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Here’s why Fortescue Metals Group Limited shares were smashed today

Fortescue Metals Group Limited (ASX: FMG), Australia’s third largest iron ore player, is expected to wield the knife again by slashing more costs from its business. The speculation comes after Fortescue announced that it would reduce its total FY15 capital expenditure to US$650 million, down 50% from previous guidance of US$1.3 billion.

As reported by The Australian Financial Review, unnamed sources have stated that job cuts could be on the cards later this week as part of a push to improve efficiencies. While BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) have both cut jobs as a result of the waning iron ore price, Fortescue hasn’t done so since late 2012 when its profits were last tested.

As it stands, analysts at UBS believe that Fortescue needs prices above US$73 a tonne to breakeven, and that’s based on a higher quality ore than what Fortescue normally produces (which attracts a significant discount). With iron ore currently changing hands for US$71.11 a tonne, Fortescue could well be operating at a loss.

Despite Fortescue’s halving of overall capex, investors still punished the stock on Monday, selling it down nearly 11% before dropping a further 5.7% on Tuesday to record a fresh five-year low at just $2.47. The stock recovered later in the session to $2.58, putting it on a trailing P/E ratio of 2.8 times earnings.

Although Fortescue might look attractive at its current valuation, investors need to be extremely cautious of the miner’s enormous debt level. As iron ore prices fall further, it will become increasingly difficult for Fortescue to service its debts which could see the price fall substantially lower.

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

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