Why Fortescue Metals Group Limited shares are getting slammed

Credit: Chatham House

Shares in Fortescue Metals Group Limited (ASX: FMG) plunged 3.2% to $1.52 today and touched a five-year low of $1.49 as investors jump ship in anticipation of the going get rockier.

This as iron ore prices post a six-day losing streak to see the commodity sell for US$41.19 a tonne, which is a level not far above a record low of US$37 a tonne hit during December.

Several analysts are also suggesting that the iron ore price could head lower due to a fight for market share that has seen an oversupply of the market by the likes of Vale, Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP).

The other problem for Fortescue is that 2016 has started with two pieces of weaker-than-expected economic data out of China, where iron ore bears think softening demand could spell more trouble ahead. Although, China did recently post stronger-than-expected export numbers to leave the picture there something of a mixed bag.

The miner has been slashing costs and refinancing debt in a bid to maintain operational profitability in the wake of the iron ore price falls, but its larger rivals are unlikely to cut production despite the public complaints of chairman Andrew Forrest in 2015.

Indeed, the miner’s mountainous debt is probably the main reason investors are getting out now, with net debt of US$6.6 billion inclusive of US$2.6 billion cash as at 30 September 2015.

The miner then has basically been built on debt, which recently had to be restructured on onerous terms as US capital markets in particular price risk higher due to worries over China.

The high interest rates (commonly around 6% to 9.75%) mean it carries considerable risk and further falls in the iron ore price could mean a large capital raising, asset sales, or private placement with Chinese investors reportedly interested.

That’s likely why the share price has been plummeting and why Fortescue remains a business to avoid for all but the iron ore bulls with a tolerance for risk.

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Motley Fool contributor Tom Richardson has no position in any stocks mentioned.

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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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