What To Do With Mount Gibson’s Cash Mountain?

This story features MOUNT GIBSON IRON LIMITED. For more info SHARE ANALYSIS: MGX

-Strong Sep qtr iron ore sales
-M&A or exploration?
-Maybe a dividend increase?
 

By Eva Brocklehurst

All cashed up and raising queries about where it should be spent? It can't be a miner, surely. Yes, it's Mount Gibson Iron ((MGX)). The Western Australian iron ore miner is sitting on a cash pile of around $400m and brokers are busy evaluating the options. The company is exclusively an iron ore miner, with three mines in production, although one is due to wind down next year. Acquisitions are on the agenda. After a strong September quarter, where 2.6 million tonnes of iron ore was sold, the company reiterated FY14 guidance for sale volumes of 9-9.5mt.

Mount Gibson has three mines – Tallering Peak, Extension Hill and Koolan Island. FY14 will be the peak of the company's current production profile, with Tallering Peak shipping its last ore in the September quarter next year. FY15 and FY16 shipments are expected to decline to around 7mt. Shipments of low-grade ore stockpiled at Extension Hill could boost this tonnage if additional trains can be secured.

Mount Gibson has paid off the majority of its debt, with $28m left in the June 2013 accounts comprised of an equipment finance liability. Assuming this debt remains, this leaves $392m as cash in hand. Cash generation was around $80m in the quarter, Credit Suisse estimates, and earnings are now positive across the broker's forecast period, although modest in FY15 and FY16 because the broker's forecast iron ore price at US$93/t and US$92/t respectively is below consensus.

Mount Gibson's cash in hand, in Citi's estimates, is 50% of market capitalisation. The broker is forecasting FY14 free cash flow of $182m, after capex of $96m, so the need to retain cash is limited. Acquisitions may be a way to go but this strategy is unlikely to be rewarded by the market, in Citi's view. Perhaps it would be better if the money were returned to shareholders. Nevertheless, management has stated it is looking for opportunities, particularly domestic iron ore acquisitions, and has raised the prospect of expanding into coking coal.

Citi notes exploration upside could boost mine life and increase production further. That's the main positive, but the company is highly leveraged to any movement in the iron ore price. A single commodity and two main mines mean Mount Gibson is also highly exposed to operation and commissioning delays.

Production and sales were ahead of JP Morgan's expectations, primarily because of improved productivity at Koolan Island. The broker retains concerns over the deployment of cash, believing that developing existing assets is the most positive way of extending mine life. In deriving a price target the broker has weighted with a risk to valuation to account for the proposed strategy of deploying capital through merger and acquisition (M&A). The stock price has doubled in the last four months and is now trading above target so the broker is disposed to an Underweight rating. To better this outlook, JP Morgan believes the company could crystalise value in its infrastructure in the mid west once Tallering Peak expires. The M&A strategy just creates uncertainty.

Credit Suisse plumbs for the middle ground. The share price has appreciated such that it has closed in on the broker's target and the rating stays Neutral. Earlier this month, a modestly higher reserve statement was issued which meant mine life additions are possible. The broker estimates up to a year each could be added to Koolan Island and Extension Hill. Koolan Is is the largest mine and life is now probably until 2021. Extension Hill should be winding up by the end of 2017. The broker, too, is wary of acquisition risk as shareholders may not benefit. Iron ore price movement will be the major catalyst for the share price. Drilling results from exploration at Fields Find and Extension Hill South may help. Mount Gibson is expected to start drilling at Fields Find within a week and at Extension Hill South in November. The company considers the latter tenement the most prospective.

The best additional value would be exploration success at Extension Hill South, in Deutsche Bank's opinion. Based on current reserves of 14.8mt the life of the mine is around five years at 3mtpa. On a quick calculation the broker believes a 2-year life extension with some modest capital expenditure could increase valuation by around 5c a share.

CIMB is increasingly positive on the stock and believes Mount Gibson is one of the safest ways to trade iron ore juniors. The broker prefers the stock to Atlas Iron ((AGO)) because of the robust balance sheet and de-risked production profile. The consistent cash flow and large cash balance provides options for expanding mine life, or maybe increasing the dividend payments? The company paid a 4c dividend in FY13.

On the FNArena database, there are two Buy ratings, three Hold and two Sell. The consensus target price is 82c, suggesting 0.3% downside to the last share price. The dividend yield from consensus earnings forecasts is 5.0% for FY14 and 3.9% for FY15.
 

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