Top broker says sell Fortescue Metals Group Limited shares

Although the market has dropped lower as a whole today, the Fortescue Metals Group Limited (ASX: FMG) share price has fallen notably lower.

At the time of writing the iron ore producer’s shares are down over 4% to $4.38. This extends its five-day decline to approximately 9%.

Why are Fortescue’s shares sinking today?

Today’s decline is likely to be related to a broker note out of Citi this morning in response to the company’s iron ore price realisation update which was released yesterday.

That update revealed that the company has had to discount its low-grade iron ore further to shift it.

In the first-half of FY 2017 the company was commanding a price that was 86% of the benchmark 62% fines, but this has now drifted to 65% for FY 2018.

Considering the first-half average price was 68% of the benchmark, this potentially means that in the second-half Fortescue expects to command a price that is just 62% of the benchmark price.

What did Citi have to say?

According to the note out of Citi, its analysts have downgraded Fortescue to a sell rating from buy and cut its price target all the way down from $5.40 to just $4.10.

The broker appears to believe that the discounts mentioned above are more structural than cyclical and has lower its forecasts accordingly.

Should you sell your shares?

I think a lot of these discounts have been factored into the Fortescue share price already, so I wouldn’t necessarily rush to sell your shares if you owned them.

A lot will ultimately depend on what happens next. If the discount stabilises then I think Fortescue will be fine and continue to report bumper free cash flows, but if it doesn’t then things could get hairy.

I would class Fortescue as a hold at the moment and intend to wait to see how the discount situation develops over the next six months.

In the meantime, I see a lot of value in higher grade producers such as BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO).

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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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