Shares of Fortescue Metals Group Limited (ASX: FMG) hit a fresh six-year low yesterday at just $2.17 – a massive 65% below their February 52-week high – as the iron ore price continues its rapid descent.
While they have managed to recover 3% in Friday's session to be trading at $2.23, the stock is still trading on a historic price-earnings ratio of just 2.4 times earnings. There is no doubt that some investors will see this as a potential once-in-a-lifetime opportunity to buy one of Australia's largest miners at such a discounted price, but Fortescue still appears to be a stock to avoid at all costs.
Here are six key reasons why:
- More pain. Iron ore hit a fresh five-year low overnight to be trading at just US$66.79 a tonne, according to the Metal Bulletin. While it has already lost more than 50% of its value since the beginning of 2014, most analysts expect it to decline even further over the next 12 months.
- No hiding. As a pure iron ore play, Fortescue is completely at the mercy of the commodity's price fluctuations. A bet on Fortescue today is a bet against the simple supply-and-demand economics that dictate that the iron ore price will fall as a result of the market's oversupply and waning demand.
- Low quality. Investors need to remember that the ore Fortescue produces is of lower quality than what miners such as BHP Billiton Limited (ASX: BHP) and Rio Tinto Limited (ASX: RIO) produce. That means it receives an even lower price for its product.
- Thin margins. While Fortescue also maintains higher cost operations than its two larger rivals, it is already operating on very thin margins and could struggle to turn a profit if prices fall any further.
- Debt. Fortescue carries a very high level of debt which will need to be repaid. A falling iron ore price will make that an increasingly difficult task.
- Dividends. The pressure on Fortescue's cash flow could force the miner to heavily reduce (or even eliminate) its dividend distributions to shareholders. As soon as that happens, expect more investors to head for the exit, pushing the share price down even further.
Instead of taking an unnecessarily high level of risk on Fortescue, there are plenty of other great ASX stocks which are also trading at compelling prices.
