FMG shares drop 3% as Morgan Stanley downgrades the iron ore giant

Morgan Stanley today downgraded Fortescue Metals Group from equal-weight to underweight, with the investment bank expecting iron ore prices to decline in FY20.

The Fortescue Metals Group share price (ASX: FMG) rally from recent lows faced resistance today, as investors bid the stock down a little over 3% by the afternoon session.

This comes after Morgan Stanley downgraded the iron ore giant to underweight, in a research note released this morning.

Interestingly however, the investment bank actually raised its price target to A$7.85 per share on FMG – though it lowered its overall rating from equal-weight to underweight.

Why the downgrade then?

Overall, while the investment bank believes that FMG is a quality company, its share price has already run 13% ahead of Morgan Stanley’s own price target on the stock.

Indeed, Fortescue Metals Group (ASX: FMG) has been a significant benefactor of bullish commodity price movements since the beginning of the year, seeing its share price rise a massive 116% in that period.

Though FMG’s FY19 profits delivered handsomely on this commodity run-up, many have questioned how long iron ore prices can remain at current levels.

In addition to an elevated share price, part of Morgan Stanley’s underweight base-case thesis focuses on the expectation that iron ore prices will decline in FY20 and that FMG's production costs will mostly fall in line with previous guidance.

By comparison, lower costs, greater efficiencies and higher iron ore prices form part of the investment bank's bull thesis, which sees FMG's share price potentially running as high as A$12.25.

Such a perspective should be viewed in broader terms: namely that Morgan Stanley expects iron ore (Fines 62%) prices to decline in the mid-term.

Do supply-side issues remain?

The uncertainty around the role of Vale in the supply-side of the iron ore market is something that Morgan Stanley also touched on.

For example, though the Brazilian mining behemoth Vale has resumed production after a dam tragedy that occurred earlier in 2019 – how long it will take for the company to return to full production remains unknown.

The company itself has cited an estimate of 2 to 3 years.

Two possible worlds: the FMG share price

This moderated view from Morgan Stanley compares starkly to the bullish research from Macquarie Wealth Management released earlier this month.

Favouring FMG’s strong cash position, Macquarie slapped an outperform rating and a share price target of A$10.60 on the pure play iron ore miner.

Such contrasting views speaks to the intense volatility we have witnessed in the iron ore market of late – as iron prices rose as high as $120 per tonne this year, before dropping as low as $80 per tonne in August.

They are currently hovering around the $90 per tonne mark.

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