Merafe delivered a very good set of results for the full year ending December 2015 (read more here). The company now looks poised to be able to pay out hundreds of millions of rands in dividends before Glencore comes calling.
Merafe has a 20.5% claim on the earnings before interest, tax, depreciation and amortisation (ebitda) of the Glencore-Merafe joint venture, which owns a collection of chrome mines and ferrochrome smelters. It is one of the largest and lowest cost producers of ferrochrome in the world – accounting for 17.5% of global market share.
|Merafe 2015 results – salient features||Metric|
|Headline earnings per share (cents)||13.9|
|Closing share price on Tuesday (cents)||82|
|Merafe market capitalisation on Tuesday (R’m)||R2 108|
|Cash flows from operating activities (R’m)||R955|
Merafe’s rise in earnings was largely attributable to increased production of 377 000 tonnes (Kt) of ferrochrome and the weaker rand. The ramp-up of the Lion 2 smelter contributed to the improved production performance, as did a solid operating performance from the Wonderkop plant. While the benchmark European ferrochrome price fell by 10% on average during the year, this was more than offset by the rand, which weakened by 17% on average during the course of 2015.
The joint venture has elected not to pursue any further growth opportunities, preferring to harvest the existing cash flows it generates. From a financial perspective, depreciation should match stay-in-business capital of between R250 million to R300 million a year.
What was particularly impressive was the amount of cash Merafe generated in 2015. Cash flows from operating activities, which included net interest and tax, came to R955 million. After investing in sustaining operations (-R259m), paying the last instalment for the Lion 2 ramp-up (-R44,3m), then paying dividends (-R45m) and reducing debt (-R57m), Merafe was able to increase cash and cash equivalents by R546m. Merafe’s market capitalisation at the close of business on Tuesday was R2.1 billion. Merafe declared dividends of R55 million for 2015.
So this begs the question, if the company continues to generate this amount of cash, what is it going to do with it? For starters, there are no growth projects to spend the money on. But the company still has debt. At December 31, 2015, bank loans amounted to R559 million. The company made a further payment of R5o million post year-end, which leaves debt outstanding of R509 million. At the results presentation Merafe CEO Zanele Matlala, indicated the company would aim to pay this amount down to R300 million at a rate of R100 million a year (i.e. over two years).
And we know Glencore needs cash. The company is in the process of “bulletproofing” its balance sheet by aggressively reducing net debt.
So based on the assumption that a) The European benchmark ferrochrome price does not fall any further from $0.92/lb; and b) The rand/dollar exchange rate holds at R15.50/US$ for the rest of the year with the company maintaining its ferrochrome sales volumes, there is every chance Merafe can continue to generate the levels of cash seen in 2015. The former looks to be the more risky, given that global stainless steel production fell by 0.5% in 2015 to 41.6 million tonnes (Mt). China – which imports much of Merafe’s ferrochrome, fell by 1.4%, hence the drop in prices for the first quarter of 2016 (see table below).
But a combination of a dearth of opportunities to spend the money on and a parent that desperately needs the cash, could lead Merafe – n my option – to pay out hundreds of millions of rands in dividends in the next year.
Quarterly European Benchmark Ferrochrome prices (US$/lb)
At the presentation, analysts asked whether a share buy-back had been considered. Matlala responded that the company did not have any authority to buy back shares, but that it would be investigated ahead of the company’s AGM.
All of which raises another question: With Glencore having bought out Royal Bafokeng’s 29% stake in Merafe during the course of 2015, why is the business still listed? Glencore now effectively owns 85% of the shares in the joint venture, so why bother having a listed vehicle for the minority stake held by Merafe? The original plan was to introduce the empowerment partner using Merafe as the vehicle. But from conversations with analysts, the 24% BEE component stipulated in the Mineral and Petroleum Resources Development Act would only apply to the mines, not the smelters, in the portfolio of the joint venture. As the mines are such a small component of the assets of the joint venture (circa 10%) would it really be worthwhile to do this through a public company? Probably unlikely, in my view.
This would imply that Glencore will come for the rest of the minorities in the joint venture – the shareholders of Merafe. With Glencore cash constrained at the moment, Merafe shareholders will continue to enjoy the dividends until such a time as the conglomerate sees better days ahead for ferrochrome. Then they will be asked to leave, for a price, of course.
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