Ferrexpo plc
Most investors have low tolerance for deficiencies in
corporate governance. Ferrexpo is a classic case of an excellent business soiled
by corporate governance issues.
The company is the world’s third largest iron ore pellet manufacturer
and supplier to the steel industry with an 8% market share. Its assets are in
Ukraine and listed on the main board of the LSE. Its iron ore reserves would
last another 55 years at the current rate of production.
The controlling shareholder appeared to be close to the
previous political regime in Ukraine. He is now subject to several
investigations into his businesses even resulting in a Ukrainian court ordered freeze
of the company’s 50.3% stake in a subsidiary. This only prohibits transfer of
the shares and doesn’t affect the operations of the business. Such are the
political risks associated with Ferrexpo.
Prior to this, the company’s troubles began with the
discovery of questionable donations of $120m to a Ukrainian charity named ‘Blooming
Land’ for several years ending May 2018. An intensive internal investigation
later, nobody’s wiser about the end use of those funds. This was well covered
in the press and the auditors, Deloitte, quit. (There were other investigations
into questionable related party transactions.)
These governance infractions were enough for shareholders to
hammer the share price - and even vote, in disdain, 33% against the adoption of
the annual accounts in the recent AGM. (This is usually a routine matter.)
Investors are justified in avoiding companies with managements
they distrust. We would draw the line if the financials we rely on are
materially in question.
The financials reveal a business generating about GBP 400m
in average ebitda (a proxy for cash earnings) subject to very low effective tax
rates resulting in about GBP 300m in after-tax earnings.
The company sells for a mere GBP 780m or 2.6 times earnings.
It pays generous dividends resulting in yields over 11%. It sports very low gearing
with net debt/TTM ebitda of under 0.5x. The average cost of the debt was a mere
7%.
A conservative lender would easily lend GBP 780m against the
resources and earning power of this business. Equity holders don’t have the
power to compel repayment as lenders do – but this doesn’t detract from the company’s
value.
In our view, such a low valuation provides enough of a
margin of safety for the investor to take his chances on Ferrexpo.