FEEXY - Ferrexpo: Under-Siege Iron Ore Miner Likely To Survive

Summary

• Ferrexpo is Ukraine's premier iron ore miner.
• Under siege from the Russian conflict, the company has seen production halve and its stock price crash.
• Yet a solid balance sheet & the national strategic importance of the firm mean it is likely to survive.

General Overview

Since our last review of the Ukrainian iron ore miner , Ferrexpo ( OTCPK:FEEXF ), it has been an agonizingly challenging time. Dogged by the continuation of the Russian-Ukrainian conflict, the iron ore pellet maker has faced a barrage of issues, from rampant labor shortages to extensive power outages, vestiges of the enduring conflict.

It does not look like it will get any easier either. Most recently, Russia has amassed an army of aircraft at the border as it prepares to make additional strikes deep within Ukrainian territory.

Young Russians are being enlisted and the Soviet economy despite profound sanction-driven damage has yet to capitulate. Bartering continues among European states regarding provision of military support with Germany showing recent reluctance to supply a fleet of tanks without additional NATO support. Switzerland has shunned the idea of expropriating Russian assets to pay for damages and Turkey – a strategically important power broker – now appears sidelined by efforts employed to recover from a tragic earthquake.

Ferrexpo Poltava Mine.

No positive overtures exist on any diplomatic front – and little indicates that a solution will be found any time soon. In our previous article, we heralded the strategic importance of the Ukraine’s mining sector underpinned by global demand, world class assets, and sound financials.

That opinion still stands. However, until inroads towards lasting peace are achieved, this investment will remain precipitously laden with risk. While we remain bullish, we recognize that Ferrexpo is the nec-plus-ultra of overwhelming country risk. Buyer beware.

Latest Updates

Recent Q4 updates reported by the firm underscore the difficulties in operating in a war-time environment. Iron ore production has since fallen off a cliff (0.4M tons in Q4 2022 v 3.1M tons one year earlier) as steep drops in power supply aggressively dent production numbers. Electricity has been restored since December, but the situation remains precarious, hampering efforts to run more than one pelletizer line.

Rail logistics routes to the West have been preferred with ports to the South disrupted by the war.

High quality iron ore production continues to be the focal point, with grades of 65% Fe or above, making up the lion’s share of output. Management have reduced production of Direct Reduction pellets (67% Fe or above) as it continues to navigate the present operational disruption.

Full year production has almost effectively halved (6.1M tons in 2022 v 11.2M tons produced the previous year). Shipments have progressed as planned despite the closure of the port of Pivdennyi in the Southwest, Ferrexpo opting to use railway routes West to ship pellets to its customers in Europe.

Russian attacks on Ukraine’s state-owned electricity network have crippled both output and the bottom line. Despite this, the US $1B iron ore pellet producer continues to maintain a net cash position of US $105M, down marginally from a year earlier ($117M). The company benefits from balance sheet resilience that includes little to no debt.

The company has become embroiled in an alleged scandal surrounding underpayment of royalties by the firm’s biggest arm – Ferrexpo Poltava Mining. A local court recently froze bank accounts as part of an ongoing probe related to the potential short payment of iron ore royalties between 2018 and 2021.

Ukraine’s Office of Prosecutor General has been mobilized and is currently investigating the company’s largest (Ferrexpo Poltava Mining) and second largest (Ferrexpo Yeristovo Mining) operations. Allegations related to underpayment of royalties to the tune of roughly $35M, that the Ukrainian miner intends to contest legally.

Since the onset of the war, Ferrexpo’s stock price has been eviscerated, giving up -61% over the past 5 years.

It is not the first time the world’s third largest iron ore pellet producer has attracted controversy – only last year a local court ruled that a share fire-sale by beleaguered former CEO Kostyantin Zhevago was not valid, with equity having to be returned to original shareholders. Whether proven or not, the added distraction of these actions has adversely impacted the company’s stock price, receding by almost a quarter during the past month.

Outlook for the firm

Iron ore shipments have rebounded somewhat following the progressive reopening of China’s economy. Chinese destined cargoes traded marginally below a seven-month high ($130 USD/t) hit a couple of weeks ago.

The Asian giant continues to embark on actions aimed at cracking down on commodity speculation which has traders presently spooked. The country’s manufacturing sector has seen a post-Covid rebound with data from multiple government outlets supporting growing hawkishness. From a supply perspective, planned asset shutdowns and weather disruptions have constrained supply from Australia’s vast iron ore tenements.

A visible rebound in iron ore prices has occurred since the progressive reopening of China’s economy.

The price environment remains supportive for Ferrexpo provided it continues to access distribution channels and stable routes to market.

Consensus remains rocky but analysts do envision the firm rebounding from its fight for existence with sizable increases in revenues and profits during 2024. Not many are yet brave enough to endorse a strong buy rating with most preferring presently to sit on the sidelines – strong sell (1), hold (3), and buy (1).

Analyst estimates see a gradual rebound in future sales.

Risk

In our comprehensive equity research, Ferrexpo remains one of the riskiest assets we have covered. The firm is steeped in geo-political risk of the highest order. The company remains a pivotal source of revenues for State coffers to fund war-time efforts but also a source of much controversy given links to its notorious owner ex-CEO Kostyantin Zhevago.

The firm has found itself the subject of tax disputes, scandals surrounding share sales, and even the arrest of Mr. Zhevago following French allegations of money laundering.

These money laundering allegations saw the Ukrainian billionaire detained at the French ski-resort of Courchevel in December last year amid claims of the disappearance of $113M from Finance & Credit, his former bank which folded in 2015. Mr. Zhevago has since resigned from his responsibilities at Ferrexpo but does maintain indirect links to the firm.

All in, it makes for a chaotic situation that has rubbed off on the equity and sees the Ukrainian miner now trading 3.7x forward earnings. The company does have some natural defenses – a balance sheet with virtually zero debt, cash on tap, and a business which is resolutely cash flow positive despite the grim geo-political outlook.

Key Takeaways

Since our last coverage , things for Ferrexpo have gotten worse. Hinged on the uncertainties linked to a highly volatile geo-political climate that has seen output constantly disrupted by the ongoing war, the company does maintain some positive green shoots that may see it fall on its feet should it survive.

A balance sheet that is robust, quality assets primed to produce mineral wealth for decades to come, and the strategic importance linked to Ukraine’s eventual rebuilding. If you can stomach the volatility and see an end to the war, then a bet on the world’s third largest iron ore pellet producer may generate a home run.

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