The graph below is definitely not an apple to apple comparison, but I ended up comparing the two secondary to their almost $1 share prices. Nevertheless, both are trading at massive discounts and are completely hated by Mr. Market. As of today, the global stock index (MSCI All-Country World Index) has entered the bear market territory.
Three facts about Chesapeake Energy (CHK, Financial):
1. Founded in 1989 Tom L. Ward and Aubrey McClendon.
2. Currently the second largest U.S. natural gas producer (next to Exxon Mobil) (XOM).Ă‚
3. Has recently denied bankruptcy concerns on Feb. 8.
Three facts about Kumba Iron Ore Ltd. (KUMBF):
1. Largest iron ore producer in South Africa; holds two operations in Sishen and Thabazimbi.
2. 69.71% of the public shares are owned by the Anglo American PLC Group. Another 2% of the outstanding shares are held by BlackRock.
3. Kumba had recently cut its dividend to zero in February 2015. Dividend yield running at that time was around 20%.
Iron ore price has declined 26% in CAGR for the past five years.
Natural gas price has declined 16% in CAGR for the past five years. Crude oil is down 17% in the same duration. It appears that among these commonly discussed commodities, iron ore price has suffered the most.
Further, I assume that both Chesapeake Energy and Kumba Iron Ore share prices are highly correlated to the commodity price of their respective businesses.
Currently, the Bloomberg Commodity Index is at its lowest point in the past decade.
The numbers (FOREX: 1 South African rand equals 0.063 U.S. dollar).
Market capitalization:
Revenue
Profits
Chesapeake Energy = Just ugly!
Isolating Kumba Iron revealed:
Operating margin
Profit margin
Total net debt (negative values mean company has more cash than debt).
Checking the recent quarterly data revealed:
*Kumba Iron’s data was not available in September 2013, June 2014, December 2014, and September 2015.
Total return (share-buybacks and dividend):
Debt to equity ratio
By these charts, I am now more confident that Kumba Iron Ore can outlast the ongoing recession in the iron ore industry.
Because of Chesapeake Energy’s increasing debt, I will now focus the rest of the article on Kumba Iron Ore. (I apologize to the Chesapeake Energy shareholders).
One important thing to consider is Kumba Iron Ore’s cost of producing iron. Their cost per ton in 2015 was at $41 per ton. An excellent table was presented by Market Realist that included all other major iron ore producers with their cash cost per ton and freight costs (cost and freight; CFR).
Clearly, the big miners (Rio Tinto, BHP Billiton, and Vale) have better margins, despite the ongoing turmoil, compared to the rest.
As of the previous update on Feb. 5, iron ore price is at $45.73 per ton. Kumba Iron Ore CEO Norman Mbazima stated that he is looking forward to reducing Kumba Iron Ore’s cost by an additional $10. That will be a target of $31 per ton or broadly at less than $35 per ton.
Here is a recent Norman Mbazima CNBC interview.
Iron ore prices have not been this low since 2008. One may wonder if the past five years were just a bubble, but with a current P/E ratio of 1.11, one may also think that something terrible may have happened inside the company (Kumba Iron Ore), or Mr. Market has just gone bananas and threw this company away to the waste basket.
For fun, I compared other big iron ore companies, and Kumba Iron, with the iron price itself.
*Kumba Iron Ore’s data was only available from January 2008, and Vale S.A.’s data was from March 2002.
The chart revealed an obvious scenario. Put this data into more math -- I used the Pearson Correlation Coefficient and had found out the following relationship between each company’s share price and the iron ore price:
So, as iron ore price goes up, these companies’ share price will also go up, and vice versa.
In terms of price to earnings ratio:
Let us say there is a minor "error" here. BHP Billiton has been a favorite by Mr. Market despite the turmoil.
(Keep in mind that long-term shareholders of BHP Billiton have been suffering from huge losses as of the moment. I myself have both Kumba Iron and BHP Billiton since January 2015 and are down about 40% to 50%. Ouch!).
Further, I think a more appropriate valuation to use with these mining companies is the price to tangible book value ratio. Are they selling less than their tangible assets (minus goodwill)?
Kumba Iron Ore is selling at almost half of its tangible book value. If I apply the group’s average of 1.46 to the current book value of Kumba Iron Ore, it would yield an intrinsic value of $1.80 per share. That would roughly be a 75% upside from today’s ADR price.
That intrinsic value, as some would think, may be too optimistic. Okay, let us say that Mr. Market would not give Kumba Iron Ore its deserving valuation. I’ll just use its current book value and see if whether there would still be an upside.
As of June 2015 (quarterly filing) Kumba Iron Ore has a tangible book value of $1,722 million, or $1.79 per share. Still, this means a meaningful large upside.
*Chesapeake Energy is currently trading at 0.86 Price/tangible book value.
The greatest time to have bought Kumba Iron Ore was when it was still at its very lowest share price, and that was on Jan. 14, when it was just trading at 55 cents to 60 cents per share.
Who would have thought it would pop right back up to a dollar a share.
Caveat: Reuters published a recent article on Feb. 12 with the recent highlights:
"While iron ore has had a few good weeks since mid-January, it's very unlikely that this is the start of any sustained rally, rather it's more likely an opportunity to go short again.
With the temporary factors over, iron ore will once again be confronted with the reality of vast oversupply and tepid demand from China, buyer of about two-thirds of the world's sea-borne cargoes of the commodity.
It's also safe to ignore announcements of minor cutbacks in production, such as the expected loss of about 4 million tonnes this year at South Africa's Kumba Iron Ore, the country's largest producer and a unit of Anglo American. This is spit-in-the-bucket levels of production losses, given the market is now oversupplied by at least 100 million tonnes. This means only output cutbacks by the big four miners, Brazil's Vale, Rio Tinto, BHP Billiton and Fortescue Metals Group, will make any difference, and so far there is no sign of this happening.”
I guess I would still hold onto my BHP Billiton and Kumba Iron Ore shares and now more willing to buy more once opportunity provides.
I still suggest for value seekers to perform research on the aforementioned companies prior to buying any ADR shares.
Happy investing,
Mark
