By Craig Martin*
Exxaro Resources Ltd. (EXX) is a South Africa-based company engaged in mining, extraction and processing a range of minerals and metals including four key pillars, namely coal, titanium dioxide, ferrous metals (which includes iron ore) and other base metals, including certain “green” initiatives.
The company is the second-largest coal producer in South Africa with current production of almost 40Mtpa. Exxaro also holds a 20% interest in Sishen Iron Ore Company Limited, which extracts and processes iron ore.
Exxaro is one of Coronation’s top ten preferred large caps on the South African market. It is included in the Houseview Equity Portfolio (among other funds). Exxaro represents 6% of the Coronation Top 20 fund (as at 31 Oct 2014), and is the second-largest holding in the Coronation Resources Fund and is held in a number of other Coronation funds.
According to Coronation, “Exxaro’s share price is primarily under pressure because of its exposure to the iron ore price”, which is down at five-year lows. Iron ore has fallen 48 per cent this year; partly on concern China’s economic slowdown will weaken demand for the steelmaking material.
Some pessimistic analysts feel that iron ore may have further to fall because of the current over-supply in the market. Citigroup produced a report that indicates that the commodity, which is approaching $US70 a tonne, will fall to less than $US60 in the third quarter of 2015.
However, at current prices, a number of smaller mines in China and Australia have already shut shop. Only a handful of companies worldwide can make money selling iron ore and if it drops to $US60 then only BHP Billiton, Rio Tinto and Kumba Iron Ore will be able to produce profitably.
The Sishen mine in the Northern Cape employs open pit mining method involving drill and blast. Push back pit designs – waste. Unfortunately, Sishen’s enormous orebody is receding, and huge volumes of surface waste must be removed in order to expose the deeper ore body. This has meant push-back pit designs and various methods for stripping nearly 270Mtpa of waste. Mining costs are rising sharply at Sishen. However, it needs to be borne in mind that the 20% of Sishen Iron Order Company Limited that Exxaro owns, is not simply the Sishen Mine in Saldanna, but is actually all of the operating assets of Kumba Iron Ore, and includes the Kolomela mine, near Postmasburg in the Northern-Cape and the Thamzazimbi mine in Limpopo Province. These other mines are actually very profitable, being able to extra ore at under $US30 per tonne.
If you look at the last quarters (30 Sep 2014) production figures out of all the Sishen operations, production was up around 40% quarter-on-quarter, but sales were in decline by around 4%. This implies that surplus stock is building up and I trust that this is a through-the-cycle story with iron-ore. Eventually demand will match or exceed supply and prices will move higher again.
Coronations makes the point that “the market is currently ignoring the high-quality Grootegeluk thermal coal mine (the core supplier to Eskom’s new Medupi power station).” Coronation feels that Grootegeluk represents the bulk of Exxaro’s value.
Grootegeluk was responsible for 43% of Exxaro’s volumes in 2012. In fact, Exxaro is sitting on incredible coal resources in the Waterberg, which gives Exxaro the largest reserve and resource base in South Africa, ahead of Coal of Africa, BHP Billiton, Anglo American and Glencore.
Currently Exxaro is trading around R108 a share, which places it on a historic PE of only 7 and a dividend yield of 4,6%. Currently, there are no analysts who were surveyed for ratings on Exxaro, who have given it a “sell” recommendation. The consensus seems to be a “hold” recommendation. Considering that the mean target price from the same analysts is around R145 a share, which is 34% higher than the current trading price, I would think that Exxaro has to rather be a “strong buy”.
*Craig Martin is an entrepreneur with investments in information technology and financial services. He has experience as a discretionary Portfolio Manager, and has worked for ABN-Amro, Aurica Asset Management and Guardbank in the past. He currently invests for his own account and operates as an independent equity analyst.
