Is it time to buy Fortescue Metals Group?

Having proved itself as a successful iron ore miner, Fortescue Metals Group (ASX: FMG) has always been a controversial company with big plans and seemingly massive debt to match them.

Today, iron ore is Australia’s top export earner. This is largely due to the growth in China and other developing countries to our north. Iron ore is being mined in the Pilbara at an unprecedented rate and exported in huge ships.  It’s all a matter of supply catching up with demand. That demand is expanding, with China growing its GDP at 7.8% per annum. In addition, the ASEAN countries are also rapidly expanding, as is India, although India is largely self- sufficient in iron ore.

Fortescue is now the world’s fourth largest supplier of iron ore. It is on track to ship 155 million tonnes per annum by March 2014.  That is a remarkable achievement for a company that mined its first ore in 2008. Importantly Fortescue has a resource base of 15.6 billion tonnes, which equates to 100 years mining at the current rate. Furthermore, Fortescue has its own rail and port infrastructure, making it self-sufficient in moving ore to port.

Fortescue is a low-cost producer.  At the 2013 Annual General Meeting it was stated that the 155 million tonne target would cost USD 10 billion, including the new mining fleet. This gives an average cost of approximately $60 per tonne.  So, even at the lowest price of $90 per tonne in August 2012, the venture has always been highly profitable. Today prices are over $140 per tonne and probably will not go below $120 per tonne in the next several years. Further expansion will be considered but the company aims to strengthen its balance sheet before taking on any significant new capital expenditure.

At the Annual General Meeting it was explained that the debt structure is flexible with early repayment options. On current figures, interest cover is 5.09 for a debt to equity ratio of 240. Note that this ratio was as high as 586.4 back in 2008. If iron ore continues above US$120 per tonne, that debt will be wound back rapidly. Confidence in these assumptions is expressed by a recent purchase of approximately 5% of the company’s shares by the large international fund manager, BlackRock Group.

Over recent years, Fortescue has demonstrated an excellent record of sustained growth. Currently return on equity is 29.1%, which should only improve as tonnages increase and prices remain firm. In the latest year revenue was a record at US$8.1 billion, up 21%, with EBITDA of US$3.6 billion, up 18%.

Currently Fortescue has a P/E of 8.51, which is very low for any company, let alone one on a solid growth path. It pays a dividend of 10c per share, yielding 2.2%. Earnings per share is projected to be 90.0 cents in 2014, up from 53.3 in 2013.

Foolish takeaway

With Chinese inventories of iron ore below historically average levels, the immediate outlook seems attractive. Urbanisation and infrastructure are driving Chinese steel demand, and the same can be said for other South East Asian countries. For Fortescue, as outlined in the Annual General Meeting, CAPEX is declining rapidly as production of iron ore climbs. A Fool could do a lot worse than purchase Fortescue for the medium to long term, even at current prices.

High-risk/high-reward resources stocks

Oil, copper, and gold continue to be in high-demand -- and their popularity doesn't look to be slowing. We've uncovered three companies poised to benefit from the rising prices of these commodities. Get our brand-new report -- "3 Tiny Resources Companies That Could Win Big" -- FREE!

Motley Fool contributor Chris Koenig does not own shares in Fortescue.

Two New Stock Picks Every Month!

Not to alarm you, but you’re about to miss a very important event! Chief Investment Advisor Scott Phillips and his team at Motley Fool Share Advisor are about to reveal their latest official stock recommendation. The premium “buy alert” will be unveiled to members and you can be among the first to act on the tip.

Don’t let this opportunity pass you by – this is your chance to get in early!

Simply enter your email now to find out how you can get instant access.

By clicking this button, you agree to our Terms of Service and Privacy Policy. We will use your email address only to keep you informed about updates to our website and about other products and services we think might interest you. You can unsubscribe from Take Stock at anytime. Please refer to our Financial Services Guide (FSG) for more information.