Iron ore miner Fortescue Metals Group Limited (ASX: FMG) is the standout performer in the sector today on speculation that Anglo-Swiss mining giant Glencore could be mulling a stake in the embattled company.
Shares in Fortescue jumped 2.5% to a two-week high of $2.05 during lunch time trade when other iron ore stocks are trading flat or down.
Rio Tinto Limited (ASX: RIO) is off 0.7% at $57.81, while Mount Gibson Iron Limited (ASX: MGX) and Atlas Iron Limited (ASX: AGO) are little changed.
Talk of Glencore's interest is exactly that. The Australian was quoting a trader who thought that Glencore would be keen to sniff around after its overtures to Rio Tinto has snubbed.
Glencore's move on Fortescue's register would spark a power re-rating of the stock for two reasons. First, it would force short sellers to buy back the stock to close positions. Around 20% of Fortescue's stock is being shorted.
Short selling refers to traders selling borrowed stock in the hope of buying it back at a lower price later to profit from the difference.
The other reason for a re-rating is Fortescue's debt problem. Glencore's investment would alleviate fears that the miner won't be able to refinance its debt.
However, unless Glencore has a crystal ball or some other means to predict how low the iron ore price will fall, it's unlikely to want to dip its feet into the Fortescue share pool.
The issue is Fortescue's relatively high cost base. At the current price of around $US55 a tonne of iron ore, the miner is only just cash flow positive.
Citigroup is predicting iron ore prices to fall under $US50 a tonne due to the slowdown in demand from China and a sharp ramp up in global supply of the steelmaking ingredient.
It's not debt or strategic deals that will save Fortescue. It's the longer-term average price of iron ore that will determine its fate.
This point is acknowledged by Morgan Stanley. The broker downgraded the stock today to "underweight" from "equal-weight", which effectively means "sell", after it revised down its iron ore price assumption by 28% to $US54 per tonne and 13% to $US47 a tonne for 2014-15 and 2015-16, respectively.
The table below shows the impact on Fortescue's cash flow.
There are options Fortescue could pursue, according to the broker. One is to sell assets, such as infrastructure. The other is to sell part of the company into a joint venture structure that would comprise of an off-take partner.
However, as mentioned above, any deal or asset sale will only make sense if iron ore can hold around current levels.
No one will be rushing to make that bet.
