Shares in Fortescue Metals Group Limited (ASX: FMG) have certainly received their fair share of the market's attention over the last week or so.
Although one brokerage firm cut their target price on the stock by 29% to $5.00 – downgrading it from outperform to neutral – the stock has still managed to climb in excess of 17% since dipping as low as $3.91 last Tuesday. Fortescue's shares are today trading for $4.59.
It's fair to assume that one of the primary reasons behind the stock's jump in value is the recent recovery in the iron ore price. It recently fell below US$90 for the first time since September 2012, but has since jumped to just below US$96 a tonne after climbing 1.7% overnight.
Although Fortescue's prospects are certainly brighter when iron ore is trading at a higher price, investors need to ask whether the good times can continue, or whether the recent run-up in price (of both the shares and iron ore) is unsustainable.
Unfortunately, I think it is likely the latter. Iron ore producers like Fortescue, BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) are rapidly increasing their production output while, at the same time, Chinese demand growth is slowing down rapidly. Combined, this will act as a strong downwards pressure on the commodity's price over time – some more bearish analysts have even forecast it to fall to just US$80 a tonne in the coming 12 months.
While Fortescue relies almost solely on iron ore to generate its revenues, this decrease in price would strangle its operating margins and earnings, and therefore make it much more difficult for the miner to repay its enormous debt load.
Even though the stock is trading on a very low projected P/E (4.2) and offers a forecast 5.2% fully franked dividend yield, I still couldn't justify the risk of exposing my portfolio to the perils of the iron ore price – especially when there are plenty of other stocks that are also posing as incredible buys right now…
