Could Fortescue Metals Group Limited shares return to $3 in 2016?

Credit: Chatham House

It’ll grate any long-term shareholders to think that Fortescue Metals Group Limited (ASX: FMG) shares were soaring at $6 per share as recently as early 2014 before the great iron ore collapse of 2014-15. The company’s shares currently bounce erratically between $2 and $2.50 per share, but a sustained recovery in the share price remains dependent on a few vital factors:

1/ Iron ore price

The iron ore price on Friday fell a further 2% to within touching distance of a 10-year low! This has come about as a result of a sustained increase in supply from companies like Fortescue, BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), while overall demand for the steelmaking ingredient remained steady or declined. As we’ve seen with the oil and coal price, a recovery is unlikely unless a major player pulls the pin on production or falls into administration.

2/ Dividend yield

Companies like Fortescue have a habit of attracting bargain pickers or big dividend hunters. BHP is being touted as the next 10% dividend yield stock following its recent price fall, however the same was being said of Fortescue 12 to 18 months ago. Ultimately, dividend payouts are generally constrained by group profit and the iron ore price is compressing profits at a time when investors are hungry for yield.

I believe we’ll see the big mining companies continue to trade around a forward dividend yield of 5% to 6%, a premium to the market to compensate for the risk associated with investing in mining companies. Correspondingly, Fortescue’s share price is unlikely to surge higher until profits do.

3/ Competitors

Fortescue’s share price has been dragged down over the last fortnight by being in the same industry as today’s bad boy BHP Billiton Limited. Fortescue’s performance over the last 12 months has almost been superior to its largest rival.

BHP has been in the news recently for its environmental issues in South America and the poor performance of its stock following the demerger with South32 Ltd (ASX: S32). Fortescue meanwhile has cut its C1 costs 47% from US$32 to US$17 per wet metric tonne in just 12 months. It has issued debt at relatively attractive rates and bought back debt at a steep discount to its offer price, and has maintained positive cashflow.

Could Fortescue Metals Group shares return to $3 in 2016?

In time, I believe they can, however it’ll only be when factors outside the company’s control turn around. New supply coming on board from Gina Rineheart’s Roy Hill project and other major players could keep the iron ore price lower and profit depressed for the near future.

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Motley Fool contributor Andrew Mudie owns shares of Fortescue Metals Group Limited. You can find Andrew on Twitter @andrewmudie

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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