Mineral Resources’ AUD 180 million fiscal 2013 net profit comfortably exceeded analyst’s AUD 141 million forecast. Despite a 26% fall in headline profit, versus fiscal 2012, underlying profit increased 11% and marks an impressive seventh consecutive year of profit growth since the company listed in 2006.
However, we maintain our thesis that inadequate operational and financial disclosure creates high uncertainty in both earnings forecasts and fair value estimate. The lack of disclosure, our expectation that return on invested capital will be below the weighted average cost of capital from fiscal 2014, and the lack of a clear competitive advantage, particularly in iron ore production, means the company has no moat.
Mineral Resources’ financial track record is impressive with the second-half underlying profit 73% above the first half. The dividend payout ratio of 52% looks undemanding, earnings per share growth has been consistent, and earnings before interest and tax to interest cover is nearly 50 times. However, with poor disclosure and leveraged iron ore exposure, risks are high and we consider the shares overvalued.
Iron ore price weakness, in September 2012, highlighted the correlation between the Mineral Resources share price and the highcost iron ore miners and spot prices are well above our longterm forecast of USD 90 per tonne (2013 price inflated at 2.5% per annum). Free cash flow (operating less investing) was negative in fiscal 2013 and borrowing arguably funded the dividend. With the mining services sector suffering from the mining sector downturn there is a risk increased competition will impact profit margins. Lower interest rates and weaker mining cost inflation may also tempt miners to in-house services.
The result lacked an associated presentation or analyst conference call and the financial report had scant explanatory information. The 44% increase in iron ore sales and 30% increase in crushing and screening capacity seem impressive but translated to just 13% revenue growth.
Gross profit margins of 39% are very respectable but divisional performance isn’t provided, meaning earnings sustainability and operating leverage are highly uncertain. Of particular concern is the iron ore mining business which fails to disclose resources, reserves, ore grades, realised prices or cash costs. It is hard not to conclude information is withheld due to weaknesses. Mine life could be short, ore grades could be low and cash costs could be high. We estimate operating performance is similar to Atlas Iron which breaks even at around USD 100 per tonne (CFR China), but it is highly uncertain due to the lack of disclosure.