Shares of Fortescue Metal Group [ASX:FMG] dropped slightly by 1.46% on Wednesday, closing at $4.73. This is close to the lowest it’s been since 8th October 2013.
Fortescue Metals Group Ltd is an iron ore production and exploration company with assets located in the Pilbara region of Western Australia.
Fortescue’s share price has struggled recently, despite its plans to boost iron ore production by 35% in the next quarter. The company’s share price has fallen by 20% since the beginning of this year.
Effectively, Fortescue is a leveraged play on the iron ore price, which has fallen 23% for the year to around US$104 per tonne.
The issue is two-fold:
1) Fortescue has an extremely high cost of production. Analysis suggests that if the iron ore price falls below US$80 per tonne, Fortescue will be losing money.
2) Fortescue’s net debt (cash less debt) represents roughly 55% of its market capitalisation of around US$8.6 billion. This is very high.
If the iron ore price falls further, its profit margin will be squeezed. As such, it will become more difficult for Fortescue to repay its debt. This is probably what worries punters.
FMG has recently reached its long-term ore production goal of 155 million tonnes per year, thanks to completion of the Kings Valley project.
At the moment, Fortescue’s share price has broken through its technical downtrend support line. Indications suggest the share price may fall further from here. Major long term support for the stock exists around the $4.40 level.
Nonetheless, if iron ore rallies, the share price could rise above the six dollar level in the next few months as a result of increasing production.
Jason Stevenson+
Resources Analyst, Diggers and Drillers