Up 81% in 5 months: Is it time to buy this future blue chip?

The term ‘blue chip’ is used to describe a growing number of companies on the ASX that once might have fallen well outside that category. The likes of Transurban Group (ASX: TCL) and Qube Holdings Ltd (ASX: QUB) have been added to large-cap and blue-chip share portfolios as demand for predictable income from solid assets has soared in the face of diminishing term deposit returns.

Up 81% in 5 months

It stands to reason therefore, that companies we consider not quite blue chips yet, could feasibly become so in the (near) future. One such company that’s enjoyed a charmed run of late has been Fortescue Metals Group Limited (ASX: FMG).

The company has achieved a number of investor demands lately:

  • Reduced debt to (slightly) more manageable levels,
  • Reduced its cost of doing business,
  • Retained its strong safety record, and
  • Targeted a higher dividend payment in coming years.

Fortescue is slowly transforming itself from a highly-leveraged, high-cost producer to a less indebted and lower-cost producer, similar to blue-chip rivals BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO).

Is it too late to jump in?

As we’ve discussed before here and here, there are a number of risks over investing in Fortescue. Fortescue relies heavily on the iron ore price remaining above $50 to aggressively pay down its debt, however there are concerns on both the demand and supply sides which could see the price fall back towards $40 per tonne again.

Analysts also expect revenues to fall over the next few years as Fortescue ploughs through its high grade iron ore and moves onto lower-yielding ore.

Overall, the stock appears priced with more downside than upside, however if the iron ore price remains high, today’s price could look like a bargain in two years’ time.

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Motley Fool contributor Andrew Mudie has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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