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Top broker rates Fortescue Metals Group Limited shares as a buy

It certainly has been a disappointing 12 months for shareholders of Fortescue Metals Group Limited (ASX: FMG).

Despite the global economy roaring and demand for iron ore increasing, the iron ore producer’s shares have fallen a sizeable 25.5%.

However, things could be about to improve if one leading broker is to be believed.

According to a note out of UBS, it has retained its buy rating and $5.50 price target on Fortescue Metals’ shares.

This price target implies potential upside of over 14% for its shares over the next 12 months. This increases to a total potential return of over 20% if you factor in the company’s generous dividend.

UBS’ analysts believe that the market may be overreacting to concerns over the discounts that Fortescue is seeing for its low-grade iron ore product.

At present Chinese steel makers are predominantly interested in higher grade iron ore that is less polluting and can produce more steel for each tonne that is processed. This has led to Fortescue having to sell its iron ore at a significant discount to the 62% fines price.

However, UBS points out that despite the discount, Fortescue’s low-cost operations mean that it is still enjoying a healthy margin.

As a result, the broker expects Fortescue to achieve earnings per share of 53 cents in FY 2018. This prices the miner’s shares at approximately 9x forward earnings.

In addition to this, it expects Fortescue to pay a full-year dividend of 33 cents per share this year. Though it is worth noting that its shares have already gone ex-dividend for its interim distribution.

Should you invest?

While I would still choose mining giants BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) ahead of Fortescue, I do agree with UBS that it is an attractive investment option at the moment.

At just 9x forward earnings and providing a trailing fully franked 6.9% yield, I think Fortescue’s shares offer a compelling risk/reward for investors looking to gain exposure to the resources sector.

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Motley Fool contributor James Mickleboro has no position in any of the stocks mentioned. 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 Scott Phillips.

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