GRR 0.00% 27.0¢ grange resources limited.

GRR - Delectably Undervalued - Kiwijuice

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    Intro : Around a week or two ago i started to look at Australian (ASX) iron ore producers after having seen the massive run FMG has had, GRR clearly stood out by a long way as the most undervalued, following is my own work feel free to link or share, as always probably a few mistakes in here somewhere but DYOR as this is not investment advice just a compilation of facts and figures/.


    GRR

    Savage River
    The Savage River mine, located in Tasmania, currently produces over 2 million iron ore pellets annually with plans currently in place to increase the level of production to 2.7m per annum. Iron ore pellets are seen as superior to using crude iron in the sinter-based process of steel production. This is due to the pellets containing fewer impurities, which means they require less energy to be used and therefore less carbon-dioxide to be emitted.
    Grange resources are 100% owners of the mine which currently has a mine life set to continue beyond 2030, with exploration activities presently under way to extend this.
    Last year GRR had total sales of 2.37m tonnes of Iron Ore product at an average price of $149.76/tonne, up from 1.90m tonnes at $127.20/tonne in 2017 - this was in part due to the increased price on premium 65% Fe pellets during the year.
    During the past few months the premium fee has dropped, although the amount GRR would be charging during this period has risen due to the increase in high grade iron ore prices.

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    Expansion plans
    GRR are currently conducting a PFS investigating the depth and resource levels within the northern pit. After the first phase of drilling it was announced that the mineral resource has been increased to 545.2Mt (Ore reserves of 94Mt at 49.8%DTR), an increase of 170Mt.
    As per the 8/4/19 announcement, the 2nd phase of drilling is nearly completed “and pending results will be processed and compiled for a future update in 2019. In addition to that a further 19 holes are planned for 8,800 metres of drilling to be undertaken from the Exploration Decline which commenced in March 2019.”


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    In addition to the underground extension of the northern pit, a feasibility study is currently being undertaken to assess the centre pit. Diamond drilling is currently taking place to allow for further accurate modelling of the pit.


    Production disruptions
    In 2018 production was disrupted by the high levels of rainfall in July/August. Since then additional de-watering infrastructure has been added to the site. In spite of this obstacle, full year production targets were still achieved.


    Other projects
    Southdown

    In addition to Savage River, GRR also own 70% of the Southdown project near Albany in Western Australia. The remaining 30% is owned by the Sojitz Corporation (AUD$5.81bn market cap) -- a Japanese trading company -- and Kobe Steel (AUD$3.3bn market cap) -- the third largest Japanese steel maker.
    Grange are currently maintaining the site with a reduced expenditure whilst they seek an equity partner. During this time GRR will progress approvals and permits.
    A DFS for the project was completed in 2012.
    A smaller development plan has reached the pre-feasibility stage and would reduce total spend down from $2.9bn to $1.4bn. A decision is yet to be made on whether the smaller development plan will progress to the DFS stage.
    Ultimately the aim of the project is to provide 10m tonnes of premium magnetite concentrate (69.5% iron) to the Asian steel market.
    There have been a lack of updates to the status of this project over the previous 12 months and it is unclear exactly what efforts are being taken in securing an equity partner.

    Grange ROC property
    At the beginning of March 2018 Grange announced they were diversifying and entering into a JV with ROC build “to seek property development projects, particularly in the high end residential property market in Victoria.”
    Some labelled this move bizarre, and it seems fair to say investor sentiment towards the diversification was less than positive.
    As per the latest quarterly report, Grange ROC property have 3 active projects all of which are said to be progressing according to plan, with 2 of the 3 projects to be constructed and sold within the calendar year. If these projects can start to show their value through significant capital returns it would be reasonable to expect the existing investor sentiment to change.

    Iron ore industry
    In giving an overview of the current state of the IO industry and how prices are being affected, I will discuss from the perspective of the 2 major forces that drive price change: Supply and demand.

    Supply
    The Vale Brumadinho disaster earlier in the year has had a very significant impact upon the supply of IO. Whilst it is difficult to quantify exactly how much supply was removed from the market, some sources have put the number at 70 million tonnes, with others going as high as 90 million tonnes, and Vale were forced to declare force majeure on some contracts.
    The events at Brumadinho caused an immediate change in the iron ore price forecasts, with the effects expected to last at least until the end of 2020:

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    Before this GRR were producing more high grade iron ore fines and pellets than either Rio Tinto or BHP.

    In the fallout of the disaster the Brazilian government shut down a further 9 Vale mines that used upstream tailing dams -- the same methodology used at Brumadinho.
    In addition to the mines that used upstream tailing dams, Vale were also ordered to halt production at their Brucutu mine -- which accounted for 30mtpa of production. Initially Vale had been allowed to reopen the Brucutu mine, but a court order over-turned this, creating further uncertainty as to when Vale’s operations may recommence.

    As well as the large supply deficit created by Vale, the Australian iron ore supply was also diminished by the recent cyclone that hit Port Hedland. Reports estimated that BHP lost between 6-8 million tonnes of production as a result of the storm, and Rio Tinto lost 14 million tonnes of production this year (as a combination of the cyclone and a fire at the Robe valley project).

    Demand
    In the past decade China have been the main driving force behind the iron ore market. It was Chinese demand that was behind the switch to daily pricing, and now China account for 60% of the world’s Iron ore demand.
    Last year saw an increase in Chinese demand for high quality iron ore due to changes in environmental laws encouraging steel producers to use less coke in the sintering process. However, 2019 was expected to be “a year of weakness for the iron ore market” with supply expected to increase at a more significant rate than demand.
    The supply disruptions alone would have been enough to force a reassessment of the market sentiment, yet it appears that Chinese demand may also have been underestimated. Heading into 2019 Chinese steel production had been expected to stagnate, despite these expectations, first quarter steel production saw a 10% year on year growth rate, and set the record for the most steel produced in any recorded first quarter. On the back of these numbers Anglo American’s chief research manager for steel and iron ore estimates that Chinese iron ore demand will rise 1.8% this year.
    A major reason for this increase in steel production comes from the Chinese government making an AUD$478bn investment in transport and infrastructure.


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    Chinese steel producers are now left with three options; paying more to secure the supply of high quality iron ore, lower production rates, or use lower grade ore. Steel producers who elected to take the third option have already had an impact on the market as the price of lower grade ores started to rise (to the benefit of FMG and their 56.7% super special fines, which increased in value).
    For high quality fines and pellet producers, such as GRR, the current market conditions are highly beneficial.


    Financials
    Last year Grange made a profit of $112.9m from mining revenues of $368.2m ($224.2m of which came from China), and are currently sitting on $224.5m in cash/receivables.

    As per the annual report GRR have financial liabilities of $52.8m -- $45.1m in trade and other payables, $7.7m in borrowings. Tax payable of $23.8m accounts for the bulk of the payables, the remainder is trade payables which are usually settled within 7-30 days.
    An easily manageable level of financial liabilities considering the strength of their financial assets.

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    In analysing the financial strength and value of GRR they seem to be performing strongly and undervalued by many key metrics.

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    Comparison
    Note:
    Data taken from www.marketindex.com.au, www.reuters.com, www.bloomberg.com, and company reports. Yearly profit and revenue were taken from the most recent annual report, while cash on hand was taken from the latest quarterly report.

    Below I have included a brief descriptions of some of the metrics used in the comparison table. For a more detailed explanation I have included full definitions of each term in the further reading section at the end of this report.

    P/E ratio = Market value per share/earnings per share
    Return on equity (TTM) = Net income/average shareholders’ equity (trailing twelve months)
    Earnings per share = (Net income - dividends)/Shares on issue
    LT debt to equity = Total liabilities/Total shareholder equity
    Current ratio = Current assets/current liabilities

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    From this table it can be seen that GRR are out performing significantly larger companies in many of these metrics. Their P/E ratio in particular seems to indicate that the company should be valued higher. A 9.8c EPS (earnings per share) is very rarely seen from a mining company with a 26c SP.
    Their current ratio indicates a highly manageable level of liabilities and suggests they will have no trouble in making necessary payments.
    Given the healthy levels of cash/receivables on hand, and the low levels of liabilities, the current enterprise value of GRR does not seem to be a fair reflection, particularly when viewed in the context of other ASX listed Iron ore producers.

    As of December 2018 GRR held $477.8m in net assets.


    Top 20 shareholders

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    The top 20 shareholders of GRR own a healthy 72.09% of the company, the bulk of this being held by Shagang International:

    The Jiangsu Shagang group are the largest private steel producer in China and have been on the Fortune global 500 list for 10 years. They possess a steel making capacity of 39.2m tonnes per annum.
    Shagang have been aggressive in expanding their steel operations, acquiring 4 rival companies since 2016. In addition to being the major shareholder they are also a significant customer of GRR.
    They initially became the major largest shareholder of GRR in 2008, when they purchased a 45.3% stake in the company. At this time Grange merged with Australian Bulk Minerals (who were also controlled by Shagang) and the company had a market cap of $1bn.

    The increased price of iron ore has impacted the margins of many steel producers including Shagang who are expected to have seen a fall in profit during the previous quarter.

    With looming potential threats to the long-term future of the steel industry Shagang have invested heavily in diversification. In 2017 they spent US$3.8bn on the acquisition of two internet data firms.

    Last year the 2nd largest holder -- Pacific international -- ended their association with the Shangang group. Since this occurred it appears that Pacific have been selling off parts of their position. As of March 21st 2018 they held 95.15m shares, this had reduced to 79.9m by February 18th 2019. Shagang’s interest remained unchanged over this period.


    Why is it currently so undervalued ?
    While there can be myriad factors affecting the SP of a company, here I will focus on a few factors I believe to be key in understanding the current valuation of Grange Resources.

    Management :
    Specifically the ways in which management communicate information to the market and engage with shareholders. This can be seen in the timing of announcements such as the recent “Savage river production update” choosing to announce a disruption to production months after it took place and just 2 weeks before the release of a quarterly. Then failing to quantify the disruption or giving the market enough data to make accurate forecasts with. This lack of hard data in their communications seems fairly common throughout GRR announcements and as such will be off putting to investors who want to crunch the numbers and not merely wait for the data from quarterly or annual reports to see how the company is doing.

    Non-core projects
    The move into real estate seemed to catch a lot of people off guard. With the exploration work currently under way at Savage river, and an equity partner still being sought for Southdown, it seems fair to ask the question: Is this the best use of the company’s time and resources? As previously mentioned, time will tell with this JV, but until it starts to show a contribution on the balance sheet this project seems to have failed to make a positive impact in the eyes of most investors.
    mce-anchorThere is also the lack of progress at the Southdown project. It has been 7 years since the DFS was completed and there is very little in any announcements to suggest a sense of urgency in finding an equity partner, especially now at a time when the iron ore market conditions are particularly favourable. It could also be questioned as to why -- given their relationship with Shagang -- have Shagang not looked to be involved in the project, and instead choose to spend billions on acquiring internet data firms?

    Pacific International sell-off
    We know between March 2018 and February 2019 that Pacific international disposed of over 15m shares. If they are seeking to fully sell off their position or get rid of a significant chunk we can expect to find out via a ceasing to be a substantial holder notice when they drop below 5%, although experience tells me these are not always brought out as promptly as they should be. If they have been selling off further parcels it would be logical to expect to see the SP rise when the selling is finished. Obviously this is speculative, but I believe worthy of consideration.

    Shagang
    In my opinion, Shagang’s relationship with GRR is by far the largest factor in shaping many investor’s perceptions of the company. When I began researching Grange I saw it as a massive red flag that the largest shareholder is also the most significant customer. I don’t believe I will have been the only person to look at Grange and have been concerned about this. Naturally, questions such as ‘Are Shagang paying a competitive price for their pellets?’ arise and can turn people off of GRR and have them looking at other Iron ore companies. Institutions might see this as an added risk and not look to get involved with a company whose Chinese owners are selling a product to themselves.
    The only way to answer such questions and remedy these concerns is through the numbers…and the numbers look good. The revenues and profit margins compare very favourably to their peers. GRR’s P/E ratio is something that is almost unseen in mining companies. So now that the key metrics look so favourable is it just a question of when will the market come around to this? Looking at the chart it seems pretty clear that sentiment towards GRR has changed and the stock has broken it’s downwards trend, yet it doesn’t mirror the successes that MGX or CIA have seen. Whether the market slowly comes around to the numbers GRR are posting, or whether there’s a tipping point that causes a sharp rise it does seem as though GRR is currently well positioned and undervalued. The increase in volume this calendar year also suggests I am not the only one to notice it.



    Further Reading
    -About Magnetite ore
    -Iron ore pricing explained
    -Latest Southdown project update
    -Chinese steel production Q1 2019
    -Iron ore prices unaffected by the trade war
    -Brief analysis of GRR’s value in terms of earnings and cash flow
    -Clive Maund’s technical analysis
    -Definitions: P/E ratio , Return on equity, Earnings per share, LT debt to equity, Current Ratio
 
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