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Iron ore crash: Miners hammered but worse may be yet to come

iron ore

The iron ore price continues to slide, losing another 2.1% overnight to take it to US$91.50 a tonne.

Australia’s iron ore miners have been hammered in trading so far today, with Mount Gibson Iron Limited (ASX: MGX) crashing 7.5%, Fortescue Metals Group Limited (ASX: FMG) 4.9%, BC Iron Limited (ASX: BCI) 4.8% and Atlas Iron Limited (ASX: AGO) down 3.8%.

Based on forecast earnings, Fortescue is trading on a P/E ratio of just 3.8 times for this financial year, and 4.5 times earnings for fiscal 2015. It’s either the buy of the century or a giant value trap.

Likewise Mount Gibson. The company trades on a P/E ratio of just 4.9, and that’s before you even consider that the company is holding $497 million in cash, (the current market cap is roughly $730 million). Mount Gibson says it expects to sell 9.5 million tonnes of ore this financial year, and has already generated $700 million in revenues.

The big concern for most of the companies above is they have much higher production costs than the majors like Rio Tinto Limited (ASX: RIO), and those low P/E ratios will evaporate if the iron ore price slides below their production costs, and stays there for a meaningful period of time.

With the majors and the likes of Fortescue ramping up production, the supply of seaborn iron ore to China is rapidly exceeding slowing growth in demand for the key steel making ingredient. As supply grows, and demand can’t keep up, simple economics suggests an iron ore price with a 7 or 8 in front of it is not out of the question.

Additionally, for companies like Fortescue that produce lower grade ore, the grade and impurity discount is rising, leading to the miner receiving even lower prices for its iron ore.

While Fortescue, Mount Gibson and the other iron ore miners may look cheap, there may well be good reasons why they are cheap. Buyer beware.

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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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