[miningmx.com] — THE ferrochrome market is notoriously fickle. As a junior reporter in the mining field, I was advised that because ferrochrome was relatively easy to switch on or off, any Tom, Dick or Harry could jump in with more or, with a bit of expansionary capital, fresh output as and when demand encouraged higher prices.
However, the onset of a market surplus was always too quick to anticipate with the result that all the marginal producers would be caught fast in their tracks. The outcome was that marginal producers would end up selling material into an indifferent market for almost anything while responsible producers would have no option but to turn the taps off.
It doesn’t look like much has changed. Merafe Resources, the JSE-listed firm, said on Tuesday that the European benchmark ferrochrome price had fallen to about 79 US cents per pound in the first quarter of this year from $1.85/lb only a quarter earlier. This was, in turn, down from $2.05/lb in the third quarter of 2008.
I think this is ominous for Merafe even though its directors – the impressive Stuart Elliot and his CEO, Steve Phiri (who comes across a far more confident CEO than when I last saw him present a couple of years ago) – made soothing noises about the company’s future. The market is essentially a strong one, they said. Ferrochrome is used to make stainless steel and construction demand from China, the primum mobile of most mining products, was hardly in recessionary mode.
Moreover, Merafe has some R540m net cash, has kicked all its debt into touch bar a long-term R350m loan, and has a six to eight month stockpile of ferrochrome from which it can sell into the market at no cost while it keeps 80% of its furnaces in mothballs.
The upshot of this message is that cash burn is not a problem. But I think the board is nonetheless concerned. It has set down a dividend policy but didn’t pay one which suggests it would love to reward shareholders but dare not.
The reason is dare not is that at a ferrochrome price of 79c/lb, Merafe will hurt bad. Elliot wouldn’t disclose, for instance, what portion of the second half share earnings of 17c (H1:25c/share) was derived from the third quarter and which from the fourth. My guess is that at a fourth quarter ferrochrome price of $1.85/lb, Merafe performed relatively poorly. At 79c/lb, Merafe suffers especially considering much of its fixed costs – labour it can’t retrench because much of it is skilled – remain.
The company has nowhere to turn but to guts it out. It has a coal division, but as Phiri says, this is tiny part of its makeup. What’s wonderful about Merafe is that it’s a single commodity play – a so-called pure play – so you can’t expect beer and skittles the one day without a bit of a hangover the next.
Merafe isn’t alone in having to batten down the hatches and having for years struggled with financing its growth (the structure of its long-standing debt was always a bit of a brain teaser), it’s conservatism is a good sign; in fact, it’s a great sign. Merafe needs R540m in the bank because 2009 could well involve a bit of cash burn, but while its focus remains singly on ferrochrome, it’s a stock likely to shoot the lights out when the ferrochrome price vaults again, as it always has, and always will.
