shares

Mineral Resources shares sink on Onslow Iron blow

This miner is having a tough session. Let's find out why.

Read more »

A man sits in a chair hunched over a laptop and covered head to toe in frozen icicles to represent Envirosuite's trading halt
Materials Shares

MAC Copper shares in trading halt as miner flags 'potential control transaction'

MAC Copper shares are frozen while Sandfire Resources shares are the fastest risers of the ASX 200 today.

Read more »

A young man pointing up looking amazed, indicating a surging share price movement for an ASX company
Materials Shares

Bell Potter says this ASX lithium stock could rise ~50%

The broker has just put a buy rating on this lithium stock.

Read more »