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Should you buy Atlas Iron?

Iron ore is not an excessively difficult resource to find — in fact it is estimated that 5% of the earth’s crust is made up of it. However, it is a highly capital intensive operation to successfully retrieve and transport it.

Atlas Iron (ASX: AGO) shares have been oversold following a weakening in iron ore prices from US$180/tonne to US$120/tonne. The current prices still remain at historical highs and as often happens, analysts have spooked the market by predicting more severe price drops than what actually eventuated. While it appears a short-term oversupply could occur, it would be short-lived and would not see the iron ore price drop below US$80/tonne before rebounding to the current levels.

Leading Austalian producers BHP Billiton (ASX: BHP), Fortescue Metals Group (ASX: FMG) and Rio Tinto (ASX: RIO) are producing in the US$35-65/tonne range. Therefore any temporary falls in the iron ore spot price would only weed out the uncompetitive producers and if anything, support the longer term iron ore price at or above the current levels.

Atlas Iron is producing at US$50/tonne FOB (ready to be shipped) and US$75/tonne delivered to China. Therefore, even under the conservative view that China’s growth continues to slow dramatically, the iron ore prices are unlikely to fall below the cost of production.

Atlas Iron has seen its share price deteriorate close to 35% in the past 12 months, while rivals such as Rio Tinto, Fortescue and BC Iron (ASX:BCI) have seen their share prices rally 14%, 33% and 59% respectively. As with any listed company, performance is generally linked to growth opportunities and with Atlas Iron currently producing 10 million tonnes per annum  and planning on producing over 30 million tonnes by 2017 there is plenty of growth left in this story.

A key risk for Atlas Iron is to secure adequate capacity to transport its growing production to Port Headland where it will be shipped out directly to customers at the prevailing spot prices. Rail access is critical, but I am confident management will find a solution and I see this as an opportunity as much as a risk as this will ultimately bring down the cost of production.

Atlas was originally listed through an IPO in 2004 with a market capitalisation of $9 million, which now has exploded to $900 million. With five operating mines, a 3% dividend, finance in place for the next phase being Horizon II, growing reserves of 507 million tonnes and more cash than debt, Atlas Iron is in an enviable position.

Management previously mentioned the company was in danger of being taken over and this was back when the share price was around the $2 level. With the strength of the balance sheet and weakness in the company’s current share price a takeover from a larger player would make financial and strategic sense.

Foolish takeaway

As always, time will tell if the bearish iron ore forecasts are overly pessimistic, but with a commodity that will always be in demand and prices that can weather a short-term fall it appears Atlas Iron warrants a place on your watchlist if not your portfolio.

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Motley Fool contributor Tim Roberts owns shares in Atlas Iron.

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