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Should you buy Fortescue Metals?

Australia’s third largest iron ore miner, Fortescue Metals Group (ASX: FMG), has announced plans to repay US$1 billion of debt early, which should see its interest costs fall further.

Just last week the miner announced that it had renegotiated a US$5 billion debt facility, achieving an interest rate reduction of 1%, cutting an estimated US$50 million off its interest bill. Today, Fortescue has announced that the company is paying back US$1 billion of debt two years early on its senior unsecured notes that are due to be repaid in late 2015, saving an estimated US$70 million in interest. The company also expects to repay the remaining US$1.04 billion in coming months.

Fortescue’s CEO Nev Power says the repayment is an historical turning point for the company, and it will continue to deleverage its balance sheet. Chief financial Officer Stephen Pearce noted that Fortescue’s strong financial position and reduction in capital expenditure meant the company could begin to make debt repayments in 2013. Fortescue is nearing the completion of its ramp up to produce 155 million tonnes of iron ore annually and therefore capital costs are falling.

The company is also focusing on cutting costs which should see free cash flow increase, allowing the company to repay more debt and cut interest costs further. Still, the company had US$12 billion of debt on its balance sheet before this announcement, so it has a long way to go in cutting debt levels.

Fortescue has also received the benefit of higher than expected iron ore prices. Many analysts had expected the iron ore price to fall to US$100 a tonne or below, as demand from China slows. But demand has increased, while oversupply has not materialised yet, leading the iron ore price to remain above US$130 a tonne for some time now.

While Rio Tinto (ASX: RIO) and BHP Billiton (ASX: BHP) have also ramped up their iron ore production, so far China is clearly keen on buying as much Australian iron ore as it can get its hands on. Even junior miners Atlas Iron (ASX: AGO) and BC Iron (ASX: BCI) are increasing their production of the commodity.

Foolish takeaway

As CEO Nev Power has said, this marks a turning point for Fortescue. If the iron ore price remains strong over the next few years, the company should easily be able to make its debt repayment schedule, and the current share price may appear cheap. The big risk is that the iron ore price does crash – putting Fortescue at risk of having to raise equity, or in a worst case scenario, folding completely.

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Motley Fool writer/analyst Mike King doesn’t own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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