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Morningstar's Recommendation: Gindalbie Metals Ltd

Recommendation: Hold

Gindalbie Metals is an iron ore mining company based in the midwest region of Western Australia. Its principal asset is a 48% stake in the Karara Mining Limited, or KML, owner of the Karara iron ore project. The other shareholder in KML is Ansteel, one of China largest iron ore and steel producers. Production of hematite ore started in March 2011 and has been supplemented by magnetite concentrate production since October 2012. Total attributable iron ore production is expected to reach 5 million tonnes a year during fiscal 2014.

Event18-Mar-2014

Business Impact:

Forecast Impact: --

Recommendation Impact: --

Event Analysis
Gindalbie Remains Extremely Risky with Additional Karara Funding Required - Ceasing Coverage
Gindalbie Metals is in a dire position. Additional funding is required for the Karara iron ore mine joint venture and the likely solution could see Gindalbie's investment diluted significantly. As usual, Gindalbie's financial result had little relevance as the income statement mainly includes interest income and relatively small head office costs with the investment in Karara Mining Limited equity accounted. Karara has been beset by problems for a number of years so the desperate situation comes as little surprise. Since we turned bearish on the stock in September 2012, the shares have fallen by 82% but we continue to believe that Karara is unlikely to be profitable and the consequences for Gindalbie and Ansteel could be very serious. The low quality of underlying assets, lack of economic moat and stretched financial position mean we will cease coverage of Gindalbie in May 2014. We maintain our view that Gindalbie has no sustainable competitive advantage or economic moat as Karara's margins are likely to be well below the industry average. We expect returns on invested capital to be very poor because of the high up-front capital cost to build a magnetite iron ore mine. Gindalbie is already exposed to the volatile iron ore price but extremely high financial and operating leverage means potential outcomes are exaggerated. The extremely wide range of potential outcomes means we maintain our extreme fair value uncertainty rating. We value the shares at, a highly subjective, AUD 0.02 per share on the basis that we consider there a 50/50 chance that the Chinese banks will let Gindalbie walk away from their investment in return for relinquishing any Karara liabilities. If it comes to it, chasing Gindalbie for loans may do the Chinese banks more harm than good. However, if Gindalbie is held accountable for Karara’s debts, the debt would far outweigh the company's capacity to pay.