Fortescue Ltd (ASX: FMG) shares bounced from monthly lows after receiving an upgrade from top broker Citi last week.
The firm has raised its rating on Fortescue shares to a buy, setting a revised price target of $21.
Fortescue shares are swapping hands at $17.25 apiece just after the open on Monday, implying nearly 22% upside potential at the time of writing.
Let's see why the broker made its moves.
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Citi bullish on Fortescue shares
Citi's decision to upgrade Fortescue shares comes after the iron ore giant's shares have tumbled more than 40% this year to date.
According to equities research chief Paul McTaggart, this sharp decline may have created a compelling buying opportunity for investors.
The broker believes that current market conditions, including expectations of iron ore stabilising around $US100 per tonne in 2025, support this view. According to The Australian Financial Review:
Consensus iron ore pricing of $US100/tonne in calendar year 2025 looks reasonable given an expected reduction in high cost production to offset new tonnes to the seaborne market.
2026 looks tougher given Simandou ramp-up.
McTaggart is referring to the anticipated ramp-up of Rio Tinto Ltd (ASX: RIO)'s Simandou mine, a major iron ore project in Guinea. This could add a layer of competition.
But the steep sell-off in the miner's shares may also be over-extended, he says. Fortescue shares are down more than other iron ore majors this year, which may create a "valuation discount" given it has the same exposure to the metal.
It's worth noting that Auburn Capital also has a bullish view on the miner's stock. It thinks the shares are attractive after the sharp sell-off in 2024.
Meanwhile, according to CommSec, consensus analyst ratings have Fortescue as a sell, meaning Citi's rating is contrarian.
Iron ore takes a dive
Citi's call on Fortescue shares stands out against a tight iron ore market. Prices are down 32% from January's high of US$144 per tonne.
Iron ore now trades at US$97.8 per tonne after nosediving further since July.
Poor demand for steel and a "housing oversupply crisis" in China are two of the main drivers of weak pricing, according to Trading Economics. Steel production has been scaled right back in China as a result.
Along with nickel, iron ore is the main ingredient required to produce steel.
The slump hasn't deterred Fortescue's Andrew "Twiggy" Forrest from taking a long-term view. Talking to The Australian, he noted that markets move in cycles.
The iron ore consumption doesn't go up in a straight direction, it has a jiggered edge on an upwards curve and we're in one of those downward edges right now, but the trend will still be strong.
[I]f you look at the big mega trends out there, I'm not worried about their trends going up or down because they happen to go up or down towards an upwards curve.
Foolish takeaway
Citi's upgrade of Fortescue shares to a buy is a contrarian view. The consensus rating on the miner's stock is a 'moderate sell'.
Despite the stock's recent decline, Citi believes the market is undervaluing Fortescue's long-term prospects.
Time will tell which side of the coin is right in the end, but much of the debate hinges on what iron ore prices do from here.
Fortescue shares are down 15% in the past 12 months.
