Short sellers target a vulnerable Fortescue

IT'S not clear if Andrew Forrest has sweaty palms just yet. But after a 5 per cent slump in his Fortescue Metals share price yesterday and a 4.5 per cent slump the day before, the short sellers targeting his company will no doubt be encouraged by the emerging mood against iron ore stocks as concerns about the Chinese economy grow.

By InvestSMART · 17 May 2012

By InvestSMART ·
17 May 2012

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While Fortescue has outperformed the likes of BHP and Rio in recent weeks, it has not been immune to the heavy selloff in resource stocks. It is now trading at $4.84, down 20 per cent since late March. Last month, BusinessDay revealed renowned short seller Jim Chanos, who exposed Enron as a fraud and bet against Macquarie Bank's infrastructure model, had singled out Fortescue in a private investor briefing in early April as a prime short-selling opportunity.

The share price has been falling since. More than 100 million Fortescue shares, or about 3 per cent of the company, are registered as a short position. Mr Chanos called Fortescue a "value trap" because of its exposure to China and iron ore.

He argued that iron ore prices are trading well above their historical average of about $100 a tonne, noting that should they fall back to earth, Fortescue would struggle to pay down its debt.

Iron ore prices have been falling over the past few weeks from $US150 per tonne to about $US135.

Fortescue argues that it is lifting production to help pay down debt while commodity prices are still high.

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Frequently Asked Questions about this Article…

Why are short sellers targeting Fortescue Metals Group?

Short sellers have been encouraged by recent falls in Fortescue shares and a broader negative mood toward iron ore stocks as concerns about the Chinese economy grow. Renowned short seller Jim Chanos also singled out Fortescue as a prime short-selling opportunity, highlighting the company’s exposure to China and iron ore.

How much have Fortescue shares fallen recently?

Fortescue’s share price experienced a 5% slump one day and a 4.5% drop the day before, and was trading at $4.84 in the article — about 20% down since late March.

How large is the short position against Fortescue?

More than 100 million Fortescue shares are registered as a short position, which is roughly 3% of the company.

What did Jim Chanos say about Fortescue and why does it matter to investors?

Jim Chanos named Fortescue as a prime short-selling opportunity and called it a 'value trap' because of its exposure to iron ore and China. His reputation as a high-profile short seller (he previously exposed Enron and targeted other corporate models) means his view has drawn investor attention and may influence market sentiment.

How have iron ore prices changed and why does that affect Fortescue?

Iron ore prices fell from about US$150 per tonne to roughly US$135 per tonne in recent weeks. Chanos noted that prices are still well above a historical average of about US$100/tonne and warned that a significant fall back toward that average could make it harder for Fortescue to pay down its debt.

What is Fortescue doing to manage debt while commodity prices are high?

Fortescue says it is lifting production to help pay down debt while commodity prices remain relatively high.

Has Fortescue been performing better or worse than other big miners like BHP and Rio?

The article notes Fortescue had outperformed the likes of BHP and Rio in recent weeks, but it has not been immune to the heavy selloff in resource stocks.

What should everyday investors watch about Fortescue right now?

Investors should watch iron ore price trends, signs of slowing demand from China, levels of short interest (which are significant for Fortescue), and the company’s production and debt-reduction progress — all factors highlighted in the article as influencing Fortescue’s outlook.