Why Fortescue Metals Group Limited shares are sinking lower

In morning trade the Fortescue Metals Group Limited (ASX: FMG) share price has sunk lower following the release of its latest quarterly update.

At the time of writing the iron ore producer’s shares are down 3% to $4.54.

What was in the update?

During the March quarter Fortescue mined 41.6 million tonnes or iron ore and shipped 38.7 million tonnes. This was a quarter-on-quarter decline of 12% and 4%, respectively.

The lower level of production, combined with increased maintenance costs, a higher Australian dollar, and rising fuel prices, led to C1 cash costs rising 9% to US$13.14 per wet metric tonne.

Unfortunately, these rising cash costs were not able to be offset by improved prices for its ore. Instead things went backwards for Fortescue, with the discount for its iron ore extending to 62% of the benchmark Platts 62 CFR index price.

This means Fortescue has averaged a price of US$45 per dry metric tonne for the nine months to 31 March, compared to US$47 per dry metric tonne in the first half of FY 2018.

Pleasingly, management expects things to improve soon. According to the release, profit margins for China’s steel mills have declined from the peaks reached in the December 2017 quarter.

Management believes that there are now signs that steel mills are refocussing on costs, resulting in increased demand for Fortescue’s lower grade iron ore.

If this proves to be the case then the discount for its low-grade ore could soon ease, leading to improved profitability for the iron ore producer.

Should you invest?

While I still have a preference for mining giant’s BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO), if the discount for Fortescue’s ore is now easing then it could be a great option for investors. Especially given how cheap its shares look at under 9x estimated forward earnings.

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