Merafe remains one of my favoured trading plays in mining because of the exposure to ferrochrome. Good growth in stainless steel production in the first six months of 2018, particularly in China and Indonesia, had a direct impact on demand for ferrochrome. Whilst ferrochrome production in China, which is the world’s largest producer, was negatively affected by short term environmental related shutdowns, strong demand is continuing and leading to a balanced market. Supply growth of only 1% is likely this year but demand is growing in the 5% to 6% region.
If we see this more balanced market (favouring producers) then then next two years look positive for stable pricing.
In the past two years have been good for stainless steel with growth of 3% likely in 2018. Strong production and demand for stainless steel is going in tandem and medium-term growth will be led by China, Indonesia, and India.
I thus target a price for ferrochrome of $1/lb for the next three years, which is 30% higher than in 2015.
Other than Merafe, Glencore has an interest due to its 79,5% share of the Merafe Pooling and Sharing Joint Venture, a joint venture that dates to 2004 and is today the largest ferrochrome producer globally.
Merafe reported respectable interim results and a bumper R200 million dividend (8 cents), up from R75 million. The shares traded ex dividend from 29 August. Merafe’s board will consider special dividends and distribute excess cash above R50 million.
For the year to December 2017, Merafe generated EBITDA of R1,7 billion off revenue of R5,9 billion. Even if the rand remains in the R13/$ to R14/$ range, the business would still generate EBITDA of at least R1,3 billion per annum. This translates to bottom line of over R700 million or EPS of 28 cents per share.
Even at a proclaimed dividend payout ratio of 30%, shareholders get roughly 8 cents per share before special distributions. Merafe could pay 50% of its earnings in dividend, roughly 14 cents, and still have a net cash position.
Because Merafe is a vertically integrated producer it captures much of the upside on price. About two-thirds of ore is internally sourced with the balance on contracts tied in to index prices. Chrome ore is about 30% of its cost of production and so EBITDA margin is well leveraged to positive pricing developments.
Merafe shares in 20,5% of the EBITDA of the JV and the earnings reported of R914 million in 2017 are the proportionate share. Glencore gets the lions’ share of earnings.
There is no debt and net asset value of R4,83 billion or 192 cents per share is 18% higher than the current market capitalisation.
There is reasonable tradability, 33% of shares in issue traded in 2017. Excluding Glencore and the IDC, 49% of shares are in public hands. Market capitalisation at R4,1 billion is sizeable. The stock traded in 2017 between a low of 108 cents to 201 cents, well up from a low point of 50 cents in 2016. Given earnings sensitivity to commodity price variability, Merafe is a nice stock traders choice. Strong commodity fundamentals mean there is a reasonable underpin to the price for now.
At 163 cents, Merafe is cheap at a forward PE ration on 5,6x, on my estimated 2018 earnings, and 85% of forward NAV. Assuming a 14 cents dividend, the gross yield is a chunky 8,5%. My DCF retains a valuation of 200 cents. Trading Buy.
Merafe Resources has shown good growth in their stainless-steel production for the first half of 2018 and the miner is still the favourite when it comes to its exposure to ferrochrome. There is more upside potential for the share price in the medium term if the miner’s operations continue to grow.
Looking at the chart of Merafe we can see that the price has been consolidating recently between the 150c and 170c per share level. Technically I would buy the share above the 175c per share level with a first target price of 200c.