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Ferrexpo (223% Profit in 14 months)

Most investors have low tolerance for deficiencies in corporate governance. Ferrexpo plc 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.

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