First it was the slump in the iron ore price but now Fortescue Metals Group Limited (ASX: FMG) has to battle speculation that it is in desperate need of a capital injection.
The iron ore producer is vehemently denying the capital raising claim but it is arguing from a position of weakness and this speculation is likely to be a second weight around its neck.
The problem with Fortescue's defence is we've kind of heard it before.
The deputy secretary of the China Iron and Steel Association said it was inevitable Fortescue would need more equity because of its high cost operations and big debt burden, according to the Australian Financial Review.
Chinese companies have recently applied to the Australian Foreign Investment Review Board for permission to buy stakes in local iron ore producers.
But Fortescue refutes the need for fresh equity as it plans to cut its cost to $US41 from $US60 a tonne of ore produced in the next three months.
This would make it a lower cost operator than Brazilian mining giant Vale with its break-even point at around $US43 a tonne, claims Fortescue.
This is perhaps a moot point for two key reasons. First, Vale has a far stronger balance sheet that will allow it to operate a lot longer at a loss than Fortescue.
Vale's position of strength stems from a recent deal it did with China where it sold shipping vessels and received a $US4 billion loan facility with a "mate's rate" interest charge. Mike King wrote about this in detail here.
What's worse, Fortescue has over $US9 billion in debt (excluding the $US2.3 billion it recently raised at a high 9.75% interest rate to repay in 2017 and 2018).
While none of the $US9 billion is due for repayment until 2019, any shareholder who says he isn't worried about the large hurdle is lying.
Secondly, most of Fortescue's iron ore reserves are of lower quality. The ore price you see quoted in the news contains 62% iron. The bulk of Fortescue's ore is around 58% or lower, which fetches a lower price.
More importantly, the size of the discount for lower quality ore tends to increase when the market is oversupplied – a situation that is forecast to last for at least two to three years.
This will ensure Fortescue's margins will be inferior to those of Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX:BHP) even if Fortescue can continue to cut its costs to just under $US40 a tonne.
It is also hard to take what Fortescue says without a pinch of salt as it doesn't have a good track record of reading industry cycles.
Remember back in 2012 when Fortescue was targeted by well-known US short-seller and hedge fund manager Jim Chanos?
Chanos called Fortescue a "value trap" for all the reasons outlined above, and boy was he proven right with the stock halving since.
Short-selling is borrowing a stock to sell in the hope of buying it back at a lower price later to profit from the difference.
Fortescue's chief executive Nev Power accused Chanos of spooking the market for his own selfish reason.
One has to wonder how much Chanos made from his short-position on Fortescue, which has tumbled 2.1% to $2.37 during lunch time trade. The stock was trading at around $6 when Chaos targeted the stock.
Fortescue could pull through this tough patch if the iron ore price stays close to its current level of $US61.85 a tonne for ore with a 62% iron content, but I will stay away from the stock as there are less risky growth stocks to bet on.
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