Investment guide: Kumba Iron Ore

Kumba Iron Ore Limited (KIO) is a member of the Anglo American PLC Group and a registered equity issuer on the Johannesburg Stock Exchange (JSE). This guide looks at investing in KIO, and asks whether or not this is advisable given the company’s current dispute with the South African Revenue Service (SARS).

Chantal Marx, invest analyst at FNB (First National Bank) Securities, stated that while Kumba has performed particularly well year to date (up over 230%), over one year the share price is down 56%. Marx added that over the last month, and particularly the last few days, the share price has come under significant pressure.

However, despite this, Marx noted that Kumba recently released interim results which were more or less in line with expectations.

Craig Pheiffer, chief investment strategist at Absa Stockbrokers & Portfolio Management, noted: “Kumba Iron Ore (KIO) has done incredibly well in 2016 so far and the share price is up 200% as at 15 September at R125. Since 15 September 2015 the share price is up from R94, so also a strong performance. However, this should be seen in context as the share has fallen from a price of over R600 in January of 2013 as iron ore prices have collapsed. The move in the KIO share price has essentially followed the iron ore price which reached a trough at $40/tonne (about R573.69) at end-2015 and is now around $60/t (about R 860.53) (from over $180/t (about R2581.60) in early 2011).”

A battle with SARS

In February this year, SARS stated that a subsidiary of KIO, Sishen Iron Ore Company, owed an amount of R5.5 billion, including interest and penalties, for the tax years 2006 to 2010. In addition to this amount, SARS announced this week that for the tax year 2011, an additional tax liability of about R1 billion, excluding any potential interest and penalties, is owed.

With regards to both matters, Kumba disagrees with the findings of the audits that resulted in these amounts being owed. In a statement released by the company following the latest announcement by SARS, Themba Mkhwanazi, CEO of Kumba, said: “As a responsible corporate citizen, Kumba and its subsidiaries believe that all taxes owed under South African tax legislation have been paid and that we comply with all applicable tax laws in all jurisdictions in which we operate.”

According to Pheiffer, any time a company has a dispute with SARS it is concerning. “The key concern here is that KIO has not provisioned for any of these additional taxes if they do become payable. These tax assessments also only cover the years up to 2011 so the question arises as to what could be added to the tax tally for the additional years up to the present. Any additional tax payments, while they would be considered a once-off, would impact earnings and dividends and for as long as the uncertainty remains, it leaves a cloud over the share. It will also be very drawn out so that cloud could remain for some time. The company has said that it has fully paid all its taxes and will object to the assessments so investors have to make a call on the outcome (which really is indeterminable).”

Marx added: “Certainly, the value of a company is (simply put) a function of its expected future cash flows. Any reduction in cash flows has a negative impact on the present value of the company. A R1 billion knock will certainly have an impact, especially considering that the company is already battling low iron ore prices. It constitutes about 20% of the company’s operating profit.”

Is KIO a good investment?

Pheiffer pointed out that KIO is a well-managed company with a market capitalisation of about R40 billion. He noted that this is a stock that domestic investors would look at. However, as KIO only produces a single commodity, its fortunes rest on the price of this commodity.

“KIO could be considered a rand-hedge share in that it produces its goods in Rands and exports them in dollars (iron ore is priced in dollar terms globally). Given the substantial oversupply of iron ore in the global market at the moment and the likelihood that prices will not move substantially higher for some time, leads one to consider not investing in KIO at the present time. Global growth remains pedestrian and there is generally more supply than demand across the commodity complex, suppressing prices in the near term,” revealed Pheiffer.

Marx noted that in the short to medium term, iron ore producers are not regarded as good investments. This is mostly due to the supply supply/demand dynamics in the market, there is currently an oversupply in the market.

However, Marx revealed that the demand dynamics have improved slightly, but this will not be enough to compensate for current and expected oversupply conditions. As a result the iron ore prices will be placed under pressure, “which will be bad from a revenue generation perspective for all iron ore producers (including Kumba).”

According to Pheiffer, domestic investors with segregated portfolios would consider Kumba as an investment. However, as already highlighted, KIO is a single commodity miner and producer, and therefore there is some risk associated with this investment. If the iron ore price was strengthening and showing growth, however, the rewards for this investment would be greater.

Marx added that investors with a long time horizon and willing to take some losses in the near term, as well as a belief that China will continue to deliver high economic growth rates (i.e. demand will be strong), would likely invest in a company like Kumba.

Competitors on the local stock market

Pheiffer highlighted that Kumba only produces a single commodity, iron ore. Other companies listed on the JSE also produce iron ore, but they are diversified miners, producing a range of other commodities as well, for example BHP Billiton.

“It’s not easy to make a simple comparison across companies but one can look at the divisional results of the big miners – that analysis shows BHP Billiton, for example, producing substantially more iron ore than Kumba at much cheaper levels. Investors have to take a view on a basket of commodities with the diversified miners though,” explained Pheiffer.

What to look for when investing

When considering investing in a company such as KIO, there are a number of things you should look at.

Marx and Pheiffer, emphasised that investors need to closely monitor the iron ore price when considering investing in KIO. Furthermore, the Rand to US Dollar exchange rate will come into play here as iron ore is traded is US Dollars and company profits may be impacted by fluctuations in the exchange rate. A weak Rand is good for KIO as they receive more Rands per US Dollar generated, Marx highlighted.

Marx added: “Investors must also watch out for changes in cash generation, mining constraints, and labour factors, all of which can impact on top-line and bottom-line growth.”

Pheiffer further stated: “Debt levels and ability to finance debt are important as is management ability and turnover. With mining stocks one should also look at levels and costs of exploration (to uncover new deposits for future year’s earnings) as well as the mining life of the current mines in production. Disputes around mining rights (as in Kumba’s case) should also be considered.”

Lastly, before investing, you should also review the current share price versus its underlying value. “All of the metrics could be fantastic with every box ticked but it could all be accounted for in the current share price. Conversely it could be all doom and gloom with prospects looking poor but the share price may have more than discounted all of the bad news,” said Pheiffer.

 Handy tip: If you aren’t ready to take the plunge and invest in the stock market, you can consider a unit trust (apply) or a savings account (compare).