The glory that Fortescue Metals Group Limited (ASX: FMG) had from ramping up its iron ore production capacity, paying down a good chunk of its huge debt and whittling away its operating costs seems to have evaporated.
Now that iron ore prices have slipped under $100/tonne, the memories of 2012 start to flood back into investors' minds.
Rio Tinto Limited (ASX: RIO) CEO Sam Walsh said recently his company has the lowest production costs and that the company will be "the last man standing" in any commodity price weakness. BHP Billiton Limited (ASX: BHP) has very low costs as well.
With the market anxiety beating down on Fortescue's share price and fears of a repeat of the cash crunch almost two years ago, this could be a contrarian buy opportunity.
Here are four reasons why it may be time to take advantage of the market's depressed view of the miner.
1) Lower production costs than in 2012
When it got squeezed in 2012, its C1 production costs were about $50/tonne and didn't leave much of an operating margin. Now, that is down to about $33-$34/tonne and probably can be improved upon as the company looks at all cost savings.
2) Higher production capacity
In 2012, quarterly production was only half or a third of the 31 million tonnes it achieved in third quarter FY2014. If iron ore prices go down, the company's profit margins may suffer, but higher revenue can generate potential earnings increases. Now, the 155 million tonne per annum production capacity would make an average quarter close to about 35 million tonnes.
3) Lower interest payments
At 31 March 2014, Fortescue had repaid US$3.1 billion of debt since November 2013. It still has more to go, but the repayment means it will save about US$300 million in interest payments. That can go to covering costs, capex and possibly flow to earnings.
4) New resource upgrade
The company announced this month that it has increased its Greater Solomon mineral resource by an additional 1.16 billion tonnes, bringing its new total to 2.66 billion tonnes. At a higher production rate, more resources will make sure it can supply that pace.
5) Iron price weakness short-term
It may take some time for China to adjust to a consumer-driven economy, but longer term the demand for iron and steel is still necessary for developing roads, buildings and social infrastructure.
Contrarian investing is hard because you sometimes have to go against a natural tendency to shun weakness, falling prices and short-term setbacks. It isn't just to take the opposite viewpoint, but to realise when the mainstream thinking and a short-sighted market may have gone too far.
