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Why the Fortescue Metals share price is up 85% in 6 months

That’s right, you read correctly. The Fortescue Metals Group Limited (ASX: FMG) share price has risen from a 52-week low in September 2018 of $3.53 to near its 52-week high of $6.55 at the time of writing, a rise of 85.55%. Furthermore, anyone who was lucky enough to buy in almost exactly 3 years ago at $1.54 would have seen an astonishing 325% gain in that time, not including dividends!

So what is behind Fortescue’s share price surge?

Fortescue Metals Group is an iron ore company founded by Andrew ‘Twiggy’ Forrest in 2003 and primarily operates in the Pilbara region of Western Australia. It now stands as the fourth largest iron ore producer in the world, behind ASX giants Rio Tinto Limited (ASX: RIO) and BHP Group Ltd (ASX: BHP) as well as Brazil’s Vale, with a market capitalisation of $20.17 billion.

According to Fortescue’s 2018 Annual Report, the company prides itself on its “unique culture, innovation and industry-leading development” of mining assets and infrastructure and claims to be the lowest-cost provider of seaborne iron ore into China.

Unlike BHP and Rio Tinto, Fortescue derives the vast majority of its revenue (over 98%) solely from iron ore production, making the company a pure iron ore play. Fortescue has managed to decrease its cost of mining one tonne of iron ore from US$33.84 in 2013/14 to just US$12.36 in 2017/18, a reduction of 63%. I think this is very impressive and bodes well for the company’s future. Iron ore is a highly demanded commodity, particularly in emerging markets as we have seen from China over the past decade.

As with any mining company, any rise in the price of a commodity above the cost of production increases profit exponentially and with Fortescue’s low-cost base, this can occur more often.

Which brings us to the share price. Fortescue’s explosive growth over the last six months comes down to the spot price of iron ore increasing over 25% since September. This 25% increase translates to a 32% rise in profitability for Fortescue and is responsible for firing the rocket under Fortescue’s share price.

Foolish takeaway

Fortescue Metals has proven to be an extremely well-managed company and would be a great place to start if you are seeking commodity exposure in your portfolio. However, commodity prices including iron ore are extremely volatile and I would be waiting for a significant correction in the spot price before looking to add Fortescue to my investments.

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Motley Fool contributor Sebastian Bowen 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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