Shares of Fortescue Metal Group [ASX:FMG] fell 1.92% to $4.09 today. The iron ore price is trading lower this week, now at US$87.90 per tonne. This represents a profit margin of roughly $7.90 per tonne for Fortescue.
On a separate note, I’ll be providing analysis on the future of the iron ore industry in Diggers and Drillers this week.
Fortescue Metals Group Ltd is an iron ore production and exploration company with assets located in the Pilbara region of Western Australia.
Like many other iron ore operators, Fortescue’s share price has struggled recently. The company’s share price has fallen by 30% since the beginning of this year.
Fortescue is effectively a leveraged play on the iron ore price. However, it has two issues:
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1) Fortescue has a high cost of production for a large miner. Analysis suggests that if the iron ore price falls below US$80 per tonne, Fortescue would lose money.
2) Fortescue’s net debt (cash less debt) represents roughly 50% of its market capitalisation of around US$7.2 billion. This is very high, though it’s improved slightly since the last quarter as its cash balance has risen.
The company increased its cash position by roughly US$500 million in the June quarter to US$2.4 billion. As long as this trend continues, the company should safely be able to meet its debt obligations over the next couple of years.
Nonetheless, further declines in the price of iron ore will squeeze Fortescue’s profit margin. This is what worries investors.
And for this reason, Fortescue will remain a leveraged play on the iron ore price.
FMG recorded a production run-rate of roughly 155 million tonnes per year over the quarter, thanks to the completion of the Kings Valley project.
Fortescue’s share price direction will depend on the iron ore price. Although the iron ore price dipped below the crucial US$90 support level, FMG’s share price has held up relatively well and hasn’t really moved since May.
If the iron ore price can increase and hold above the US$100 dollar level, Fortescue’s share price should be trading above $5 per share.
Jason Stevenson+
Resources Analyst, Money Morning
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