Description
An unhedged major copper/zinc producer selling for 4X estimated 2007 exit EV/EBITDA.
Shares outstanding: 468 million.
Est. EV as of publication date: $11.14 billion.
Est. 2007 EBITDA $2.7 billion
Shares of Kazakhmys PLC trade on London. The shares were issued in October 2005 as an IPO. The ticker code in London is KAZ.L, priced in British pounds. The shares also trade on the Berlin Stock Exchange, under the ticker code KQ1.BE, priced in Euros.
The US pink sheet ticker symbol is KZMYF.
Kazakhmys PLC is one of the world's "lesser known" mining giants.
KAZ.L is the world's 10th largest vertically integrated producer of copper. Mines and smelters are based exclusively in Kazakhstan. Production of copper, zinc, gold, and silver comes from 14 underground mines and 5 open pit mines. 2006 output was as follows.
Copper: 368,000 tonnes
Zinc: 59,500 tonnes
Silver: 21.5 million ounces.
Gold: 58,600 ounces.
At year end 2006, reserves of copper/zinc were in excess of 20 years. The long reserve life results in lower depreciation charges (4.6% of 2006 revenue) than many mining firms.
Kazakhmys controls its power supply.
KAZ.L operates several large reserve coal mines. Coal production creates power for the smelter operations. The company produces all of the electricity required for operations at very low costs. This ability to generate low cost refinery power provides KAZ.L with a competitive advantage over many producers.
Kazakhmys also owns approximately 1100 km of railway infrastructure, which minimizes transport costs. This infrastruture provides KAZ.L with the ability to ship production either to China, or to Europe.
Vertical integration makes KAZ.L one of the low cost metal producers worldwide.
Kazakhmys' mines produced $3.3 billion of revenue in 2006, and generated EBITDA of $2.296 billion. The EBITDA margin was 69%.
KAZ.L's German fabricating business generates high revenues but low margins.
MKM (the manufacturing division) purchases copper in the open market. This copper is used to produce wire, sheet, plate, tubes and bars. In 2006, MKM revenues were $1.7 billion, and normalized EBITDA was $44.6 million. While all fabricators showed strong revenue increases due to commodity input price changes, MKM posted a 25% increase in revenues due to increased output.
Kazakhmys PLC has a debt free balance sheet.
Kazakhmys concluded 2006 with EBITDA of $2.308 billion, or $4.91 per share. Net profit was $1.402 billion or $3.00 per share for 2006. Income taxes were just under 35% in 2006.
The company is a significant generator of cash. Assuming that metal prices continue to be strong, Kazakhmys PLC could generate EBITDA in excess of $2.7 billion in 2007. After deducting capital for taxes, expenditures and dividends, the firm may close out 2007 with a cash balance in excess of $1 billion.
In approximately 2 years, copper production may increase by 40%
Kazakhmys has one of the world's larger copper mines scheduled to commence production in 2009. Forecast output from the Aktogay mine may exceed 155,000 tonnes of copper per year, when fully operational. This could increase KAZ.L net copper output to 532,000 tonnes per year.
Current proven reserves from this deposit are estimated to be 5.8 million tonnes of copper. At forecast production rates, the Aktogay will have a life of approximately 36 years.
Short term production issues have held the shares back recently.
In the first quarter of 2007, copper production rose by 12%, while zinc production fell by 2%. An open pit zinc mine had been closed to strip overburden in the 4th quarter of 2006, and was not processing ore throughout much of the 1st quarter. Gold and silver production fell by 17% and 4% respectively in the quarter, due to processing delays at the precious metals refinery complex.
According to the company, the gold and silver ores were subsequently processed at quarter end, and should be included in the second quarter revenue.
2007-2008 capital will being spent to increase output from existing mines.
Capital expenditures have averaged $355.5 million per year over the past two years. This expenditure rate should be maintained for 2007. The bulk of capital expenditures will go towards increasing the Nikolaevskoe concentrator capacity. At present the Artemyevskoe mine is unable to operate at maximum capacity and KAZ must use expensive 3rd party processing for a portion of the mine output. This will end late in 2007.
4 additional mine concentrator expansion programs are scheduled to be completed in 2007-2008. When fully on stream, these may improve recoveries and allow for greater total output.
Kazakhmys has a call option to acquire 25% of ENRC Kazakhstan, a private mid tier metals producer.
The option expires on December 31st, 2007. In exchange for total consideration of $826.1 million, KAZ.L has the right to acquire these shares. ENRC is proposing to issue up to 25% of its equity on the LSE later in 2007. Initial valuations suggest that this company may have a total market capitalization of $6 billion. Should this prove to be accurate, the call option would carry value.
Risks
KAZ.L has all of its mines located in one country, a former Soviet Republic. As a result, there are country specific risks. Among other risks, bear in mind such terrifying possibilities as nationalization of assets without compensation, punitive changes in taxation, and the ever present possibility of fraud and corruption at both government and corporate levels. Some may consider BOD and directors to be of questionable integrity.
Conclusion
KAZ.L, as a policy, states that it does not hedge mining output. Consequently, shareholders benefit fully from rising metal prices. According to management, a 10% change in the price of copper increases/decreases profits by up to $234 million, or $.49 per share. A 10% change in zinc prices increases/decreases profits by $33 million, or $.07 per share.
The firm does hedge its MKM purchases, but only for the purposes of matching short term imput costs with sales.
With increased copper production & continued strength in metal prices, Kazakhmys may show EBITDA growth in the range of 20%+ this year. My forecast EBITDA may be conservative. If the 2007 year end EV/EBITDA of less than 4X is met, KAZ.L might be inexpensive. The sound balance sheet and defined mid term growth prospect is a plus. I anticipate the dividend of $.385 per share may increase.
The 2006 annual report may be found here.
The recent corporate roadshow may be found here
Catalyst
Unhedged production may lead to highly positive earnings surprise in 2nd quarter. Resolution of short term mining issues should occur. Company may benefit from lateral shifts in the mining sector as mid tier miners get taken out. 2008 production should grow by double digit rates in 2008 from extensive concentrator upgrades. A major new mine slated for production in 2009 should sharply increase output.