You may feel as though you've have heard this one before, but we think it'll be well worth reading on. Four-and-a-half years ago, we tipped mineral sands miner Kenmare Resources (KMR) on the promise of tightening market fundamentals and expanding production. The wisdom of that call was finally unpicked last summer, when the owner and operator of the Moma mine in Mozambique completed a wholesale $275m (£220m) capital restructuring and refinancing. So why are things different this time? Simply put, our conviction is that prices for ilmenite - Kenmare's key output - are only now starting to lift off their multiyear lows, and will be further supported by the closure of the Chinese iron ore mines, the by-products of which contributed to oversupply between 2013 and 2016.
- Supportive refinancing
- Market in recovery
- Big discount to NAV
- Record production
- Opaque commodity pricing
- Historic cash flow issues
Full-year results, published last week, showed Kenmare is moving towards profitability. As was the case throughout 2015, cash profits were negative in the first six months of 2016, but edged up to $15.9m in the second half of the year thanks to improved shipment volumes and lower unit costs. During that period, spot prices of titanium feedstock also started to nudge higher, an effect that is only starting to be passed on to the contract pricing that covers the majority of Kenmare's sales.
Unfortunately, pricing for ilmenite and rutile (which is primarily used as titanium dioxide pigment in paint), as well as zircon (which is used in ceramics) is fairly opaque, meaning investors are reliant on market commentary. Fortunately, what signs there are, are good. Firstly, industry leader Iluka Resources (AU:ILU) expects to increase prices by around $50 a tonne from next quarter. Secondly, Kenmare managing director Michael Carvill reported that after a supply deficit emerged in the middle of 2016 the ilmenite market has "shown strong and steady price improvements" and will result in "significantly higher average realised prices" in 2017. A similar supply crunch looks set for zircon, which makes up around a fifth of Kenmare's revenues and commands a price of $800 per tonne. That compares with around $160 a tonne for the various grades of ilmenite, according to analysts at Mirabaud.
Even by mining company standards, Kenmare's profits are relatively sensitive to commodity price and cost movements. So the 18 per cent fall in cash operating costs to $136 per tonne of final product in 2016 is encouraging, particularly as unit costs are expected to decline further in 2017, alongside higher production. Part of the reason for greater confidence this time around relates to infrastructure. Once-unreliable power supply has now been upgraded by national grid operators, while a focus on mechanisation and recoveries are also helping to improve efficiency.
This is the underlying investment case that led Kenmare's banks and shareholders to back last year's financing. And while the debt-for-equity portion of the deal has left a consortium of lending banks with about 13 per cent of the shares, which is testing some investors' nerves, in the banks' own interests it seems unlikely the stake will be dumped.
KENMARE RESOURCES (KMR) | ||||
|---|---|---|---|---|
| ORD PRICE: | 320p | MARKET VALUE: | £351m | |
| TOUCH: | 309-320p | 12-MONTH HIGH: | 366p | LOW: 131p |
| FORWARD DIVIDEND YIELD: | nil | FORWARD PE RATIO: | 5 | |
| NET ASSET VALUE: | 708¢ | NET DEBT: | 6% | |
| Year to 31 Dec | Turnover ($m) | Pre-tax profit ($m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2014 | 174 | -101 | -3.6 | nil |
| 2015 | 143 | -61.9 | -2.2 | nil |
| 2016 | 141 | -17.1 | -28.0 | nil |
| 2017* | 226 | 36.0 | 29.0 | nil |
| 2018* | 277 | 88.0 | 75.0 | nil |
| % change | +23 | +144 | +159 | - |
Normal market size: 1,500 Matched bargain trading Beta: 0.87 £1=$1.25 *Canaccord forecasts, pre-tax and EPS numbers. | ||||
