Ferrexpo
Ferrexpo plc is a Swiss headquartered resources company with assets in Ukraine, principally involved in the production and export of iron ore pellets, used in producing steel. Ferrexpo is committed to realising the potential of its principal asset, Ferrexpo Poltava Mining (FPM), one of the largest iron ore resources in the world. The Group has several large-scale growth projects in advanced stages of planning, which are currently on hold pending improvements in global market conditions. Ferrexpo remain committed to their aim to be a leading global supplier of iron ore pellets, providing outstanding service to customers and strong returns to shareholders. Ferrexpo plc is a member of the FTSE UK Index Series. It is currently one of only two pure-play iron ore companies listed on the LSE.
Ferrexpo is a sponsor of this site. Proactive Investors guarantees coverage of all sponsor news announcements from an investor view-point. For an in-depth analysis of Ferrexpo, click here.
London’s only pure play on the iron ore market
The global iron ore market is dominated by just three companies: BHP Billiton (LSE: BLT), Rio Tinto (LSE: RIO) and Vale (NYSE: RIO), and all three companies generate a substantial portion of their iron ore production from just two countries: Brazil and Australia. Unlike many commodities, iron ore prices tend to be set annually, when the big three iron ore producers hold contract negotiations with their biggest customers in the steel industry. This annual showdown, which starts at the beginning of the New Year, and is usually concluded within a few months, sets the benchmark for other iron ore producers across the globe from 1 April of each year. As one would expect, these contract negotiations are also crucial to the outlook for the steel industry.
Until very recent times, iron ore production was considered rather dull. Looking at more recent contract prices for fines, the most traded iron ore product, they fluctuated from year to year, but never increased at the pace they did in 2007 and 2008. In 2005, 1 dry metric tonne of fines averaged US$64. By 2008 it hit $132. Spot price increases where even more robust moving from a low of US$57/tonne in June 2005 to a peak of US$196/tonne in February 2008. The price volatility for lump and pellets, the two other main iron ore products, were similar.
Fast forward 12 months and the world of iron ore producers have reverted back to pre-2007 frenzy in commodity prices. The global recession has taken its pound of flesh from many industries, including all businesses linked to the steel industry. From a world where inflationary pressures in raw materials like iron ore were feeding through to steel prices and the real economy, the world is now in reverse, with interest rates slashed in the advanced economies and massive capital infusions being required to try and stave off the threat of a prolonged recession and address the risk of deflation. This sudden and sharp drop in iron ore spot prices has lead to a stalemate in the annual iron ore contract negotiations, with the big three iron ore producers refusing to agree new contracts, for fear of offering to large a price cut when demand is forecast to pick up in the second half of 2009.
Beginnings in Ukraine
This is the world that Ferrexpo has experienced in its short life as a listed company on the London Stock Exchange. It is an established iron ore producer in Ukraine, first formed in 1960 and privatized some four decades later. When Ukraine was part of the USSR, it was of great strategic importance, with its vast reserves of raw materials and substantial agricultural output. This strategic importance still continues today. Looking west from Ukraine is the expanding border of the European Union, look east and you see Russia. To the south is the Black Sea, and routes to the international markets for export. This unique location can be felt through the Ukrainian political system, with the two major parties representing on the one hand individuals who want to push for EU integration and on the other those who prefer to keep ties with Russia.
London’s only producing pure iron ore play
So four paragraphs on the Ukraine and iron ore – why? Ferrexpo is the only company listed in London that offers a pure play on the iron ore market, so its shares are often considered by the analyst community as a “beta” trade on the iron ore spot price. The Ukraine is also home the world’s largest iron ore resources, and has the potential to become a very large iron ore exporter, and thanks to its strategic location, can export raw material by rail into Europe or by sea to international markets.
Ferrexpo is a pure play on this potential, as it is by a long shot the biggest iron ore land holder in the country. The Group owns and operates an integrated mining and processing facility, comprising an open pit iron ore mine and crushing, concentrating and pelletising plant.
Substantial upside in Ferrexpo lies in its undeveloped assets. The deposits which the Group is currently mining have approximately 955 million tonnes of proved and probable iron ore reserves, but it has 6.5 billion tonnes of JORC-classified resources across the portfolio. The Yeristovskoye deposit alone, which is adjacent to the current pit, has proved and probable reserves of 632 million tonnes. Add in Soviet-classified resources, and the total jumps to a whopping 20 billion tonnes.
Before the world imploded in September 2008, Ferrexpo was moving ahead with plans to expand production from around 9 million tonnes per annum to 35 million tonnes per annum by 2018.
Wisely, the company has frozen all developments until the iron ore price and demand for iron ore recovers. The good news is that when the recovery does come, Ferrexpo will be able to restart is development programs very quickly. Equally, the company has cut production levels slightly (Total pellet production fell 2.6% in the first quarter 2009 compared to the final quarter in 2008).
A trading update for 2008 and production update for the first quarter of 2009 were as different as night and day. Trading for the full year was nothing short of robust, as the company reaped the full benefit of the surging iron ore market. However, by the end of Q3, demand for iron ore had diminished considerably, and the group cut production levels to reflect lower demand. At the same time, Ferrexpo benefited from the massive devaluation of Ukraine’s currency which generated a “sharp reduction” in costs. Average cash costs of production in the first quarter were US$37.40 per tonne, impacted by lower production in January, but the mid-tier iron ore producer confirmed that in March production costs were back to December 2008 levels (US$35/tonne). This is against an average DAF/FOB (Deliver at Frontier / Freight on Board) price in the first quarter US$76.7/tonne. Ferrexpo stated that it was offsetting weaker contract market prices by selling iron pellets into the seaborne spot market.
Michael Abrahams, Chairman of Ferrexpo, summed up the company’s performance:
"The Board is greatly encouraged by the performance of Ferrexpo in 2008, and particularly during the challenging fourth quarter. Kostyantin Zhevago has firmly grasped the reins of the company and has shown leadership in extremely difficult market conditions. The company has been able to manage its production carefully to achieve low costs while maximising sales volumes and prices. Aggressive cost and capital management initiatives are already bearing fruit and our strong customer relationships and logistical advantages make us confident that we will be able to trade profitably in 2009. At a time of continuing uncertainty in the iron ore market, Ferrexpo remains flexible, resilient and efficient and is well placed to benefit from any upturn."
Takeover target?
One can’t research Ferrexpo and not notice that there has been some substantial movements in the shareholder register in recent months. RPG Industries SE (“RPG”), the major shareholder of New World Resources (LSE:NWR), a fellow FTSE 250 constituent and a substantial coking coal producer, acquired a 25% stake at 86 pence per share from Ferrexpo majority shareholder, Kostyantin Zhevago, who now holds 51%. Post transaction, Mr. Zhevago moved to the position of CEO of Ferrexpo, while Miklos Salamon, Executive Chairman of New World Resources and Marek Jelinek, CFO of New World Resources, will join the Board as non-executive directors. The deal was widely speculated as the first step in a full blown merger between the two companies.
However, to date, no additional speculation has surfaced. RPG had originally intended to sell the stake in Ferrexpo down to New World Resources, but has since decided against this course of action given the uncertainty in the markets and the need for New World Resources to conserve its cash. RPG has stated that they now intend to hold onto the stake in Ferrexpo, while the New World Resources directors will still join the Ferrexpo Board. In addition, when we spoke to Ferrexpo, they were adamant that Mr. Zhevago had no intention of relinquishing his majority stake in the company. What is for certain is that two investors hold 75% of the equity in Ferrexpo, so the possibility of a hostile takeover is non-existent.
Analysts
As one would expect, when the iron ore price was surging, analysts were falling over themselves to recommend Ferrexpo with lofty price targets. Now that the dust has settled and we are entering a more precarious phase of global growth, the forecasts have been trimmed and ratings downgraded. After bottoming out (from a share price perspective) in late 2008, the consensus recommendation has risen from a ‘sell’ to ‘hold’ on valuation grounds with a few analysts upgrading Ferrexpo to a ‘buy’ on expectations that iron ore demand may pick up in the second half of 2009. Shares in Ferrexpo certainly have rebounded, climbing from around 20 pence in November to 85 pence today.
Looking ahead
Ferrexpo has more than enough on its plate to keep it busy for years and years. With massive iron ore resources strategically located with export routes into Europe, Russia and the international markets, the company looks set to benefit immensely from its dominant position. Iron ore prices may be more subdued in the near term, and most analysts remain cautious on the outlook for the iron ore market in 2009 and 2010, but over the medium term the picture is rosier. Shares in Ferrexpo have fallen back with the rest of the commodity sector, but with net debt of only $220 million, cash flow, huge reserves, and a 4% dividend yield, this company has the potential to outperform in the next leg up. Certainly has risks, but it has plenty of potential for capital appreciation over the medium term.
