Fortescue Metals Group Limited (ASX: FMG) shares have retreated a further 3.8% today to be trading within just 2c of setting a new five-and-a-half year low. In what has proven to be a disastrous time, Fortescue's shares have declined nearly 62% since peaking in February this year.
At its current price of $2.38, the stock is trading on a trailing P/E ratio of just 2.55 times earnings. While some investors will no doubt see this as an incredible opportunity to buy one of Australia's largest miners, Fortescue still appears to be a stock to avoid.
There are four key reasons:
- Fortescue is a pure iron ore play which means that it is completely at the mercy of the commodity's price. While iron ore has nearly halved in value this year, it is expected to fall even further which would apply additional pressure to Fortescue's margins.
- The ore that Fortescue produces is a lower grade to what BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) produce, meaning it receives a lower price for its product. With the spot iron ore price now below US$70 a tonne, it's possible Fortescue is already operating at a loss (or, at least, on very thin margins).
- Fortescue has an enormous level of debt which needs to be repaid. As iron ore drops in value, it will become increasingly difficult to service.
- In order to service the debt, it's entirely possible that heavy reductions will need to be made to the dividends distributed to shareholders. Should this scenario play out, we could see investors rush for the exits faster than they already have.
Instead of taking an unnecessarily high level of risk on Fortescue, there are plenty of other great ASX stocks which are also trading at compelling prices.
