ENRC’s Sittard Surrounded, But Sitting Pretty
By Daniel O’Sullivan
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“Sorry, but we’re surrounded by chaperones here and we’ve already said all we can say…” And that conference call interjection from the public relations people advising ferroalloy and iron ore producer Eurasian Natural Resources Corporation (ENRC) meant that whatever else chief executive Dr Johannes Sittard wanted to talk about on the day of his company’s maiden listed results, including the mooted possibility of a multi-billion dollar merger with fellow Kazakhstan-based miner Kazakhmys, was off-limits.
Nevertheless, Dr Sittard was forthcoming about another merger situation, the recently announced US$1.5 billion acquisition of Aim-traded ferroalloy company Oriel Resources by Russian steelmaker Mechel, which some Russian analysts see as being a very cheap deal for the acquirer. An Oriel sale should have interested ENRC, as both companies are in the business of mining chrome ore in Kazakhstan, and Oriel’s ferroalloy smelter in northwest Russia is well-placed to serve key Russian steelmakers. Indeed, some thought it odd that Oriel management agreed to a 47 per cent share lock-up with Mechel before soliciting a competing bid from ENRC as an obvious rival suitor.
However, Dr Sittard makes it clear this game was already too rich for him – “We have looked at Oriel several times over the years, but we were surprised at the price tag in that deal. Let’s just say it is a very nice price for the seller”. Dr Sittard doesn’t agree with those who see the takeout as cheap in terms of enterprise value to forecast cash earnings multiples, as these do not take account of the development risk still attached to Oriel’s mining assets. And he adds jokingly, “If you look at the share price at which you could have bought Oriel a few years ago, perhaps you could say we missed an opportunity!”
In any case, ENRC is currently completing its own deal - the US$210m acquisition of Serov, a proposition somewhat similar to Oriel, in that it combines chrome mining with ferroalloy smelting operations, but this time all located in eastern Russia. The deal is ENRC’s first real corporate activity since it listed in London last December, and also quite an obvious step-out as it includes a measure of vertical integration. Alongside mining its own ore Serov is already a major customer for ENRC chrome ore mined in Kazakhstan. And Serov already sells some 200,000 tonnes per year of ferroalloys, compared to the 180,000 tonnes per year Oriel’s Tikhvin smelter will manage after further planned investment. The rider, such as it is, is that Tikhvin output will be 100 per cent high-carbon whereas Serov produces a mix of high, medium, and low-carbon product.
The ENRC results statement, however, tagged Serov ferroalloy output as simply low-to-medium-carbon, and when pushed on Oriel being a better buy because of this quality differential, Dr Sittard clarified that Serov does indeed produce some high-carbon product, as previously stated in other references to the deal, but that management had not thought it worthwhile highlighting the exact product mix in these results. Why not? “Our results are strong enough that we don’t need to raise any false hopes,” says Sittard.
ENRC’s 2007 financial results certainly were strong in headline terms. Slight volume increases plus improved ferroalloy pricing globally saw the core division grow its contribution to group operating profit from half to three-quarters, with operating margin increasing from 32 to 48 per cent. The iron ore division, the largest such producer in Kazakhstan, boasting major Russian steelmaker MMK as a key customer, also saw good profit growth. The slight caveat is that although there was a small increase in the amount of mined ore and concentrate produced, high value-added pellet production actually declined slightly. Profits and margins dropped in the alumina division, but this was overwhelmingly due to an increase in costs. In early December the company successfully completed its first aluminium smelter which should be a significant earner from now on. It was initially commissioned at 62,500 tonnes per year (tpy) but should reach a run rate of 125,000tpy by the end of this year.
Rampant cost inflation remains a pressing concern in Kazakhstan. However against prevailing local inflation running at 19 per cent over the year, each of the three divisions managed to contain increases in cash costs per tonne - a performance Dr Sittard expects them to repeat in 2008. This year has already started well on other fronts – in March, ENRC’s logistics division was confirmed as the winner of a contract to build and operate a new 300 kilometre freight rail link from south-east Kazakhstan into China. As part of the deal for spending US$900 million over a four-year construction period, ENRC will have first dibs on this new transport capacity into the world’s hungriest commodity consumer. |
