My first stock analysis (ASX:MGX)

[jdenhaan]

Hi all!

Just want to run this one past you. I've been studying stock valuation and analysis vigorously for about a week or two and have started to apply some of the things I've learned to come up with my first stock analysis.

I've picked the company Mount Gibson Iron Ltd. (MGX), because they were highlighted as a potentially interesting buy in an article I read online. I just wanted to see whether my own analysis would correspond with this assessment or whether I would swing the other way. I would love your honest opinion on this!

Company situation

Mount Gibson is an iron ore miner that has existed since 1996 and went public in 2002. Obviously iron ore is a sector with its up and downs, depending largely on overseas (mainly Chinese) demand and demand driven by the construction sector. With the Chinese economy in a bit of a slowdown and the mining boom past its (first) peak, trading conditions for MGX have not been easy; year on year profits are a bit down. Having said that, iron ore productions was up significantly last quarter, so things are looking up. In the long term, I expect the Chinese economy to pick up pace at some time and it's only a matter of time before iron ore demands surge again.

On top of all this, Mount Gibson is sitting on an absolute motherload of cash (420 million) and has nearly completely paid off its debt. The obvious question is what to do with this cash. Dividends have been fairly conservative (~3.7% given today's share price), so I expect there's some big plans in the pipeline with the company hoarding its cash.

Fundamentals based on FY2013 report

Total assets: $1555m
Total liabilities: $373m
Outstanding shares: 1090m

If you do some simple math you can easily derive from these numbers that the company currently trades at a share price below its book value of $1.08 per share.

Total debt: $19m
Debt to current assets: 0.03
Cash reserves: $420m

Debt is negligible and easily covered off by cash reserves.

Net profit: 157m

EPS = 0.14

P/E ratio at current price ($1.01): 7

A P/E ratio of 7 is very low and given the healthy balance of this company, almost a bargain in my opinion.

My conclusion: buy and hold for the long term.



Technically it looks like the stock has bottomed out. The EMAs are all pointing up up up.

There's no reason why this stock can't at least double in value over time and move back to its 2011 high of over $2. Obviously, a lot will depend on how the Asian economy develops, as well as how management spends it cash reserves. But it seems like a fairly safe investment, given that the company trades below its book value.

Opinions?

 

[robusta]

The numbers probably look good. The only trouble I have with a single resource business like MGX is I can't work out the price they will receive for their commodity in the future. Asia may grow slowly, quickly or not at all, production is increasing internationally so I have no idea where the supply demand equation will settle. There are some good looking balance sheets in gold, uranium, rare earths, iron ore... But for me I'm not smart enough to predict the future profits.

 

[tech/a]

Like it technically
Hold it currently.

 

[Ves]

A P/E ratio of 7 is very low and given the healthy balance of this company, almost a bargain in my opinion.

I won't comment on any of your qualitative analysis because I don't follow the company and don't have any intention of looking deeply into a mining company.

However I would suggest that P/E ratios are irrelevant for mining companies.

Price / Earnings in its most basic sense says if I pay this price per share, what return per annum would I receive if the company can pay me out all of its current earnings forever. In that sense it is quite a rigid metric, in that it does not consider what happens if the company retains earnings (amongst a myriad of other factors you need to consider to arrive at a valuation).

Mining companies have assets with finite lives (ie. the raw commodities they extract from their mine will eventually run out) so you cannot use a perpetuity calcuation (such as a P/E ratio) when valuing the asset.

To value this company you would need to figure out how much of what they are mining they can get out of the ground (gross quantity), how much it will cost to do it, and how long it will take to do it. You would need to find a way of converting any future cash flows / out flows into a figure in today's dollars.

 

[ROE]

I dont have these either but I read a fair bit so I have an idea around iron ore and various resource stock
with junior Iron Ore, Rail access is a real issue, you got to look who allow them to access rail infrastructure and how much they going to charge them for it ... are they cost effective?

I know a while back FMG fight hard to keep people off their rail infrastructure...

Currently Rail Infrastructure are control by BHP/RIO and FMG

you can say they have a competitive advantages against all other miners as this is their infrastructure and they have the first call to use it and bring their product to market, everyone else wait in line or has to go to court to get access and even then they have to pay a price for the access.

 

[jdenhaan]

Looks like I may have been to quick around the bend when it comes to P/E values. I'll read into it a bit more!

Interesting point on the rail access: looks like BHP, RIO and FMG have a 'competitive moat' there.

 

[So_Cynical]

MGX is a high cost producer so for the company to make big money IO has to trade significantly higher than it has been recently, so in a nut shell your Punting on the IO price going up significantly and thus the China Boom kicking again.

If IO falls significantly and stays there, MGX would/could be producing at close to break even or operating at a loss...this fact is, has and will continue to be reflected in the SP.

 

[burglar]

Looks like I may have been to quick around the bend when it comes to P/E values. I'll read into it a bit more!

Interesting point on the rail access: looks like BHP, RIO and FMG have a 'competitive moat' there.

First they (FMG) advertised for Locomotive Enginemen.
Then they bought some Locomotives.
Over an 18 month period they built the track.

And all of a sudden they had their first shipment of Iron Ore to China.
I had to laugh, because I thought they had no wagons !! :


BHP and RIO had a 'competitive moat'.

FMG just went out and bought a railway.

So on the point of rail access ...
if no-one allows you access, you can build your own!

Good ole wiki:
http://en.wikipedia.org/wiki/Fortescue_railway

 

[jdenhaan]

First they (FMG) advertised for Locomotive Enginemen.
Then they bought some Locomotives.
Over an 18 month period they built the track.

And all of a sudden they had their first shipment of Iron Ore to China.
I had to laugh, because I thought they had no wagons !! :


BHP and RIO had a 'competitive moat'.

FMG just went out and bought a railway.

So on the point of rail access ...
if no-one allows you access, you can build your own!

Good ole wiki:
http://en.wikipedia.org/wiki/Fortescue_railway

Interesting! I wonder what's stopping MGX from using that mountain of cash of theirs for a similar project. Maybe their current developments don't yet warrant a separate infrastructure...

It's interesting by the way how everyone is talking about China 'slowing down'. They are still growing 7% year on year, enough to double the economy in a decade.

 

[jdenhaan]

MGX is a high cost producer so for the company to make big money IO has to trade significantly higher than it has been recently, so in a nut shell your Punting on the IO price going up significantly and thus the China Boom kicking again.

If IO falls significantly and stays there, MGX would/could be producing at close to break even or operating at a loss...this fact is, has and will continue to be reflected in the SP.

Once again, an interesting point (I'm learning so much here!). I've heard there is the possibility of an oversupply in the not-too long term with Brazil and India opening up their reserves.

On your note that MGX is a 'high cost producer' I started digging in the 2013 annual report and found that over an 853 mil revenue, the operating cost is 698 mil, or a profit margin of ~18%. Roughly speaking, this means an 18% decrease in the iron ore price would vaporise profit. Given that iron ore is currently at ~132 USD, we'd need to drop down to USD 108. The last time we saw that price was during the crash in 2012. Is a crash like that coming again? A correction maybe, but a crash?

 

[burglar]

Interesting! I wonder what's stopping MGX from using that mountain of cash of theirs for a similar project. ...

Andrew "Twiggy" Forrest was in negotiations with BHP & RIO
He was lobbying State & Federal politicians.
He left no stone unturned.

He didn't do it lightly.


Atlas (AGO) has an agreement with FMG.
Others will get access to existing rail and port facilities.

 

[McLovin]

Once again, an interesting point (I'm learning so much here!). I've heard there is the possibility of an oversupply in the not-too long term with Brazil and India opening up their reserves.

Maybe this one is too risky for a first investment. It looks tempting though with such a low P/E and so much cash in reserve!

If you hang around here long enough you'll see that the investors rarely touch mining stocks, and there's a reason for that. They really are more for the TA crowd. Although you posted a chart too, so maybe you can trade MGX.

The thing to remember with miners is you need to understand their production costs. They're price takers, which immediately puts me off. And also understand that a high cost producer will be more levered to price changes than a lower cost producer. When prices are rising this can give the appearance of it being a superior business, but when the tide turns they can end up with an uneconomic mine. Think about, for example, the change in profit for two producers one producing at $20/tonne and the other at $100/tonne if the iron ore price moves from $110 to $120. The higher cost producer will have doubled their profit, while the lower cost producer will only have increased their profit by 11%.

 

[jdenhaan]

Although you posted a chart too, so maybe you can trade MGX.

I'm not sure if 'posting a chart' qualifies me as a TA I was just trying to build the case for a 'buy' with some technical signals, but I guess I was oversimplifying things a bit in regards to the price of the underlying commodity (iron ore)

 

[burglar]

Everyone needs to be pigeon-holed. TA, FA, whatever.
How can you deal with someone who has a foot in each camp.
Or someone who skips through the minefields.

I just had to say that, ... and I don't even know why!?

When FMS rail reached Port Hedland on the wrong side of the port, BHP refused to co-operate.
This forced FMS to build a huge infrastructure to get rail over the top of BHP territory.

This photo may or may not be that structure, ... but you get the drift.

 

[burglar]

I don't know what that has to do with your chosen company MGX.

What I would say is MGX is operating in a complex environment.
They will require co-operation from their neighbours in regard to rail facilities and port facilities.

 

[jdenhaan]

I don't know what that has to do with your chosen company MGX.

What I would say is MGX is operating in a complex environment.
They will require co-operation from their neighbours in regard to rail facilities and port facilities.

Not much directly, but it's an interesting insight into the workings of the market MGX is in As usual, I oversimplified things a bit.

 

[burglar]

Not much directly, but it's an interesting insight into the workings of the market MGX is in As usual, I oversimplified things a bit.

Oversimplifying is only bad when the trade is going against you!

 

[jdenhaan]

Well I made a dangerous assumption regarding the value of this company, which fluctuates wildly with the price of iron ore. It might be priced under or close to book value now, but the book value of mining companies is rather unstable and unpredictable, since it depends on the price of the iron ore they have in the ground by the time it gets exhumed.