Within the last two weeks, iron ore producer Fortescue Metals Group Limited (ASX: FMG) has shot up almost 11%, leaving the S&P ASX 200 Index (ASX: ^XJO) in the dust with its 0.4% decline. Severely low iron ore prices pushed its shares down, so is this recent rise just a "dead cat bounce", or is there something that could drive the stock higher from here?
Although iron ore did rise to just a little under $95 a tonne, this little reprieve may be only short-lived because more and more iron ore is being exported, weighing down the commodity price. The big miners, BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) are also feeling the pinch, but they are the lowest cost producers in the industry, so they have wider earnings margins to survive.
— Opportunity or "value trap"
With a price/earnings ratio of 4 and a decent 3.9% dividend yield, at first glance the stock could look like a value play. Full-year earnings are expected to be well above FY 2013 due to the great increase in iron ore production.
However, what may have the hallmarks of value could be a value "trap", if earnings don't appreciably rise from here. Value must have growth or the stock could stay cheap for a long time.
— Expanding production further
If Fortescue produces much more, it can partially offset a lower iron ore price by raising sales volumes. However, its lower grade of iron ore is selling at a bigger discount now. Near-term earnings may take a hit and the share price could suffer for it.
— Paying down debt
Higher revenues helped Fortescue pay down debt by over US$3.1 billion, but if iron ore prices remain under pressure, further repayments of its huge multi-billion dollar debt become harder.
Taking this into account, the headwinds are strong against the company. Foolish investors need to see growing earnings and higher commodity prices to really benefit over the long term. I would say you should hold off from Fortescue Metals Group. BHP Billiton would be a much better choice because of its product diversification and more stable dividends.
