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Fortescue Metals Group Limited slammed as shares hit 5-year low

Fortescue Metals Group Limited (ASX: FMG) shares have slid to a fresh five-year low this morning, free-falling more than 6% from yesterday’s closing price to as low as $2.79. The shares haven’t traded this low since June 2009 and have now fallen an agonising 52% since the beginning of the year, which compares to a 0.6% rise from the benchmark S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO).

So What: Today’s plunge comes after the iron ore price dropped 4.4% overnight, recording its lowest price in more than five years at just US$71.80 per tonne. The commodity has nearly halved in value since the beginning of the year and further falls are predicted over the coming 12 months.

Given Fortescue’s status as Australia’s third largest iron ore miner – and one with a high production rate and a lower cost base than most others in the sector – you might be wondering why its shares have been hit so hard. Fortescue is a pure iron ore play; that is it relies solely on iron ore for its revenues, whereas BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) both maintain more diversified operations.

As the iron ore price tumbles, it applies enormous pressure on Fortescue’s margins, making it increasingly difficult for the miner to repay its enormous debt load. Should the iron ore price continue to fall, Fortescue may struggle to make a profit and could be forced to cease dividend payments to instead repay its creditors. In today’s low interest rate environment, that is certainly a concern for investors.

Now What: Fortescue’s shares will no doubt tempt some investors. With a market capitalisation of roughly $9.2 billion, the stock is trading on a trailing P/E ratio of just 3x, making it a compelling prospect should the iron ore price suddenly rebound.

However, investors also need to note the enormous risks facing the business and the industry as a whole, and recognise that there is a good reason why Fortescue’s shares are trading at such a low price. Until Fortescue gets its debt situation under greater control, and until volatility in the sector begins to subside, investors may be wise to give the miner a wide berth.

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned.

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