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Fortescue Metals Group: Growing headwinds, staying on the sidelines

Fortescue Metals Group Limited (ASX: FMG) was covered in my article in October 2011.  I stated then that investors should be careful of FMG being a value trap. The Motley Fool are happy to stay on the sidelines.

The main concerns are the cyclical high price of iron ore, the extrapolation of past rapid growth, over-reliance on a single product (and a commodity product at that), over-reliance on effectively only one customer, and the characteristic of the only customer being a sovereign nation.

FMG released its half yearly results on 15 February 2012.  For the six months ending 31 December 2011, FMG shipped 27M tonnes of iron ore.  FMG received roughly AUD$122 per tonne, down from AUD$160 last year.  Its cost of sales are AUD$71 per tonne, up from AUD$64 per tonne last year. Operating cashflow of $1.18b was dwarfed by investing cashflow of $2.4b. No prizes for guessing how the hole was plugged – more debt, of course.

Funnily enough, and this never cease to puzzle me, despite the high demands for cash in its operations, FMG has decided to pay out 4 cents per share in dividends.

There are further headwinds, literally.  Cyclone Heidi affected production, and delayed port construction. Costs continue to increase, which is hardly surprising, given earlier announcements by BHP Billiton (ASX: BHP) and Rio Tinto (ASX: RIO) of blowouts in costs, especially in Rio’s Pilbara expansion.

It appears to me that FMG is in a mad dash race against time. It needs to get to 155MTpa output as soon as possible, and this needs to happen before the creditors come knocking, before anything happens to derail China’s boom story, and this has to be done in the face of rising input costs and shortage of skilled labour.  FMG will certainly be praying for fair weather ahead.

We at the Motley Fool are happy to watch this amazing race by the sidelines.

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Motley Fool contributor Peter Phan does not own shares in FMG. The Motley Fool’s purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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