What Happened to the Fortescue Metals Group Share Price?
Shares of Fortescue Metal Group [ASX:FMG] fell by 5.71% to $2.81 today.
The iron ore price is trading at US$70 per tonne. Based on its total costs, this represents a profit of roughly $6.50 per tonne for Fortescue.
Why Did This Happen to FMG Shares?
Fortescue Metals Group Ltd is an iron ore production and exploration company with assets located in the Pilbara region of Western Australia.
Fortescue is effectively a leveraged play on the iron ore price. However, it has two issues:
1) Fortescue has a higher total cost of production for a large miner for a number of reasons. My analysis suggests that if the iron ore price falls below US$76.50 per tonne, Fortescue would lose money based on its total costs (including exploration, price discount, C2 costs, interest and sustaining capital).
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2) Fortescue’s net debt (cash less debt) represents roughly 54% of its market capitalisation of around US$5.9 billion (after the next payment). This is very high, though it’s improved slightly since the last quarter as its cash balance has risen.
What Now for Fortescue Metals Group Ltd?
FMG has a US$1 billion payment due in April 2017. At the moment, US$2.6 billion in the bank is sufficient to meet this obligation.
But assuming the iron ore price returns to around US$80 per tonne, FMG will generate roughly $525.5 million in free cash flow by this time — this is at a production rate of 155 million tonnes per annum. If FMG can keep lowering its C1 costs, the company will benefit by higher free cash flow generation. Increasing free cash flow is good news.
With that said, FMG then has another US$900 million due in 2018. This payment should be covered with the growing cash flow and existing facilities. However, this is where the problems start.
FMG has a further $4.9 billion due in 2019.How it will meet this payment is anyone’s guess at the current iron ore price.
Now you might be thinking, 2019…right now is 2014. That’s five years away!
This is called investing. You don’t invest in a company blindly thinking that everything will be alright in the long run. This strategy almost always ends in tears.
Consider if financial markets experience a credit crunch at this time similar to 2008/09. This is bound to happen again in the next couple of years. And the next time it happens, it will be a lot worse than the previous nightmare that markets endured.
Then consider the extra production that Rio Tinto [ASX:RIO], BHP Billiton [ASX:BHP], Vale S.A [VALE5:SA], and Roy Hill will bring online over this time. What impact will this have on the iron ore price?
And I’d say FMG would certainly lift production over time. Then you can throw in a whole bunch of low-cost African iron ore producers that may be producing at this time. One example is Sundance Resources [ASX:SDL].
On another note, I’ve provided significant analysis covering the iron ore story in Diggers and Drillers. Check out the newsletter if you want to know more details on the iron ore market — I go into specific details on the demand side and where I see it going.
Technically speaking, FMG either needs an iron ore price to double, increase production significantly whilst lowering costs, or renegotiate the debt to later payment dates
When it comes down to it, from this price, FMG could either be the punt of a lifetime or an absolute disaster. Fortescue’s share price direction will depend on the iron ore price. At the moment, things aren’t looking great.
Jason Stevenson+
Resources Analyst, Money Morning
The post Why the Fortescue Metals Group Share Price Fell Today appeared first on Stock Market News, Finance and Investments | Money Morning Australia.
