International Ferro Metals (IFL)

The price of ferrochrome, an alloy used in stainless steel production, is going through the roof. From around $1.20 per lb at the start of the year, contract prices in the second quarter were $1.92. And, with spot prices currently around $3 per lb, expectations are for third-quarter contracts to settle around $2.50, with even $5 seen as possible by the year-end. This is great news for ferrochrome producers that are increasing their output - in particular, Australian-domiciled International Ferro Metals (IFM), whose shares are in the FTSE 250 index.

IFM operates an integrated ferrochrome mining and smelting business in north-west South Africa, a key ferrochrome producing territory. Indeed, the South African link is part of the reason why the price of ferrochrome has risen fast. South African miners have not been able to process the stuff because of problems with power supplies. The South African power company, Eskom, is restricting ferrochrome producers to 90 per cent of their contracted supply. This is hitting IFM. Its smelters could produce 267,000 tonnes a year, but the power shortages will limit production to nearer 232,000 tonnes.

IFM can, however, increase its output because its smelter is still in the ramp-up phase. It had some commissioning problems last year because of component failures. These have now been rectified, but the result will be to limit production for the year to June 2008 to 204,000 tonnes. Nevertheless, management says the smelter is now working well, and IFM is firmly established among the lowest-cost ferrochrome producers worldwide. Its cash costs are about $0.60 per lb, compared with twice that level for the marginal Chinese ferrochrome suppliers who currently set market prices.

For 2008-09, IFM hopes to produce as much ferrochrome as its power supply will allow. And, for 2009-10, it should produce its maximum 267,000 tonnes even if power restrictions continue. This is because IFM has agreed to build a 12.5MW on-site power plant, fuelled by furnace gases. It should be running by the middle of next year to plug the gap that Eskom has left. The power plant was conceived as a way of generating carbon emissions credits and, by good luck, was ordered before electricity supply problems hit South Africa, leading to long waiting lists for power generation equipment.

Next year, IFM will start construction work on a new mine near its existing open-cast operations. Its output will support an expansion of its smelter's volumes to 667,000 tonnes. Ramping up to these volumes should begin at the start of 2010 and take 17 months. The scheme will cost around 4.5bn rand ($590m at current exchange rates). The good news is that, while IFM will take on some debt to help fund this, its projections say that cash flow will cover most of the expenditure. Of course, the expansion will also need more power. Eskom is telling IFM that it will be able to supply it, but City analysts are more cautious. They think Eskom's own development plans indicate that it won't have the generating capacity till, perhaps, 2012. That should not matter too much.

Stock broker Numis says that even an 18-month delay to the expansion ramp-up would prompt it to trim its forecast for 2009-10 EPS by just 3¢ to $0.65 (see table).