SIF Portfolio: Can Central Asia Metals deliver a copper-bottomed profit?

There aren’t many AIM-listed mining stocks whose shares have risen consistently since 2010. But I think it’s fair to say that Kazakhstan-focused copper group Central Asia Metals has managed this impressive feat. The line along the bottom of this chart is the AIM All-Share index, which has risen by just 5% over the same period. Index investing has its limitations!

Central Asia Metals’ main asset is the Kounrad mine in Kazakhstan. It also has a 75% stake in a copper tailings project in Chile. One of the group’s main attractions is that its production costs have fallen sharply this year, thanks to the devaluation of the Kazakhstan Tenge.

As a result, this company has fantastic profit margins. During the first half of this year, the average copper price received was $4,903/tonne. That’s well over double the group’s fully-absorbed costs of $2,136/tonne (my calculation).

To add to its appeal, CAML appears to have funded the development and growth of the Kounrad asset with equity, not debt. Net cash has piled up on the balance sheet and there’s no debt. Shareholders are being rewarded with generous dividends.

Stockopedia’s algorithms are also keen on CAML, which has a StockRank of 98. The company qualifies for six Guru Screens, and has also now showed up in my Stock in Focus screen.

Should I add Central Asia Metals to the SIF Portfolio? My only other mining exposure is through gold miner Pan African Resources, so I’m not overweight in this area. But I do still have some concerns:

• Heavy exposure to a relatively esoteric and (for me) poorly-understood currency and jurisdiction
• Am I too late for the big gains?
• Is CAML really as cheap as it seems?

Let’s take a closer look.

The valuation looks promising

CAML’s ValueRank of 62 is the lowest of its QVM ranks. But the shares do still score well in several areas:

CAML’s P/B of 2.9 makes it clear that the company is being valued on its earning power, not the book value of its assets. So how profitable is this business? The earnings yield (EBIT/EV) of 12.8% is well above my screen’s minimum of 8%, and is a big attraction.

A trailing dividend yield of 4.6% is also appealing, especially as the trailing price/free cash flow ratio of 17.6 implies that the dividend was covered by free cash flow last year. (The inverse of the P/FCF gives the free cash flow yield, which is 5.7%.)

The stock’s trailing P/E of 12 is a TTM (trailing twelve month) figure. It’s probably a bit flattering, as the FY2015 P/E is 14.5, and the forecast 2016 P/E is 13.5.

However, CAML’s valuation does appear to be backed by solid earnings and cash flow. One caveat to this is that UK shareholders are heavily exposed to both the GBP/USD and USD/KZT exchange rates.

Solid quality, for now

CAML’s earnings yield (EBIT/EV) of 12.8% tells me that the stock’s valuation is attractive, relative to its earning power. But how profitable is this business, and how sound are its financial foundations?

A QualityRank of 92 suggests that investors don’t need to have any serious concerns:

The only weakness here is that the group’s 5-year average net margin is negative. That is due to the final year of startup losses in 2011. This should drop out of the figures this year, and provide a more meaningful (and positive) average:

CAML’s Piotroski F-Score of 8/9 is reassuring. It highlights the group’s strong cash generation, rising profits and lack of long-term debt. The only ‘fail’ is that the current ratio has fallen from 11.6 to 8.15 over the last year! Both ratios are so high that this isn’t a concern, in my view.

According to Stockopedia, CAML’s operating margin has ranged from 50% to 108% over the last four years. These wild swings highlight how the firm’s profits are heavily geared to the price of copper, energy costs and exchange rates. There’s no escaping these factors with miners. In my view it’s important to remember this, and not to take too much comfort in high quality scores.

Motoring momentum

If CAML’s quality is good, the group’s momentum is even better. A MomentumRank of 99 suggests there is little to find fault with at the moment:

Of course, trees don’t grow to the sky. But after falling by about 40% over the last five years, the price of copper has started to rise recently. A number of reports have suggested the market is starting to tighten.

CAML’s production rose by 27% to 6,908 tonnes during the first half of this year. If the group can continue to ramp up production into a strengthening market, then we could see several rounds of earnings upgrades.

The shares currently trade on a forecast P/E of 13.5, falling to a P/E of 12 for 2017. That doesn’t seem demanding to me, given the group’s strong cash generation and lack of debt. Although I am not an expert on this company’s assets, I’m reassured by CAML’s controlled spending and willingness to return surplus cash to shareholders.

This may be influenced by its shareholder base. The group’s largest shareholders is prominent Kazakh businessman Kenges Rakishev, who has a 19% stake and a seat on the board. This might deter some investors, but it’s worth noting that a number of prominent UK and US fund managers also have sizeable stakes:

Source: http://www.centralasiametals.com/investors-and-med...

My decision

I’m going to add Central Asia Metals to the SIF Portfolio this week. The holding will stay in the portfolio for a minimum of six months as usual, after which it will be reviewed.

I suspect there are some experts on this company among Stockopedia readers. I’d be very interested to hear your views on the quality of this firm’s assets and management. My quantitative and rules-based approach doesn’t place much emphasis on these factors, but they are important with companies of this kind.