Ferrexpo heavily undervalued and full of promise, analysts say

Ferrexpo (LON:FXPO), the Ukraine-focused iron ore pellet producer, posted strong interims earlier this month and indicated a very positive outlook, with demand for its output from the steel making industry expected to remain strong. Yet its shares have suffered badly recently and are down nearly 30 per cent since July, suggesting to analysts they are heavily undervalued.

On 3 August the company revealed interim sales and profits had soared thanks to continuing strong demand for its product from the global steel industry.

Interim earnings before interest, tax, depreciation and amortisation (EBITDA) jumped by 86% versus last time to US$401m on revenues ahead 63% to $855m.

Group production versus last time was pegged at around 4.8m tonnes of pellets, although production of the high grade, 65 per cent iron pellets, increased by 4 per cent to 2.2m tonnes.

Chairman Michael Abrahams says in the statement that the strong interim performance was underpinned by “an excellent operational performance with production of iron ore pellets once again at full capacity and costs effectively managed in an inflationary environment”.

He adds that this strong operational performance was supported by continued growth in demand for iron ore, in particular pellets, during the period, with global iron ore prices remaining at high levels.

Abrahams indicated a rosy outlook for the group, saying demand for iron ore “is expected to remain strong in the medium term.”

In the wake of the results, the heavy fall in the Ferrexpo share price recently has bemused Seymour Pierce analysts led by Matthew McDonald.

In the light of the sell-off his team has decided to  re-examine Ferrexpo's valuation with particular emphasis on peer multiples, which, of course, are lower due to the recent market pullback.

The analysis shows that despite current relative valuations reducing Seymour’s overall valuation for the company, Ferrexpo's ‘high beta’  - which suggests higher risk but has potential for higher returns in relation to the market - has resulted in a greater stock discount.

McDonald recalls that in Seymour’s initiation note on Ferrexpo, back in April of this year, the analysts noted that the market does seem to understand the large production increases which are likely to result from the development of the group’s Yeristovskoye operation, with pellet production targeted to increase there to 20million tonnes per annum by 2018E.

However, Seymour believes valuations for the stock have persisted in ignoring the value contained within the company’s large unexploited resource base.

Moreover, recent market declines have resulted in Ferrexpo’s price falling by around 30 per cent since July in spite of fundamentals and prices for iron ore remaining strong due to tight industry supply/demand balances and evidence of restocking taking place at steel mills.

Consequently, Seymour reckons the stock not only has “considerable upside” of 52% to its overall valuation of 503p/share, but is also now trading at a 25% discount to the broker’s estimated operational asset value of 439p/share.

The broker’s upside is based on closing price for Ferrexpo of 332 pence on 23 August. 
Midday today, Ferrexpo shares stood at 352.4 pence, up 13.4 pence, implying an upside of 42 per cent versus Seymour’s target price.

The company has in total 6.9 billion tonnes of JORC resources, which it says makes it world class in size and the largest in Europe. It has a further 15.2 billion tonnes of resources classified under the Soviet GKZ Code.

Ferrexpo sells about 90% of its production to an established customer base on long-term supply contracts, which are subject to price renegotiation annually with reference to the annual international benchmark price for iron ore pellets.