The recent surge experienced by the iron ore price has caught the market's attention and some investors are now questioning whether Fortescue Metals Group Limited (ASX: FMG) is a buy, after all.
Over the last 15 months or so, confidence in Australia's resources sector has plummeted, dragging the share prices of most companies in the sector down with it. After having traded at US$135 a tonne at the beginning of 2014, iron ore plunged below US$47 a tonne for the first time in more than a decade, threatening the very existence of miners all around the world – Fortescue included.
But since bottoming out at the beginning of April, the price of iron ore has rampaged higher. According to the Metal Bulletin, it regained another 2.3% overnight to trade at US$64.77 a tonne, which is believed to be well and truly enough for Fortescue to generate a profit on its operations.
Fortescue Metals Group is Australia's third largest iron ore miner, and the fourth largest in the world, behind Rio Tinto Limited (ASX: RIO), BHP Billiton Limited (ASX: BHP) and Brazil's Vale. As it stands, it operates at far higher costs than any of those miners but believes it can greatly improve its cash breakeven level during the 2016 fiscal year.
The stock currently trades for $2.33, down 63% since March 2014.
Should you buy?
If the commodity were to remain at levels similar to today's price, Fortescue could be making anywhere north of US$20 a tonne by the end of 2016, which would make it seem like quite an attractive buy today. But therein lies the problem: it is extremely difficult to see iron ore trading at these levels over the coming years.
Indeed, lowering operating costs is the primary goal of all iron ore miners based on the assumption that the commodity's price could continue to fall heavily as a tidal wave of fresh supplies clashes with waning global demand. In fact, some analysts believe iron ore will be worth roughly US$40 a tonne in the years to come, while others believe it will even fall below that level.
One of the biggest issues for Fortescue compared to its larger rivals however, is its sheer level of debt, which is in excess of US$7 billion – the majority of which will become due in 2019. This poses as a potentially catastrophic risk for prospective investors should the iron ore price fall to the levels predicted by those analysts.
As is the case with all mining businesses, Fortescue Metals Group is a price taker, meaning that it has no control over the prices at which it sells its ore. Given the bearish forecasts for the sector as a whole, investors would be wise to give Fortescue a miss in favour of some of the market's other appealing prospects.
