The supply-demand dynamics for iron ore are at a tricky place. The market is suffering from both rapid increases in supply and declines in demand. The big players in Australia and Brazil stand accused of deliberately pumping more iron ore onto the market to force marginal players out of existence.
That tactic is working: high-cost producers in China, Canada and Africa have been going belly up. While that is sure to help restore the supply-demand balance, we’ve yet to get a sense of how things will settle and at what price levels. With a current spot price of $55, producers like Assore are only just making a profit. Those dynamics have driven its share price down some 80% over the past 18 months.
Further complicating the picture for Assore is a change in accounting policy in 2013 that switched to the equity method as opposed to traditional proportionate consolidation for the Assmang 50-50 joint venture with African Rainbow Minerals. That has made the analysis of underlying performance more difficult.
Assore generates 90% of its post-tax profit from Assmang, a non-listed entity. Following the accounting change, its contribution to group earnings is reflected only at the bottom line.
Assore grew revenue 27% to R1.68 billion but operating profit tanked 61% to R162.6 million as cost of sales advanced by more than 75%. The accounting irony is that attributable income is six times operating income, even though attributable income retreated 61% to R935 million. The dividend was halved to 300c/share.
Assmang derives most of its income from iron ore sales and the price of 62% fines (the percentage of iron content in the ore) fell on average by 38% to $82/tonne for the period under review. It has since declined further to around $55/tonne. Apart from waning demand, export sales were further hurt by delays in loading iron ore vessels at Saldanha port. The weakening rand partially mitigated these effects.
Given the surge in supply of iron ore, its dollar price is likely to remain suppressed. However, most sales are derived in dollars and the substantial dollar appreciation recently should prop up group earnings. Also, demand from India is trending upwards and the just-launched quantitative easing programme in the eurozone is expected to support demand in the medium term.
The company does have some exciting expansion plans that could improve its economies of scale, making it more cost-competitive. Assmang is erecting a manganese alloy smelter in Malaysia where the price of electricity is significantly lower than in SA. This will help margins. Additional relief on margins is being experienced due to reduced freight rates on the back of the sharp drop in oil prices.
Its Wet High Intensity Magnetic Separation plant at the Khumani mine is also ramping up to full production. The plant increases the recovery rate of high-grade fines material. There are other subsidiary projects aimed at increasing production in manganese and chrome.
Assore’s price:earnings ratio of 3.4 (industry: 4) has fallen to levels last seen during the 2008 financial crisis, when the price of iron ore dropped to around $60/tonne. Assore’s 15-year average PE is 11 (industry: 15). This indicates value and it might be a good time to contemplate buying the stock, which has lost 70% of its value since January 2014 while the price of iron has fallen by 52%. Assuming no major downward movement in prices and using conservative growth assumptions amid a tame economic outlook, we derive a target price of R165.68/share with a forward PE of 8.2. We make this a speculative buy because continued oversupply might further depress the price of iron ore. As shown by one-year future prices, market sentiment is still bearish, but historically, futures prices have been unreliable in predicting the future spot price.
- High barriers to entry
- Growing demand from India, Japan and other Asian countries
- Weaker rand to boost realised export sales
- Closure of high-cost producers offsetting excess supply
- Net ungeared position reduces financial risk amid shrinking revenue base
- Increased supply from Brazil and Australia suppressing price
- Rising administered costs such as electricity and fuel levies
- Uncertain labour market and regulatory environment
Analyst: Phibion Makuwerere, Editor: Colin Anthony
Nature of business: Assore Ltd is a holding company principally involved in the mining of iron, manganese, and chrome ores. It also produces other industrial minerals as well as manganese and chrome alloys. The group’s principal investment is a 50% interest in Assmang Ltd with African Rainbow Minerals (ARM) holding the other 50%. Assore exports the bulk of its products with the remainder used in its beneficiation processes or sold locally.
Disclosures: The analyst has no financial exposure to the instrument discussed. The opinion represents his true view.
For Intellidex’s full disclaimer, methodologies and definitions please click here.