Description

Long Central Asia Metals

All values given are in US Dollars unless indicated otherwise

“Vic Mancinelli again set a record at CTB, our agricultural equipment operation. We purchased CTB in 2002 for $139 million. It has subsequently distributed $180 million to Berkshire, last year earned $124 million pre-tax and has $109 million in cash. Vic has made a number of bolt-on acquisitions over the years, including a meaningful one he signed up after year end.”

Excerpt from the Berkshire Hathaway 2011 annual report

When I first read this quote many years ago I did wonder how often you can find such a business for sale. With Central Asia Mining you have a business in the markets which has done this over the past 10 years and is for sale at a reasonable valuation.

Central Asia mining came to the AIM market in September 2010 raising 60 million dollar at 96 pence a share to develop their first ‘mine’ in Kazachstan named Kounrad. Since 2010 the company has returned 98 pence to shareholders over 8 years in dividends and last year generated about 70 million of free cash flow.

Low cost producer

The company’s first asset was a 60 percent interest in the Kounrad mine in Kazachstan, if you can really call it a mine. Kounrad was a Soviet are copper mine which was abandoned and exhausted in 2005. CAML saw potential in leaching copper from waste dumps which were considered uneconomical to extract the ore from. The only thing they have to do to recover this copper is irrigating these dumps with a low acid solution because the acid dissolves the copper ions in these dumps. The then ‘pregnant’ solution is captured and treated to recover the copper which is formed into 99.99% pure copper cathode sheets. In 2014 they increased their share to 100% in Kounrad.

Since no blasting, mining and milling is involved in this process operating costs are accordingly low. At a C1 cash cost of 52 cents per pound of copper last year this mine is in the lowest 10% of all producing copper mines worldwide. This translates into a 76% EBITDA margin at Kourad last year. And since the largest investment is laying pipes to transport liquids, the free cashflow profile of Kounrad is very nice as well. This mine produced around 60 million a year in EBIT (and before corporate SG&A) in the last 2 years.

While Kazachstan is not everyone’s favorite vacation destination the company has no problem to return the cash to shareholders. There is an advantage that this mine is in Kazachstan with the local currency (the tenge) being very susceptible to changes in commodity prices. And since the majority of the mining costs are in the local currency this provides some buffer to commodity price fluctuations. In fact, over the last few moths the tenge had depreciated about as much as the price of copper (to eventually recover, very much like the price of copper).

Management has been quite adept at incremental improvements and today manages to produce about 14,000 tonnes a year in copper from a facility which was designed for 10,000 tonnes a year. This is a theme which will return later on in this story.

The last important point is that this mine has a relatively long mine life until at least 2034 when the license expires. Management has indicated they are quite confident the mine life will be longer when the license gets extended. All major capex has been done until the end of the mine life.

If you take the current lower copper price into account, this mine will produce at least 50 million in cash this year (before SG&A of 12 million) and should continue producing a healthy amount of cashflow going forward due to its low cost of production. One could argue that the current EV of CAML is pretty close to the value one would assign to this mine alone.

Sasa Mine

In 2017 CAML acquired the Sasa mine in what was then still called Macedonia (now North Macedonia). If one looks further than the fact that this mine is not located in Central Asia there are some nice features.

The acquisition price back then was 402 million (or just a little less than the current EV). This was financed by a combination of debt (around 180 million), some cash on hand, a deferred consideration and an equity issuance of around 200 million. For the last 2 years this meant a 11-12.5% cash return on investment per year.

The Sasa mine is a lowest quartile (just on the 25% point) underground lead-zinc mine and had 60% EBITDA margins last year. This diversifies the company to another commodity and jurisdiction which is always nice.

In general, underground mines are not very interesting to own since they require plenty of reinvestment in underground development to access new ore. This in not the case at Sasa due to the way this mine has been developed and management took this into consideration when they made this acquisition. That is why in the last 2 years the reinvestment into fixed assets has been 20 million below the depreciation charge at the company level.

As was mentioned, management has been looking at ways to increase the value of this mine with initiatives to increase production slightly. This will be done by a more optimal utilization of the current infrastructure. CAML installed new crushers in 2019 which should increase recoveries by about 2% and are doing more efforts to increase grade control at the mine. They are also looking at changing the mining plan to a cut and fill method from a sub level caving method. This is done to reduce the need to invest in new tailings facilities in the future, which was responsible for most of the capex in the last 2 years at Sasa.

In the meantime CAML has been doing some minor exploration drilling to extend the mine life even beyond 2038. There is also regional exploration potential which can be interesting but to which I currently assign no value.

Given that this mine is producing close to 50 million per year in EBIT before SG&A at the corporate level, a valuation close to the current company EV is not unreasonable given its long mine life.

Other projects

When investing in natural resource companies the reinvestment of the cash-flow is very important and it appears this management team should be able to conjure up some nice growth opportunities when given time.

Looking at the history of this company I noticed that management of CAML was always very disciplined in evaluating growth projects. In the past they had evaluated a handful of projects but all with a minimal outlay of cash (a few million usually). They walked away from many projects because the operation was not low cost enough or economical enough to warrant an investment.

Growth at their current asset base is limited and they are looking at new opportunities to grown. This can be achieved with an new acquisition or low cost greenfield exploration (which they have done before).

Management has a history of under promising and over delivering which is always nice. A clear example was the Kourad project which was built on time and 17% under budget, uncommon in a sector which is known for cost and time overruns. The same is true with their guidance on production number forecasts.

Valuation

This company now trades at what is, before the suspension due to Coronavirus uncertainty, a 10% dividend yield (which was covered 2 times by FCF).

The EV/EBITDA is 4 and the P/FCF number to the equity is 5.

The price is a little above the book value for a company which had a return on equity of 14-15% in the last 2 years and is on the lowest quartile of the cost curve.

So, not really a stretch I would say.

Risks

Well, the countries where CAML operates are not exactly Tier 1 for corporate friendliness but then again they are not known for real abuses.

The company has some debt but they are planning to have it paid back within a few years. Management even negotiated with the banks to be able to repay the debt more swifty than is outlined in the initial debt agreement.

They are operating in the natural resources extraction industry, so volatility is expected. While most data points expect a rise in copper and zinc prices, history has a habit to surprise when if comes to commodity prices. But the likelihood that this company will produce at a loss are really slim. In 2015 for example, the most recent Annus horribilis in the sector, the company had a 52% EBITDA margin.

The coronavirus has proven it is capable to ruin the party so there is a real possibility that the mines have to be halted temporarily. But given that these mines are quite far from civilization (especially the mine in Kazachstan) the likelihood has been reduced. And the chance that both mines have to be suspended at the same time is less likely as well.

Lower than expected grades is always a possibility in mining, but less likely given the reatively long mining histories at both sites.

Summary

When the company decided to withhold the 2019 final dividend due to the coronavirus uncertainty the stock fell by about 35%. In the last month CAML has recovered somewhat but I believe CAML is an interesting opportunity to invest in one of the better run mining companies which owns 2 low-cost, long-life mines in 3 diversified but quite important commodities at an attractive valuation. One could claim that a single of their mines is worth the current company’s EV alone.

Management have been good operators and allocators of capital so there is more (but small) upside to come at Sasa and with inorganic growth projects. Management has indicated they are always on the lookout to evaluate and acquire interesting projects which comply with their stringent acquisition criteria.

Catalyst

Repayment of debt over the coming 2 years to return being a net cash company

Recovery in copper/zinc/lead commodity prices

Accretive acquisition or investment in an interesting greenfield project

Reinstatement of the 9-10% dividend with the possibility of a higher dividend when the debt is repaid and the company is net cash positive again. In the years prior to the Sasa acquisition, when CAML was net cash positive, they paid out almost 75% of their FCF, which would translate to a 15% dividend yield at current prices.