Looking to buy Fortescue shares? Here are the questions I asked before jumping in

Miner on his tablet next to a mine site.

Miner on his tablet next to a mine site.

I decided to invest in Fortescue Metals Group Limited (ASX: FMG) shares in 2021 after a sizeable fall of its share price. But, it wasn’t the easiest decision to make because there are a number of different factors to consider.

In the long term, I think companies that can grow their revenue and margins are the ones that can deliver attractive compounding returns.

Businesses that are able to scale globally have large addressable markets, which means they have more room to grow. Names like Altium Limited (ASX: ALU), WiseTech Global Ltd (ASX: WTC), Xero Limited (ASX: XRO) and Pro Medicus Ltd (ASX: PME) are examples are ASX tech shares that have done this very well.

However, ASX mining shares are not typically known for that sort of growth profile. So, I believe it’s wise for investors to go into resource businesses with their eyes wide open about how things can go up and down, sometimes like a rollercoaster.

What is the iron ore price?

One of the first things that I think it’s worth questioning is what Fortescue’s key commodity is priced at.

Most readers have probably heard of the cliched phrase ‘buy low, sell high’. I believe it’s a good idea to take that approach when waiting for the right time to buy an iron ore miner.

Supply and demand can have a significant impact on the iron ore price. The rise and fall of the amount of money that Fortescue can get for its production per tonne can have a big impact on how much net profit after tax (NPAT) and cash flow Fortescue can generate.

It may seem obvious to say, but the Fortescue share price rises when the iron ore price goes up and drops when the iron ore price goes down. A lower iron ore price can prove an opportunistic time to invest.

I’m happy to start thinking about buying Fortescue shares when the iron ore price drops below US$100 per tonne. According to Commsec, the iron ore price was sitting at US$83 per tonne on Friday, comfortably below the level I’d like to start looking at the iron ore miner.

How much could the Fortescue dividend fall?

With an expectation that Fortescue’s dividend will sometimes fall, I believe it’s wise to anticipate that the company won’t pay a big dividend every year. However, I still want to see and receive decent cash flow for owning a resource business like this.

Bear in mind when the Fortescue share price drops, it can boost the prospective dividend yield.

According to Commsec, the Fortescue annual dividend could fall to just $1.02 per share by FY24. But, at the current share price, that would still equate to a grossed-up dividend yield of 9.2%.

So, I can see from this that at the current level, investors can still be pleasingly rewarded during lean times for the iron ore price.

Is it making good progress with its green hydrogen?

The main reason why I invested in Fortescue is that it’s diversifying away from just iron ore, and the business is investing heavily in that.

It aims to become a global power in green hydrogen. It’s looking to produce millions of tonnes of it by the end of the decade. This could be very helpful for the world’s decarbonisation. Fortescue aims to make hydrogen by just using water, powering the process with renewable energy. This is being done through the subsidiary Fortescue Future Industries (FFI).

Over time, I think this segment will become increasingly important for the Fortescue share price.

The company is betting billions of dollars on creating a worldwide portfolio of green hydrogen production facilities.

It has already signed on large clients that want to buy large amounts of green hydrogen in the coming years, including European energy giant E.ON.

In its latest quarterly update, Fortescue reminded investors that it signed a deal with energy infrastructure developer Tree Energy Solutions in October, which aims to accelerate the development of a “world-leading green hydrogen and green energy import facility” in Germany.

It also announced last month that Fortescue and Incitec Pivot Ltd (ASX: IPL) had progressed with planning for the conversion of Incitec Pivot’s Gibson Island ammonia facility to run on green hydrogen to its final stages, with the start of front-end engineering design as well as executing a framework agreement to govern the project through to a final investment decision.

In summary, I think this part of the business is going well.

Foolish takeaway

After considering these things, I think that the Fortescue share price looks attractive to consider for the long term. However, I will point out that a lot of Fortescue’s revenue comes from China, so what goes on with the Asian superpower is very important – it’s a risk worth keeping in mind.

The post Looking to buy Fortescue shares? Here are the questions I asked before jumping in appeared first on The Motley Fool Australia.

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Motley Fool contributor Tristan Harrison has positions in Fortescue Metals Group Limited. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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