• Growing demand from steel mills in Malaysia to spur higher sales volumes. We project 54% volume growth from FY20 to FY22e.
• Low production cost of US$28.81/WMT. Reserves to expand with only 5% of its mining concession area explored so far.
• Initiate coverage with BUY and TP of S$0.28. Valued at 11x FY21e PE, in-line with industry average. Fortress is smaller in size but is growing faster and enjoy higher returns than industry.

Company Background

Fortress Minerals (FML) is an iron ore concentrate producer in Malaysia. As FY2019 was the Group’s maiden year of commercial production, profitability margins were partly crimped by initial ramp-up costs and gestation. Its mining concession is located in Bukit Besi, Terangganu, Malaysia, with 7.18MT of reserves and 13 years of concession life.

FML explores, mines, produces and sells magnetite iron-ore concentrate. Steel is the world’s most commonly used metal and iron ore is a key ingredient in steel-making. FML sells primarily to steel mills in Malaysia and China.

Investment Merits

1. Healthy volume growth of 40% expected in FY21e to meet construction demand. 1HFY21 production volume surged 57% YoY to 231,007 WMT. Demand was driven by new offtake agreements with steel mills in Malaysia. We expect FML to increase production by 54% from FY20 to FY22e. Malaysia’s 9M2020 production of iron and steel bars and rods grew 5.5% YoY. On the basis of projected GDP growth of 6.5%-7.5% and construction-sector growth of 13.9% in 2021, demand for steel and iron ores is expected to increase.
2. High profitability due to low-cost structure and proximity to customers. Unit cost of US$28.8/WMT against ASPs of US$95.9/DMT yielded gross profit margins of 66.7% of (industry average of about 50%) in FY20. Another advantage FML has is the close proximity of its Bukit Besi mine – of about 100km – to domestic steel-mill customers. The quality of its iron ores (TFe grade of 65.0%), consistent supply and short delivery time are expected to ensure captive buyers from steel mills in Malaysia. Iron ores from Australia require a delivery time of about 10-20 days vs. daily trucking services in Malaysia.
3. Considerable exploration upside potential with 5% of concession area explored. FML completed its plant expansion in late FY2020. Of its concession area of 526.2 ha at Bukit Besi, less than 5% has been explored. There is thus substantial potential for mining as larger tracts are explored. FML’s mining rights will only expire in early 2033.

We initiate coverage with a BUY rating and TP of S$0.28. Our TP is based on 11x FY21e PE, in-line with industry average.

About FML

FML was incorporated in Singapore on 13 November 2017 as a private limited company. It was listed on the Catalist on 27 March 2019. It operates its mine through its subsidiary, Fortress Mining.

Business operations are located in Kuala Lumpur, Malaysia, though its Bukit Besi mine is situated in Bukit Besi, Terengganu, Malaysia.

REVENUE

With the company’s first shipment of iron-ore concentrate in 2QFY19, revenue in FY20 increased 25.7% YoY to US$25.9mn. Sales revenue is calculated from average realised prices (per dry metric tonne, DMT) multiplied by the volume of iron ores sold. Average realised prices are benchmarked to the Platts Iron Ore index (IODEX), Daily Iron Ore Price Assessment for composition of 65% Fe CFR (cost and freight terms) North China.

Net profit in 1HFY21 was higher than the whole of FY20 on the back of higher volume sold. The latter compensated for lower average realised selling prices.

IODEX iron-ore prices have been above the US$110/DMT mark for the past two months (Figure 3). As iron-ore prices hit a seven-year high, FML is expected to realise higher revenue.

1HFY21 revenue was US$20.1mn. There was a 60% YoY surge in sales volume for 2QFY21, which good weather conditions partly contributed to. Assuming FML maintains production levels prior to 2QFY21, it should be able to achieve revenue of US$36.4mn for FY21e (Figure 4).

There was no revenue contribution in FY20 from steel mills in China (Figure 5). In 9MFY21, FML sold iron-ore concentrates to 3-4 major customers in Malaysia. It has been focusing on demand from domestic steel mills since 2019.

Offtake agreement. FML announced on 1 September 2020 that one of its subsidiaries, Fortress Resources, had inked a new one-year offtake agreement with a domestic steel mill in Malaysia. Fortress Resources will deliver 400,000 WMT of iron ore to this customer over 1 September 2020-31 August 2021. This volume is more than the total volume it sold in FY2020. The selling price of the iron ore concentrates will be based on a formula guided by the average of the available daily price of Platts for 65% Fe CFR North China, adjusted subject to the Fe content of each shipment of the deliverables.

We estimate a 10% YoY increase in volume sold for FY22e (Figure 6).

EXPENSES

Main expense items in 1H21 were royalties payable to the State Government of Terengganu, and holder of mining leases for its concession, ocean freight, transportation, labour, plant and overheads.

FML pays a royalty fee directly to the State Government of Terengganu at the rate of 5.0% of revenue or as specified by the government, and holder of the mining leases at triple the rate of the former.

FML constantly takes steps to reduce its unit costs, including continuous implementation of productivity improvement and cost management strategies. The company managed to reduce average unit costs by 7.0% from FY19 to FY20. With larger volumes production, it should be able to benefit from economies of scale.

BALANCE SHEET

Assets. Fixed assets doubled from FY18 to FY20 (Figure 10), with plant and equipment increasing from US$7.3mn to US$13.5mn. This was the result of plant expansion.

Liabilities. FML has very low levels of borrowings. It had a net cash position of US$2.1mn in FY20.

CASH FLOW

Cash flows have been strong since listing in 2019, considering commercial production only started in FY19 (April 2018). Cumulative operating cash flow from FY18 to FY20 was US$15mn. Capex averaged US$5mn for the same period.

Investment Thesis

1. Healthy volume growth of 40% expected to meet construction demand. 1HFY21 production volume surged 57% YoY to 231,007 MT. The increase was used to fulfil new offtake agreements with steel mills in Malaysia. We expect production to increase by 54% from FY20 to FY22e. 9M2020 production of iron and steel bars and rods in Malaysia grew 5.5% YoY. Based on the expected GDP growth of 6.5%-7.5% and construction-sector growth of 13.9% in 2021, demand for steel and iron ores is expected to increase.
2. High profitability due to low-cost structure and proximity to customers. Unit cost of US$28.8/WMT against ASPs of US$95.9/DMT yielded gross profit margins of 66.7% in FY20. Another advantage FML has is the close proximity of its Bukit Besi mine – of about 100km – to domestic steel-mill customers. The quality of its iron ores (TFe grade of 65.0%), consistent supply and short delivery time are expected to ensure captive buyers from existing steel mills in Malaysia. Iron ores from Australia require a delivery time of 10-20 days vs. daily trucking services in Malaysia.
3. Considerable exploration upside potential with 5% of the concession area explored. FML completed its plant expansion in late FY2020. Of its concession area of 526.2 ha at Bukit Besi, only less than 5% has been explored. There is thus substantial upside potential for mining as larger tracts are explored. FML’s mining rights will only expire in early 2033.

Risks

1. Covid-19 disruptions. Malaysia’s movement control disrupted FML’s operations from 18 March to 29 April 2020. In November 2020, there was an outbreak of the virus in a workers’ accommodation, which led to widespread infection. FML’s business operations are highly dependent on local workers, some of whom reside in their staff dormitories. Any unexpected outbreak of the virus may result in a suspension of its business operations again.
2. Iron-ore prices may fall from current peak levels. Iron-ore prices affect the company’s revenue directly. Iron ore prices have reached seven-year high, aided by fast-recovering steel markets and stimulus measures in China. A shortage of supply caused by Covid-19 measures which disrupted shipments of iron-ore concentrates to China and global supply chains also contributed to increased prices. In the medium term, supply is expected to recover. Though a demand recovery could be slow as most countries are still trying to contain the virus, demand for steel from China is expected to remain strong. This should keep prices above US$110/DMT.

INDUSTRY

Iron ore is the source of primary iron for the world’s iron and steel industries. About 98% of iron ores produced are converted into pig iron for steel-making, which is widely used in the construction of buildings, bridges, household appliances, transport vehicles, etc.

China is the world’s largest producer and consumer of crude steel. It accounts for 53.3% and 49.2% of the world’s production volume and demand respectively. It is also the world’s largest importer of iron ores, making up about 70% of the world’s demand. Demand from China has been supporting the uptrend in iron-ore prices since 2016.

Steel production. With the manufacturing sector reeling from Covid-19 measures, steel production fell sharply in 2Q2020 (Figure 14). Recovery has been uneven across the countries, depending on their containment of the virus, stimulus measures, etc. As such, world steel consumption is expected to contract by 5% this year, before expanding in 2021 (Figure 15).

Iron ore. Being one of the first countries in the world to resume economic activities after its successful containment of the coronavirus, China’s domestic demand for iron ores and imports has been increasing since 2Q2020. China’s persistent demand combined with a seasonal drop in supply from Australia and Brazil have bumped up iron-ore prices. Throughout the pandemic, the prices of iron ore have been remarkably resilient, trading with low volatility.

Mid-term, iron-ore prices are expected to dip from their peak due to a restocking of supplies. In the short term, demand from China is expected to remain robust. For the rest of the world, we expect demand for iron ores to recover only from 2021.

Malaysia.  The construction industry is the basic source of steel demand in Malaysia. In Malaysia’s Budget 2020, the government pledged to continue or revive mega-infrastructure projects such as the Bandar Malaysia central transport hub project. It is projected that steel consumption in the country will grow from 9.4mn tonnes in 2017 to 12.4mn tonnes in 2025, at a CAGR of 3.5%.

Under Malaysia’s more recent Budget 2021, the government has pledged to allocate more resources to “restart” the economy. GDP is expected to contract by 4.5% in 2020 due to the pandemic, before returning to 6.5-7.5% growth in FY21.

Outlook. The construction sector is expected to shrink 18.7% in 2020, led by significant contractions in all subsectors: civil engineering, residential and non-residential buildings. The sector is expected to return to growth of 13.9% in 2021.

Mining GDP is expected to contract by 7.8% in 2020 and increase by 4.1% in 2021.

For the first 9 months of 2020, the production of iron and steel bars and rods in Malaysia grew by 5.5% YoY. On the basis of a recovery in the economy and construction sector in 2021, demand for steel and iron ore is expected to increase.

FML faces competition from both PRC and global iron ore producers. There are 3 other main competitors in Malaysia. There are no figures available regarding the market share of these companies.

Fortress mainly serves their group of captive customers in Malaysia and has achieved remarkable growth in a short span of 2 years. The desire to achieve greater economies of scale through higher production volume will drive all iron-ore producers to continue their expansion plans, in terms of increasing processing capacity and acquisitions.

Valuation

We initiate coverage of FML with a BUY recommendation. Our TP is pegged to 11x FY21e PE (Figure 20).

FML has been trading at a discount to its larger peers in Australia and Brazil due to its smaller scale, liquidity and short history. With the higher (ROE) returns and faster growth than the industry, we believe FML should trade in-line with peers.

In the near term, the company may be affected by iron-ore prices coming down from their peak. Mid-term, demand and the price of iron ore should grow as Malaysia and China ramp up their steel production.

FML’s expanded capacity in the last two years has positioned the company well to meet higher demand. It also has considerable exploration upside in its mining concession, as only 5% of its concession has been explored so far.

The report is produced by Phillip Securities Research under the ‘Research Talent Development Grant Scheme’ (administered by SGX).