Kenmare Resources plc (LON:KMR) was the topic of conversation when DirectorsTalk caught up with Davy Research Analyst Colin Grant.
Q1. What are the highlights from Kenmare’s Q2 production report?
Firstly, Q2 production volumes and grades were lower than the same level last year with ilmenite volumes of 242.9k tonnes, which was down 14% year on year, and grades were down by 47bps to 4.23%. The company encountered some production issues regarding the management of slimes levels in the quarter. Actions have been taken to address this issue. Full year guidance on volumes has been lowered to the bottom end of the previously indicated guidance range, which was 1,125k-1,225k tonnes for ilmenite. The lower end of the range is 4% below our forecast, which was the midpoint of the previous guidance range. The new volume guidance implies that the company expects volumes in H2 2022 to increase year on year. While the Q2 volumes might be viewed as a slight disappointment the outlook for H2 volumes is very positive.
Secondly, shipments in Q2 were impacted by a previously announced reduction in transshipment vessel capacity. This led to an increase in finished goods inventory at the end of Q2 of 214.9k tonnes. However, this is just a timing issue and will largely be resolved by year end and into H1 2023.
Thirdly, the company indicated that net debt has declined by $17m in H1 to $65.5m. This is very positive. And free cashflow in H2 is expected to be a record given the expected increase in production volumes, prices and shipment levels.
Q2. How was pricing in Q2?
Pricing increased in Q2 for both ilmenite and zircon, which are Kenmare’s two main products. Demand remains in excess of supply, which continues to be restrained despite record prices. This is a major point of difference from the last time ilmenite prices briefly got to $400/tonne in 2012. As a result of this we expect the peak to trough move in prices to be much shallower than took place in the last downcycle when ilmenite prices declined by over 70%.
Q3. How do you view Kenmare as an investment opportunity?
The stock trades on a 2022 PE of around 3x and we expect it to be net cash by year end. This means that at the current run rate the company’s Enterprise Value (EV) would be zero in just three years. The mine life is over 100 years so we see a very large long term opportunity for investors.
The market is in a state of denial regarding the outlook on inflation and the level of prices. This is partly because most investors are too young to have experience of investing during a period of inflation. Firstly, the rate of inflation will move around but we expect it to be higher than pre pandemic levels. The last time the US CPI was the same level as it is today the Fed funds rate was 12%. Central banks cannot increase interest rates to these levels as we have record global aggregate debt so the economic impact would be far too severe. So inflation rates will move around but it is here to stay and could increase materially over the course of the decade as it becomes ingrained. Secondly, the general price level is not going to decline back to previous levels. This is implied in Kenmare’s valuation, which is pricing in a trend price in ilmenite that is over 40% below spot. The recent burst in inflation has caused a step change in the price level so we see the trend price being considerably higher as reflected in the low levels of supply at current prices.
