Gamble of the week: junior metals play

By Tim Price Aug 27, 2010

Tim Price

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While BHP Billiton's bid for PotashCorp has reignited the materials sector, energy, natural resources and minerals were already telling the secular bull story of our time. That's thanks to the rapid industrialisation of the developing world.

Relative to the mining majors, such as BHP Billiton and Anglo-American, Ferrexpo is a junior player in the metals business. It concentrates on the mining, processing and sale of iron ore in the form of pellets, which are used for the production of steel.

The company enjoys a London listing but is headquartered in Switzerland. Its principal asset, Ferrexpo Poltava Mining (FPM), is in Ukraine, and is one of the world's largest iron-ore resources. It became the first Ukrainian company to list on London's main market following a successful initial public offering (IPO) in June 2007.

In Ferrexpo's interim results, published earlier this month, it reported a 74% increase in revenue, a 340% increase in pre-tax profits, and a 456% increase in underlying earnings per share. It's now on course to report record profits for 2010. The analysts at Edison Investment Research expect full-year production of pellets to be 10% higher than last year. High Ukrainian inflation will affect unit costs, but increased internal efficiencies are likely to dull the pain. Edison also believes that with a current year price/earnings multiple of 7.3 times, the stock trades on a significant discount to the sector's historic average of just over ten times.

Gamble of the week: Ferrexpo (LSE: FXPO)

Ferrexpo is exceeding City expectations. Revenue was 12% higher than Edison's own forecasts. Meanwhile, pre-tax profits and earnings were also higher than estimates. The company is the world's sixth largest producer of iron-ore pellets. That makes Ferrexpo a cyclical business geared to the global industrial cycle. But on the flip side it enjoys a compelling valuation advantage over its larger peers, and it has plenty of potential for growth. A more than robust Altman Z score (my preferred metric for assessing the probability of a business avoiding bankruptcy) of 5.7 leaves Ferrexpo as a cyclical, but highly attractive, junior mining proposition. Its current market capitalisation is £1.8bn and the stock has already returned 50% for the year to date.

Ferrexpo is followed by 19 City firms; 13 rate it a 'Buy', with five brokers advocating 'Hold' and just one advising 'Sell'.

Recommendation: CYCLICAL BUY at 273p

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