Commodity markets are peculiar beasts. Just look at iron ore and coal: both remain oversupplied, and despite mini rallies this year, sit at prices that in the context of the last decade can only be described as bleak. Yet mining equities have been one of the standout asset classes so far in 2016 due to a mix of dollar-hedging, short-covering and the hope of catching the bottom of the commodities cycle. In some instances, we think this is overdone, and Russian steelmaker Evraz (EVR) is one such example. Not only does the company have one of the largest debt piles in the sector, but the structural challenges facing its end markets combined with continued pricing pressure mean this year's doubling of the share price could soon reverse.
- Fully-integrated business model
- Fresh access to debt capital markets
- High debt-to-profit ratio
- Troubled outlook for steel and coal
- Stalling capital expenditure
- Profit margin decline
Evraz is probably as well known in the UK for its 31 per cent shareholder and Chelsea FC owner Roman Abramovich, as it is for its important place in the global steel market. Not only is Evraz the world's biggest producer of rails and one of the largest manufacturers of wheels, but it has considerable operations in South Africa and the US, and is the top producer of construction steel in Russia. Its fully-integrated business model - through which Evraz mines iron ore and coal, smelts and then manufactures steel products - is a strong defensive characteristic and the company benefits from some of the cheapest operations in Russia. In 2015, its cash costs for washed coking coal and iron ore products were down to $31 and $30 a tonne, respectively.
Those reductions are still struggling to overcome a battered market and an overstretched balance sheet. Last year, with the iron ore spot price averaging $55 a tonne, Evraz saw a 39 per cent decline in cash profit to $1.44bn and particularly weak performance in its steel divisions, where costs actually increased as a proportion of revenue. That said, free cash flow held up well, declining only 21 per cent to $799m - resilience that was largely due to capital expenditure cuts and the release of working capital.
This picture would not be so onerous if Evraz's net debt was not expected to jump to 3.8 times cash profit by the end of this year, according to JPMorgan's forecasts. This may present problems for the dividend payment expected next year, given that management has said it will only fork out when net debt is less than three times cash profit. Signs that international debt markets are once again opening up to Russian corporates may help sentiment, though.
EVRAZ (EVR) | ||||
|---|---|---|---|---|
| ORD PRICE: | 155p | MARKET VALUE: | £2.2bn | |
| TOUCH: | 154-155p | 12-MONTH HIGH: | 155p | LOW: 54p |
| FORWARD DIVIDEND YIELD: | 3% | FORWARD PE RATIO: | 8 | |
| NET ASSET VALUE: | 10¢* | NET DEBT: | $5.4bn | |
| Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($m) | Earnings per share (¢)** | Dividend per share (p)** |
|---|---|---|---|---|
| 2013 | 14.4 | -613 | -42.0 | nil |
| 2014 | 13.1 | -1,084 | -98.0 | nil |
| 2015 | 8.77 | -707 | -55.0 | nil |
| 2016** | 7.39 | 358 | 27.0 | 4.7 |
| 2017** | 7.72 | 312 | 25.0 | 4.7 |
| % change | +5 | -13 | -7 | - |
Normal market size: 20,000 Matched bargain trading Beta: 1.69 £1=$1.29 *Includes intangible assets of $1.5bn, or 107¢ a share **JPMorgan forecasts, adjusted EPS, DPS excludes 2013 6p special dividend resulting from asset sale | ||||
