The iron ore rout is the talk of markets and sector heavyweight Fortescue Metals Group (ASX:FMG) has been copping a hiding.

Although iron ore prices stabilised on Friday night, that didn’t stop another FMG sell-off yesterday as the stock fell by another 4.3%, bringing its cumulative August decline to more than 20%.

But in its recent analysis of reporting season, UBS suggested that markets have overshot when it comes to near-term FMG bearishness.
 

Fortescue Metals — oversold?

The recent decline in prices “has driven many to position for further downside risk on iron ore miners”, the analysts noted.

And as an un-diversified miner that generates more than 90% of its revenues from iron ore, Fortescue Metals is particularly exposed.

However, FMG has also raised its overall export volumes during a period in which spot iron ore prices surged above US$200/tonne, which left the company with net cash of US$2.7bn as at 30 June.

Plenty of that cash is expected to flow to shareholders through a record dividend of more than $3 per share when FMG reports its full-year results on August 30.

As as result, Fortescue is now trading with a dividend yield that’s “50-60% above its peers”, UBS said — a discrepancy which is exacerbated the more FMG’s share price falls.

“We think the market has oversold this stock ahead of its FY21 announcement on August 30,” UBS said.

They noted that both BHP and Rio Tinto “rallied into their strong results, and we think FMG is likely to see similar price action until then”.

However, over the medium term their forecast isn’t so bright — in line with the consensus forming in the market that iron ore will continue falling back towards US$100/tonne as Chinese demand cools and supply ramps up out of Brazil.

The UBS forecast is for prices to finish 2022 at $US100, which is below the current consensus estimate of around US$130, the bank said.

Longer-term, UBS expects prices to fall back to around US$75/t by the end of 2024.

“After the reporting date, we would strategically position short (FMG) with iron ore expected to fall,” UBS said.

 

‘Fade’ the lockdown

Elsewhere, with reporting season about halfway done, the ratio of ASX100 companies who beat earnings expectations (relative to misses) is currently tracking at 3.4-to-1 — an all-time high.

“This stellar run lifted the ASX200 to a record high on 13-Aug, albeit since easing on a declining iron ore price,” UBS said.

In any earnings season, the central focus for investors isn’t just the full-year numbers, but the outlook for the year ahead.

UBS noted that the COVID-19 battle which Sydney and Melbourne are currently losing will undoubtedly drag on economic growth and at least delay the housing boom.

However, despite some jitters on global markets last week, local investors are focusing on the bright side — plenty of bumper FY21 profits, low interest rates, and a bullish FY22 outlook once COVID-19 restrictions are wound back.

In other words, “fade the lockdown, for now”, UBS said.

The analysts flagged the risk that lockdowns in the major east coast markets may have to be extended for longer.

And there’s also the risk that ongoing Delta outbreaks will weigh on the Chinese economy and US consumers.

However, “we expect a dovish RBA to delay QE tapering, which combined with fiscal support, should offer a firm floor to Australian equities”, UBS said.

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