Abstract: since our report on iron goods on November 16, 2016, the company's share price has risen by 70%, but even so, if we assume that the K & S project is at full capacity and produces 3.2 million tons of iron concentrate (65% iron grade) per year, the valuation of the shares is still cheap, with a price-to-earnings ratio of only 2.7 times 2018. Meanwhile, the price of 65% iron ore remains strong, now about $95 a tonne, up from $90 a tonne in mid-November 2016. In the coming months, any news that the project can start commercial operation in the first half of the year will be an important catalyst. On the other hand, at the end of March 2017, the lock-up period of 937.5 million additional placing shares (cost: HK $0.21) issued by the company at the end of last year will expire, which may constitute uncertainty.
Background: iron cargo produces iron concentrate products in the Russian far East, which is close to the northeast of China.
The K & S project has begun trial production and is expected to start commercial operation in the first half of 2017. Meanwhile, the Kuranakh mine has been closed since the first half of 2016 because of the high cash cost. Petropavlovsk PLC, a Russian gold miner, owns a 31.1% stake in iron goods. In addition, Junan Development, a Hong Kong-based mining exploration and trading company, owns a 17.8 per cent stake in Iron cargo.
Iron ore prices have continued to rebound in the past few months. The latest price of iron ore with an iron grade of 65% is about $95 a tonne, up from $90 a tonne in mid-November 2016.
The company aims to start commercial operation of K & S in the first half of 2017. As of January 18, 2017, K & S has delivered a total of 200000 tons of iron concentrate to Chinese customers during the trial operation. According to the company, K & S has entered the final stage of production testing and will start commercial operations in the first half of the year. In terms of annualized production, K & S produces about 3.2 million tons of iron concentrate (65% iron grade) at full production.
Major changes in our simple financial model: (1) earnings per share are calculated based on the number of new shares issued in December 2016; (2) our forecast for iron ore prices of 65% iron grade has increased from US $90 per tonne to US $95 per tonne (the latest price); and (3) the cash cost per tonne has increased by about 10 per cent to reflect the impact of the appreciation of the ruble against the dollar.
Based on the latest iron ore prices, the company's 2018 forecast price-to-earnings ratio is 2.7 times. In figure 1, we assume that K & S will have a full production and annual production capacity of 3.2 million tons in 2018, and make a corresponding scenario analysis. If iron ore prices remain at $95 a tonne, we estimate that the company will record a net profit of $153 million, representing a price-to-earnings ratio of 2.70 times.
If the basic assumption of the company is very conservative, the valuation is reasonable. If we make a lower assumption of $60 (the company's own basic assumption), the company will still record a net profit of $41 million, equivalent to 10 times 2018 p / e.
The adjusted price-to-book ratio is 0.46-0.82. Iron goods price-to-book ratio of 3.59 times, at first glance, this valuation may be higher. However, this is due to an impairment loss of $770 million recorded by the company between 2013 and 2015 due to the sharp fall in iron ore prices (equity as of the end of June 2016: $114 million). Considering the strong rebound in iron ore prices, if the company reverses the impairment loss of 50% Mel 100%, then the company's price-to-book ratio is 0.46-0.82 times, which is a more reasonable level.
Negotiations are under way to relax the terms of repayment for 2017. The company's outstanding loan from Industrial and Commercial Bank of China is about $234 million. As cash inflows are relatively limited before the start of commercial operations, Iron goods is in discussions with Industrial and Commercial Bank of China to relax payment terms for 2017. If more favorable conditions are obtained in the end, it will be a positive catalyst for the company or another.
The volume of transactions has risen sharply. Our last report on iron goods was published on November 16, 2016, when the average daily turnover of iron goods in three months was only $890000. Iron goods has attracted more investors' attention as commodity prices have improved, with the average daily turnover of the shares rising to $4.1 million in the latest three months.
Risk factors: (I) K & S was put into commercial operation later than expected; (ii) there were implementation risks of the K & S project (such as higher-than-expected cash costs); (iii) significant adjustments in iron ore prices; (iv) significant appreciation of the rouble against the dollar as the company's revenues were mainly denominated in United States dollars while most of its costs were in roubles; and (v) failure to repay bank loans on schedule in 2017.