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Why the Fortescue Metals share price has tripled since January

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The Fortescue Metals Group Limited (ASX: FMG) share price has tripled since early January, rising from a low of around $1.44 to trade at around $4.39 currently.

Much of that recovery has to do with the surge in the iron ore price, but it’s also to do with how Fortescue has been slashing production costs. The increased margin and higher cash flow mean the iron ore miner has been able to make a sizeable dent in its total debt load too.

In the 2016 financial year, Fortescue has repaid US$2.9 billion, reducing its annual interest bill by US$186 million.

Iron ore prices have fluctuated wildly so far this year but may have found a comfortable level recently of around US$50-US$55 a tonne.

In mid-January, the commodity tumbled below US$40 a tonne, before speculators helped drive the price back up to over US$70 a tonne in April. Chinese regulatory action to diminish the impact of speculators has since seen the iron ore price fall back to average around US$53 a tonne in the past two months.

iron ore price July 2016

Source: MetalBulletin


UBS analysts estimate Fortescue’s breakeven price has dropped to US$32 a tonne, assuming the Australian dollar is buying 75 US cents. The investment bank says the miner is generating more than US$2 billion in free cash flow on an annualised basis at current iron ore prices.

That should allow Fortescue to continue paying down debt, with shareholders also likely to benefit further with an increased fully franked dividend.

Mount Gibson Iron Limited (ASX: MGX) and Hancock Prospecting’s Roy Hill mine are estimated to break even in the US$40-US$45 a tonne range. The latter is expected to reduce that to around US$35 a tonne once the mine achieves full production of 55 million tonnes annually.

Rio Tinto Limited (ASX: RIO) and BHP Billiton Limited (ASX: BHP) are still regarded as having the lowest costs in the industry of under US$30 a tonne.

Foolish takeaway

It’s good news for long suffering Fortescue shareholders, but the miner does still face growing supply of iron ore in the face of weakening demand for the commodity. Now might be a good time to take some profits.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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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