FEEXY - Ferrexpo: Wait For The Outcome Of The U.S. Election

2023-12-10 23:07:33 ET

Summary

• Ferrexpo's business is currently depressed due to the impact of the Ukraine war on its ability to export, but it is still profitable and cheap.
• The company's pellet production situation has improved sequentially, but its access to Ukraine's Black Sea ports is highly restricted, impairing the situation relative to pre-war comps.
• The end of the war could lead to a substantial recovery in Ferrexpo's stock, with the potential for a quadruple of EBITDA and return through dividends and special dividends.
• We think a Trump win might be a major factor in seeing a probable end to the war and will look to see if a trade can be made on the announcement of election results.

Ferrexpo (FEEXF) is understandably attractive by some measures. Their business is depressed due to the Ukraine war's impact on the ability of Ferrexpo to export but they are still profitable and rather cheap on even current run-rates. In principle, the end of the war should mean a very substantial recovery in the stock. Otherwise, at current run-rates, there are better alternatives in markets that aren't under this stress at all. Still, there is a speculative argument for Ferrexpo, although not one that we would probably jump on.

Financial and Operating Situation

For the Q3 , we actually see improvements in the pellet production situation of the company sequentially.

The Black Sea grain initiative has been abandoned, and in general, there is highly restricted access of the company to Ukraine's Black Sea ports and alternative means of export are being utilised, which results in a much slower turnover.

As of the H1, which is the last financial release, the EBITDA was $64 million. The prices of iron ore have come up meaningfully, more than 10% , and with operating leverage that should mean a pretty meaningful increase in EBITDA could be seen in the H2 2023. We think around 50-60% increases are possible, and that downside in iron ore prices, despite slowdowns in major iron ore importers like China, is pretty unlikely. We estimate run-rate EBITDA to be about $200 million annually at this point, which puts the valuation at around 2x EV/EBITDA, which is of course quite low.

As a reminder, the entire Ferrexpo operation is located just east of the Dnieper River, thankfully somewhat far from the front. As we understand it the exact locations are all just southwest of Poltava city, marked on the map.

The operation includes 3 mines and pellet production facilities, and Ferrexpo is responsible for about 3% of Ukraine's total export revenue, 4% in 2021.

Risks

The risks are super obvious, which is that Ferrexpo could get blown up, especially as it would be a strategic blow to the Ukraine economy, but not of course the overall effort which is being funded by the West to a great degree.

Commodity risks are iron ore prices. The value of the pellets they produce and the fact that they are vertically integrated into mining means that they are exposed to the price of iron ore, and under ordinary circumstances their shares would trade correlated with the prices of iron ore. There isn't too much incremental downside risk to iron ore, but a recession wouldn't be great.

Bottom Line

A 2x EV/EBITDA run-rate multiple looks pretty good. What's more is that their ability to turnover products has been meaningfully affected by export issues because the Black Sea logistics routes are unavailable and won't likely become available until after the end of the war. When the open conflict ends, it's highly likely that Ferrexpo's exports will more than double and EBITDA will quadruple because of operating leverage. The company, while based in Ukraine, is run with Western capital allocation principles and they have paid very substantial special dividends in the past. This would happen again, and that special dividend could easily amount to around 100% of the value of Ferrexpo currently. 50% yield would be paid out from current prices on the basis of the underlying payout policies if EBITDA were to quadruple. Specials could get the figure to 100%.

The only decisive factor that might change in the coming year is the election of Trump, which were it to occur would radically increase the likelihood that a settlement is reached between Russia and Ukraine as Trump would want to bank that diplomatic and economic win, at the expense of other geopolitical objectives where Republicans will typically take a more isolationist view.

Our strategy would be to eliminate speculation on speculation and wait for the election to occur. If Trump wins and Ferrexpo's price does not respond to that event, it would be the optimal time to buy. Owning in the meantime just exposes capital to the risk of something unexpected and negative happening at the facilities.

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