Ann: 2020 AGM CEO Presentation, page-4

XRF is not the world's greatest business - demand for its products is deeply cyclical, the company has a lumpy revenue stream and a meaningful commoditised element to its product offering and it displays little organic growth across the cycle.

But it does have some redeeming features.  

For starters it's balance sheet is in pristine condition, with net cash and current assets more than double current liabilities.

It is a healthy cash flow generator, with cumulative Operating Cash Flow over the past 12 years (a period which represents a full business cycle, incorporating both the commodity boom as well as its subsequent bust) totaling some $30m, out of which a little over $15m was reinvested back into the business ($12.5m in PP&E investment and $2.9m in R&D/Intangibles.

So OCF covers "stay-in-business"-type capex by a comfortable factor of 2 times.

The company's surplus capital has been well-managed, with $10m of acquisitions made over that period, and $12.5m returned to shareholders in the form of dividends.

Since listing, the company has called upon shareholders for a total of $5.6m (the majority of it to fund a $6m acquisition in 2011).

It has only run with a net debt position for a period of 18 months (and even then it was at a modest level, with maximum net debt of $1.9m at the FY2018 balance date).

Another attraction is that it has a stable management team - the average tenure of the company's directors is in excess of 10 years.  (Of course, this is a bit of a double-edged sword because it detracts from best practice governance which advocates for board renewal over time. Accordingly, I'd argue that there is a lack of true independence at board level for XRF, but given the track record of the directors having not done anything stupid or reckless, I think that lack of independence can be overlooked: it is clearly a very conservative board, and its longest-serving director owns 8m shares, so there is a degree of executive alignment with shareholders.)

And one thing the XRF executives can't stand accused of is that they are excessively remunerated: Collectively, the CEO, CFO as well as 4 NED's come at a cost of a touch over $900k, which is a level that has remained unchanged for the past 5 years.


Moving on to future earnings and valuation:

The cyclicality of XRF's earnings is quite evident:




As can be seen, the cycle peak coincided with the mining boom between 2011-2013 and it bottomed in 2017. The subsequent upswing is clearly underway.  

My FY2021 forecasts are not intended to be prescriptive; rather, they merely extend the cyclical recovery.

(Note:  The increase in FY2021 over FY2020 might look large (+29%), but that is only because I am using normalised earnings, i.e., excluding any non-recurring items such as profit on asset sales, impairments or - in the case of the FY2020 result - the significant Jobkeeper payments and other Covid-related subsidies, so FY2021 is cycling a FY2020 which had a Covid-impacted second half (EBIT in JH2020 was down 11% on JH2019))

Another thing that warrants noting is that, while FY2021 projected operating earnings are approaching the levels of the last cycle peak, which makes it tempting to assume that the companies earnings are close to peaking, this is not necessarily the case because it overlooks the fact that the asset base of the company is today some 50% larger than it was during the last cycle peak (Total Assets today = $45m, compared with $24m at the end of FY2011 and $31m at end of FY2012).

So, while EBIT is approaching historical peak levels, EBIT/Assets still has some way to go before becoming maxed out:




Assuming that EBIT/Assets gets to 15% (so not even reaching the 17% record levels of 2011/12/13), on today's $45m asset base, that implies EBIT of almost $7m.

Which is meaningfully higher than FY2020's $3.7m normalised EBIT number as well as my expectation of between $4.7m to $5.0m for FY2021.

So I think - provided demand continues to remain strong for the foreseeable future - that XRF still has significant earnings headroom.

Valuation-wise, capitalising EBIT of $7m on a conservative EV/EBIT multiple of, say 8x (which corresponds to an EV/EBITDA multiple of around 6.8x) implies an Enterprise Value of around $57m, and an Equity Value of around $60m, given the net cash balance.

With 135m shares on issue, that works out to a peak cycle target price of around $0.45/share.

In terms of FY2021's prospective valuation, the stock is trading on undemanding valuation multiples of EV/EBITDA = 6.0x, EV/EBIT =7.6x and P/E = 11.4x.

So, despite the stock trading not far off seven-year highs, I think it remains undervalued not just in relation to possible peak cycle levels, but also on a 12-month prospective basis.

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