Fortescue is now stuck between a rock and a hard place.
Investing heavily in expansion at the top of the cycle is a classic resource stock error that we have seen many times in the past. They have $10 billion in debt and at current iron ore spot prices they will have very little cash flow over the next year.
They have halted about $1.5b in capital expenditure and have even started offloading assets with the announcement of the sale of the Solomon power station today.
But the fact is that if iron ore prices stay around current levels for the next year then Fortescue will have to find $2 billion of external funding to pay for their current expansion plans, according to a recent broker report.
And Moody’s is close to downgrading the junk rating on Fortescue’s debt. In other words Fortescue will find it hard to raise debt because of their current debt load and the fact that they will not be cash flow positive.
Also they will dilute their current shareholders massively if they look to raise equity. As we say, they are stuck between a rock and a hard place.
So, what does this mean for the share price? Take a look at the Fortescue price chart:
From a technical analysis viewpoint, Fortescue has turned back down into long term downtrend, as the 35-day moving average has turned back down below the 10-day moving average.
If you look at the chart you can see that it retested the uptrend back in April this year but has since fallen nearly 50% from $6.00.
We shorted Fortescue in Slipstream Trader at $5.75 and took profits on the position at $4.25. The stock is down another $1.00 since then.
If you look at the RSI indicator below the chart you can see that FMG is now looking rather oversold. It has bounced from an oversold RSI level many times in the past. But I would certainly not buy FMG, based on the fact that it is oversold.
Personally I wouldn’t be surprised to see FMG fall to $2.00 or below if things continue to deteriorate in the iron ore market. But you should tread carefully if you’re thinking about shorting FMG at these levels.
I think the horse has bolted on the easy trade, and from here you will need to time your entry with more precision.
Murray Dawes
Editor, Slipstream Trader
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