Ferrexpo PLC (LON: FXPO) – Sustainable business growth rate trajectory with robust balance sheet position

Ferrexpo PLC (LON: FXPO) is a FTSE 250 Index listed iron ore pellet producer with mines in Ukraine (Poltava region) and sales operations internationally. It has been serving the global steel industry by mining, processing, and selling of iron ore for more than 40 years. It possesses nearly 20 billion tonnes of resources, which makes their asset base as the largest iron ore deposit in Europe. The Group targets to be a cost-efficient producer of iron ore pellet with a reliable logistics infrastructure. The Company has a sizeable logistics infrastructure of 154 barges, 2,850 rail cars and 28 Capesize vessels. It employs over 11,292 people (including subcontractors). The Company launched the Initial Public Offering (IPO) on 15 June 2007, and since then it is a constituent of London Stock Exchange. The Group has invested over US$2.3 billion in production and mining facilities since 2007.

On 6 October 2020, the Company is expected to release Q3 FY20 production report.

 
(Source: Presentation, Company Website)

Key Fundamental Statistics



Industry Outlook Dynamics

The realised iron ore prices were affected by the battered global demand during H1 FY20, which can affect profitability. However, as per the recent report from Global Market Insights, the market size for Global iron ore pellets market is projected to reach nearly US$70 billion by 2026, representing a compounded annual growth rate of 3.2% between 2020 to 2026. The key drivers for the market growth include - Increasing adoption of iron-based chemicals, Growing product consumption across MEA (the Middle East and Africa) region, and Rising awareness regarding the reduction of carbon emissions from steel plants.


(Source: Presentation, Company Website)

Growth Prospects and Risk Assessment

Ferrexpo PLC is a third-largest exporter of pellets to the global steel industry, and it has a sizeable asset base for catering to a diverse customer portfolio at a competitive cost as compared to peers. It has invested over US$2.3 billion in production and mining since the IPO in 2007. Moreover, the Company has a strong market reputation with a diversified sales portfolio to provide business resilience.  Also, the Company is a low-cost producer and stay cash flow positive through the commodity cycle. Overall, the Group has a well-invested production process, skilled workforce, global logistic capability, and long-standing customer relationships, which ensures financial stability to the Company. Despite the Covid-19 disruption, FXPO continued to operate with minimal disruption in H1 FY20. Moreover, the demand recovery in China is encouraging and shall strengthen the cash generation in H2 FY20.


(Source: Company Website)

However, the growth trajectory can be impacted by various factors, such as corruption risk arising from operations in Ukraine, lower iron ore prices, increasing freight rates, and operational risk regarding production stoppages or equipment failures. Furthermore, the weak demand for global steel amid Covid-19 disruption can affect the business further.
 
Segment Analysis

It operates through a single business segment, which is responsible for producing global steel amid Covid-19 disruption. Geographically, customers are located in five regions – Central Europe; Western Europe; China & South East Asia; Turkey, Middle East & India; and North-East Asia, and they contributed around 36%, 13%, 30%, 5% and 16%, respectively, in terms of FY19 sales volume by market region.


(Source: Presentation, Company Website)

Synopsis of Recent Developments

25 August 2020: The Board of FXPO appointed Lucio Genovese as Chairman of the Board, with immediate effect. He was already an existing Non-executive Director of the Company and replaced the retiring Steve Lucas.

7 July 2020: The Company reported that the infection rate in local communities of their location remains low, and thus in H1 FY20 pellet production was up 5% to 5.6MT (H1 FY19: 5.4MT), and H1 FY20 sales volumes increased by around 21% to 6.1MT (H1 FY19: 5.0MT). The higher sales have been driven by de-stocking and robust production performance. Moreover, increased sales in Asia offset the weaker demand in Europe.

15 June 2020: The Company affirmed that it continues to perform strongly, and therefore, announced the interim dividend of 6.6 US cents, which was paid on 3 July 2020.

Non-Financial Key Performing Indicators

The Company produced 10.5 Million Tonnes (MT) of own ore in FY19, which was slightly above the level of FY18. Moreover, the LTIFR (lost time injury frequency rate) reduced to 0.58x in FY19 as against 1.18x in FY18, reflecting a significant improvement. Also, there was no fatality reported in FY19 as against one fatality in FY18.


(Source: Presentation, Company Website)
 
Key Shareholders 
 

Financial Highlights (H1 FY2020): Decent liquidity profile and robust balance sheet


(Source: Company Website)

On 5 August 2020, the Company provided the unaudited financial results for the six months ended 30 June 2020, with higher sales and production, strong cash generation, lower C1 cash costs and debt, and solid underlying EBITDA of US$352 million. The revenue for H1 FY20 decreased by 1% year-on-year to US$776 million (H1 FY19: US$787 million), mainly due to a lower realised average free on board (FOB) price in H1 FY20, which was partly offset by a significantly higher pellets sales volume.

Total selling and distribution costs for H1 FY20 increased to US$162 million against the same period last year (1H FY19: US$132 million), due to higher international freight costs from CFR (delivery including cost and freight) sales. Further, the general & administrative and other expenses for H1 FY20 surged to US$50 million against the US$45 million in 1H FY19. The increase was driven by the lower audit and professional fees and the net effect from higher R&D (research & developments) and personnel costs in Ukraine. Led by the lower realised prices and decrease in revenue, the EBITDA margin reduced to 45% in H1 FY20 from 47% in H1 FY19. Due to a lower outstanding debt balance, the interest expense reduced by 49% year-on-year to US$8 million (H1 FY19: US$ 15 million) in H1 FY20.Profit for the period stood at US$250 million in H1 FY20 as compared with US$270 million in 1H FY19, primarily driven by the lower underlying EBITDA.

The Company witnessed a strong balance sheet position with a lower level of debt. The Company has decreased net debt to US$174 million and increased cash to US$169 million (both are compared with the same period last year) as of 30 June 2020. Net cash flow from operating activities for the first half of 2020 slightly increased to US$258 million as compared with the corresponding period of the last year (1H FY19: US$256 million). The Board has declared an interim dividend of 6.6 US cents.

Operational Highlights (H1 FY2020)

In H1 FY20, the total pellet production and sales volumes increased by 5% and 22%, respectively. The increase represents the highest first-half volume produced since 2016 and the second highest production volume for the first half since 2007 (when Group was listed). It was also benefiting from a diversified sales portfolio. As the demand in China remained robust, the Company has shown a stable iron ore price in H1 FY20.

The Company’s average C1 cash cost of production decreased by 11% year-on-year to US$40.9 per tonne in 1H FY20 (H1 FY19: US$46.0 per tonne). FXPO’s production costs benefited from continued cost control measures and lower energy prices. The Capital investment for H1 FY20 decreased by 16% year-on-year to US$96 million (H1 FY19: US$114 million), due to completed investment in concentrator expansion and pellet line refurbishment programme. Regarding the entrance in the new market, the Company has commenced production and trial shipments of DR (direct reduction) pellets, with 185kt of DR pellets sold in 1H FY20. Further, the plant capacity expected to surge to 12 million tonnes of pellets in 2021.

Financial Ratios – Strong Profitability Margins versus the Industry Median

 
(Source: Refinitiv, Thomson Reuters)

Reported profitability metrics for the first half of 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to the industry. Ferrexpo Plc has delivered a substantial return for the shareholders’ as return on equity of 18.7% was higher as compared to the industry median of 2.5%. On the liquidity front, Ferrexpo Plc’s current ratio was higher than the industry median of 1.89, reflecting sufficient liquidity to meet short-term obligations and shows a robust liquidity profile to tackle the uncertainty due to COVID-19 outbreak. On leverage front, the debt-equity ratio was 0.26x, which was lower as compared to the industry median of 0.54x, reflecting that the Company is less leveraged as compared to the industry. 

Share Price Performance Analysis


Daily Chart as on 26 August 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On 26 August 2020, at the time of writing (before the market close, at 8:27 AM GMT+1), Ferrexpo Plc shares were trading at GBX 184.00, down by 0.32% against the previous day closing price. Stock 52-week High was GBX 212.40 and Low of GBX 92.57, respectively.

Bullish Technical Indicators

From the technical standpoint, the shares were trading flat as compared to the short-term support level of 100 and 200-day simple moving average price. Also, 14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price. MACD line is placed above the central line, indicating a bullish setup. The Company’s stock has delivered a positive return of around 4.21% in the last one month.

Ferrexpo Plc Vs FTSE-Mid 250 Index (6 Months)

(Source: Refinitiv, Thomson Reuters)

In the last six months, Ferrexpo Plc share price has delivered 36.16% returns as compared to negative 14.81% returns of FTSE Mid 250 index, which shows that the stock has outperformed the index during the last six months.

Valuation Methodology

EV/EBITDA Approach (NTM)  
 


To compare Ferrexpo Plc with peers, EV/EBITDA multiple has been used. The peers are Anglo American Plc (EV/NTM EBITDA was 4.50x), Chamberlin Plc (EV/NTM EBITDA was 4.09x), Bushveld Minerals Plc (EV/NTM EBITDA was 2.90x), and EVRAZ Plc ( EV/NTM EBITDA was 4.33x). The Average of EV/NTM EBITDA of the Company’s peers was 3.95x (approx.).

Business Outlook

Inevitably, the associated uncertainties of the COVID-19 pandemic will persist for a prolonged period. However, the Company is encouraged by the H1 FY20’s performance as it has successfully navigated through the first months of the COVID-19 outbreak. Although the steel markets recovery in Japan and Europe will be slower than in China, the competitive cash position on the iron ore cost curve shall provide resilience to adverse market conditions. Considering the strong cash generation in H1 FY20, the Company has resumed dividend payments. Furthermore, the Company has adopted well to a changing market environment as it sold higher volumes to China where demand remains robust. It is anticipating a demand recovery outside China as the market returns to more normal conditions in H2 2020. Therefore, it is confident that it will be able to redirect pellet sales in the respective markets with favourable demand dynamics.


 (Source: Presentation, Company Website)

Over the course of 3 years (FY16 - FY19), the Company's revenue surged from US$986.33 million in FY16 to $1,560.72 million in FY19. Compounded annual growth rate (CAGR) stood at 16.53%.

Considering the strong operating performance, high level of cash generation, decent dividend growth rate, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Ferrexpo at the current price of GBX 184.00 (as on 26 August 2020, before the market close at 8:27 AM GMT+1), with lower-double digit upside potential based on 3.95x EV/NTM EBITDA (approx.) on FY20E EBITDA (approx.).
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.
*Dividend Yield may vary as per the stock price movement.

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