[This post is in response to an exchange of opinion on another...

[This post is in response to an exchange of opinion on another thread with HotCopper member, Stefan.
To wit: “Cam, “I am not sure about ORI being a quality business anymore, i sold out after the HY result in May.
Agree the story is good being tied to mining volumes as opposed to commodity pricing however the cash conversion is poor and debt has been increasing beyond the Capital investment in new production initiatives. Your thoughts?”]


Stefan, when you talk about “quality business”, I’m assuming that refers to whether or not the company can organically increase its intrinsic value, i.e., whether or not it should be considered to be of investment grade quality (my elitist assumption being that only companies that increase in intrinsic value are worthy of investment).

While I’m no apologist for ORI, I don’t agree for one minute that ORI is not of investment grade quality.

Historically, the company’s intrinsic value in real terms has definitely increased over time, despite management having spent almost a billion dollars on a very significant value-destructive acquisition.

I’ll be the first to concede that a history of shareholder value creation might indeed be a necessary condition for future value creation, but it is not always a sufficient one.

So I always try to quantify things by looking at how capital is deployed over a reasonable period of time, and what the consequent financial outworkings of such allocation decisions are.

In ORI’s case, let’s go back to 2008 (I choose this starting point not arbitrarily, but because the period between then and now mirrors the natural lead time of the business, and compares the current financial performance as an outworking the major capital investment decisions were made back then).

In 2008, ORI generated Sales of $6.5bn and EBITDA of some $1.1bn, and EPS of $1.60/share

In the ensuing five years (I’m including FY12 year because it includes capex relating to the Bontang and Nanling development projects, and the KI and Yarwun uprate projectst) the company has spent around $2.6bn on growth capex and acquisitions (this excludes stay-in-business capex which the company has kindly disclosed has averaged around $190m pa over that period).

The delta in the financial performance in the company between 2008 and 2013 is as follows (I chosen FY13 as the terminal year for purposes of matching consistency as it reflects the debut financial contribution from the Bontang plant, the KI AN uprate project, the Yarwun NaCn uprate project and the Nanling detonator project, whose capital expenditures are contained in the $2.6bn aggregate growth capex number):

FY13: Sales = $7.2bn, EBITDA = $1.55bn, and EPS = $2.20cps (these are all consensus forecasts, I acknowledge, but given the contractual nature of ORI’s supply arrangements, forecast risks for ORI have proven to be low over the past 7 or 8 years, so while the actual financial results will certainly differ from consensus expectations today, I don’t think any variances will be by an order of magnitude of sheep stations.)

Additionally, we need to account for the removal from ORI’s current level of EBITDA, of around $150m which represents the foregone EBITDA following the demerger of DLX.

So, the adjusted EBITDA uplift is around $600 ($1.55bn - $1.1bn + $0.15bn)

So what we have is a company having invested $2.6bn (around $7 per share) of capital which has delivered an EBITDA increase of $600m, ceteris paribus.

This is an implied EBITDA multiple of 4.3x, compared with the stock’s 7.7x EBITDA rating in the market.

In EPS accretion terms, the EPS accretion is $0.60 per share, or when capitalised at the stock’s current multiple of 13.5x, it equates to a valuation uplift of $8.10 per share (that’s excluding the DLX effect as I’m too lazy to work out the EPS dilution from the DLX demerger. Including DLX would obviously have made 3102 EPS, and hence, the value accretion, higher.)

So, even without accounting for DLX, they’ve spent $7/share and the result is over $8/share in result valuation uplift.)

[Now I know this is crude exercise, because it takes the liberty of assuming all other things remain constant, which is clearly not correct, so as an exercise it is more indicative than it is prescriptive, but I think it provides a good reasonableness test on what’s going on under the hood of the car.]

But I need to stress that this exercise INCLUDES $900m for the disastrous Minova acquisition, which has turned out to be a wholesale lemon, and whose EBITDA has actually gone BACKWARDS during the period under review.

If we strip out the Minova effect, the implied capital paid for the incremental EBITDA is just 2.8 times, and on a per share basis they’ve spent $4.60 per share for the $8.10 per share implied valuation uplift (again, excluding DLX effect).

So, excluding Minova, the magnitude of the valuation uplift is so significant as render any margins of error objections obsolete.

In other words, the intrinsic value of the organisation does definitely increase over time, making ORI an investment grade company in my opinion (as long as they don’t go out and BUY anything).

One final important point to be made on this matter: this is a significant capital investment program for the company that is just coming to completion, and it has been funded fully out of operating cash flows, at the same time that the company has maintained dividends to shareholders and spun off a not-insignificant paint subsidiary to shareholders. That fact, in the context of the definition of the company being investment grade, is an important one.



As for your concerns about the balance sheet getting out of shape in the May half result.

Remember a few things:

1. ORI’s Operating Cash Flows are acutely seasonal, with the May Half: Sept Half split historically averaging 1:4, (i.w., 80% of OCF reports in the SH), viz.:

MH08: $162m
SH08: $574m
MH09: $218m
SH09: $816m
MH10: $269m
SH10: $534m
MH11: $141m
SH11: $616m
MH12: $39m (I suspect this is what has got you a bit worked up)

(The reason for these OCF distortions is due to the lost days in the mining industry over the holiday periods (Christmas, New Year and Easter), when blasting operations don’t occur, compounded by the typical tropical rainfall season in Queensland; and in the North American businesses, the northern hemisphere winter has an even greater adverse climatic effect.)


2. The May half of 2012 included some extraneous events for ORI which would have wreaked havoc with the company’s working capital requirements, notably the severe disruption to KI, where a month of operation time was lost, costing the company $90m, as well as the commissioning of Bontang and Nanling, both of which would have required significant calls on working capital as their wWork-in-Progress pipeline started to fill.

The effect of this can be seen in the metrics: Working -Cap-to-Sales ended up 10% for the May half of 2012, compared to 6.4% for the SH11 and 7.9% for MH11.

I estimate that the working capital drag due to these two events was well over $200m in the half which, combined with foregone cash flows from loss of sales from KI, meant that the $2.3bn net debt balance at May, 2012 is overstated by some $300m.

But anyway, even if we ignore these “one-offs”, with the NIBD as it stood in May 2012, ORI’s solvency metrics remain highly accommodating, with NIBD-to-EBITDA of 2.1x and EBITDA-Net Interest Coverage of over 8 times.

To put $2bn of NIBD into context, $1.5bn of EBITDA in FY13 converts to about $1.0bn in OCF, and assuming stay-in-business capex of $250m pa going forward, that implies a mere 3-year debt payback, which is highly bankable

Add in $360m pa for dividends of $1.00 per share, and the debt will be extinguished in 5 years’ time.


So those are my thoughts around the capital position and trends of the company, insofar as they relate to the stock being of investment quality.


Valuation-wise, at P/E of 13.5x, EV/EBITDA 7.5x and FCF yield 8.5% on Market Cap and 6.8% on the EV, of I think the stock is fairly priced and I don’t intend adding at this stage to my modest position.

My hope is that this China thing becomes a rout and the ORI baby gets thrown out with the entire Resources/Mining Services bathwater, as tends to happen periodically.

That’s when I intend stepping up to the plate and buying more.

I suspect and hope that such an opportunity will present itself within the next few months.


Best Always

Cam