Merafe Resources Deep Dive: Financials and Historic Performance [Part 2]

A look into the financial statements of the business

In the first part of this deep dive, we took a look at the business model of Merafe Resources and the industry it operates in. To recap if you missed Part 1, Merafe is one of the worlds largest Ferrochrome producers. They make money by mining chrome ore and refining this into Ferrochrome. Ferrochrome is mainly used in the production of stainless steel.

In this part of the Deep Dive, we will take a look at the financials of Merafe and how they have performed over the last five years.

 

Revenue

Merafe has seen impressive revenue numbers in the most recent financial year-ended 31 December 2021. Revenue has grown from R5.89bn in 2017 to R8.1bn in 2021. This amounts to a compounded annual growth rate (CAGR) of 7.37% per year. Half-year unaudited results have been released for the 6 months ending 30 June 2022 and revenue for this period was R4.29bn. If we gross this up to a full year figure, we get revenue of R8.52b an increase of 6.5% from 2021 figures.

From the chart, we can see that revenue numbers for 2021 were significantly higher than 2017 2020. This drop-off in 2020 is to be expected given the slowdown of production caused by national lockdowns. However, given that 2021 revenue is substantially higher than 2017, 2018 and 2019 revenue this might indicate that future revenue may come down and normalise given the cyclical nature of mining businesses as chrome prices rise and fall due to supply and demand.

 

Profit

The company achieved an operating profit margin of 27% and a net profit margin of 21% in the 2021 financial year. This is the best performance Merafe has seen in the past 5 years. Revenue and profit have moved hand in hand over the past 5 years. When revenues dropped in 2019 and 2020 this had a massive impact on profits in these years and resulted in a net loss for these two years. This leads me to believe that fixed costs are high given that minor changes in revenue have caused large swings in profitability. It seems that there is a hurdle of a minimum amount of revenue Merafe needs to earn to remain profitable given the fixed cost nature of the business. Based on the past performance this hurdle appears to be around R6bn in revenue.

 

Balance Sheet

When taking a look at the balance sheet on 31 December 2021 we can see that Merafe is solvent and liquid. Total assets amount to R4.95bn and far exceed total liabilities of R1.18bn. The entity has very little debt on the balance sheet as part of its capital structure and thus the debt-to-equity ratio of 2% is of no concern to me.

When looking at the liquidity of the business they have a quick ratio of 2.82, a current ratio of 4.68 and an interest coverage ratio (ICR) of 930. The entity thus has an extremely healthy balance sheet and should be able to easily pay off debt or raise additional funding if the need had to arise.

The entity has a very healthy cash pile of R966m. The cash on hand exceeds the current liability balance of R892m. There is thus sufficient cash to settle the short-term debt.
 

Financial Performance

In the most financial year, the entity was able to achieve a return on assets of 41.54%, a return on equity of 55.35% and a return on invested capital of 53.97%. These are some seriously impressive numbers however, there has been little consistency in these numbers in the past. I would thus not expect these returns going forward. A mining company with exceptionally high returns on capital and equity is often an indicator that the company may be at or nearing the top of the cycle and it is seldom the case that a company will produce returns like this year after year.
 

Cash Flow

Merafe produced a free cash flow of roughly R670m in 2021 (2020: R150m). Operating cash flow was R1.16bn while capital expenditure was R490m for the period. Operating cash flow has been positive for all of the last five financial years, and this is very positive for investors. The entity should thus be able to produce consistent free cash flow going forward if it can control capital expenditure.

 

Conclusion

Merafe Resources has a rock-solid balance sheet and financial performance has been impressive in the most recent financial year. I am however concerned about whether the entity will be able to replicate these impressive results going forward given the lack of consistency shown in the past due to the cyclicality of the business. In the next part of the deep dive, we will take a look at the valuation of the business and what a fair price to pay is.