A resilient iron ore price and its efforts to reduce debt helped to drive Fortescue Metals Group Limited (ASX: FMG) shares strongly in the second half of 2013, with its price climbing to $5.93 from a low of $2.87 in June. With shares falling a whopping 10.7% last week, is this a buying opportunity or should investors steer clear?
Shares in Australia's third largest iron ore miner have now dropped to just above $5.10 each. The fall can largely be explained by a drop in price of iron ore which is currently sitting at its lowest level in five months at just US$130.70 a tonne. A number of analysts have predicted that prices will continue to fall over the course of the year, as Australia's mines ramp up production levels of the steelmaking ingredient, while Chinese demand has also been pegged to fall.
Of particular concern is Fortescue's current net debt which sits at US$9.9 billion ($11 billion). While it has maintained a heavy focus on reducing operating costs and improving productivity, should the commodity continue to fall in value it could impact the miner's ability to repay debt as soon as the market had hoped for.
Despite these concerns, 60% of equity analysts still rank the stock as a "buy" in addition to the 28% who are maintaining a "hold" recommendation. With an average 12-month target of $6.13, some analysts have even gone as far to say shares will climb to $8 and could certainly benefit from a falling Australian dollar and strong demand from China.
However, while the company would be a massive beneficiary should iron ore prices remain at current levels (or climb higher), they are a pure iron ore play making it quite a risky investment. Even Rio Tinto Limited (ASX: RIO), which generates roughly 80% of its revenues from iron ore operations is risky. Its shares also dropped 6.9% last week as the iron ore price fell.
Instead, investors may be better off considering BHP Billiton Limited (ASX: BHP). Although iron ore is its highest revenue generator, its operations are much more diversified making it less susceptible to a fall. Its shares are currently trading at $36.18 each and it offers a trailing fully franked 3.2% dividend yield.
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