Kazakhmys – An SBM value opportunity lesson – A reminder of our analysis

UPDATE – Given the spat of broker upgrades in recent days, we thought it worthwhile reminding our readers of our call on this stock and jut how undervalued it is. We repeat – “nobody rings a bell at the bottom” – you can only go on fundamentals and “nerve”!

One look at the chart below is enough to induce sickness in anyone who has been long of Kazakhmys in recent weeks (including ourselves!). From starting the year at just over 800p per share, the stock has dropped to just 392p at the close of play going into the Easter holidays – a smidge over a 50% drop – that is some going for a former FTSE 100 in such a short timescale. 

The reasons for the fall? Ejection from the FTSE 100, falling earnings and fears over copper prices going forward, a stream of broker downgrades, ENRC stake write down and finally, if that was not enough, concerns over what the oligarch owner Vladimir Kim is going to do with his stock holding as he has pledged the 90m he owns to various banks in support of personal loans. Is that sufficient to put you off investing? If so, then as with a number of other of our picks in recent months – ENRC, Bumi, Lonmin etc, and in which we caught up moves of 50-100%, the fact that there is so much bad news, but more importantly that it is KNOWN, is a potential opportunity. The stock market moves on rumour and anticipation – unknown news drives stock prices sharply – known news is usually absorbed within the price. Remember the stock market adage number 1 – “it is better to travel than arrive”. The news is most certainly baked well into the KAZ price here we would argue.

Let me explain a little further re the workings of the stock market – the market moves constantly between the greed and fear extremes – from large cycles that take years to play out right down to intraday moves in stocks. A savvy investor looks to buy at the point of maximum greed and sell somewhere on the greed swing – as far as possible towards the right pendulum. A ‘trader’, in contrast, generally looks to get in on the greed side of the swing – as early as possible, and in exchange for the trade off between risk and reward through missing the fear side of the pendulum and hesitating until the move past the equilibrium point has occured, he will thus reap a lower reward.

The investor who looks at fundamentals and buys with a safety measure baked into the share price is, at face value, taking more risk as he is fighting current sentiment when the stock is in such a violent downtrend like this one. However, if his sums are correct, and he is comfortable in the value backing, then ironically, his risk is actually less than going in on the greed side of the pendulum when the coast seems moderately clear. This of course assumes one is not over leveraged. Remember the universal rule investing rule – risk and reward are perfectly correlated.

And so, we speculate that after such a massive drubbing, that Kazakhmys could, at this price point now, present a compelling buying opportunity. From a pure technical perspective, the stock is as oversold on its weekly chart as it was in late 2008/09, and on its daily chart, it has never been more oversold with an RSI measure of just 18. From a technical basis, when married with the volume seen in the chart below, one has to argue that the selling has been done – by the exasperated bulls, by the margined players looking for the bounce who have been squeezed out (last Tuesdays move down to 382p had all the classic signs of a capitulation move), by the fund managers reacting to the analyst downgrades, and by the index funds forced to sell upon its ejection from the FTSE 100. Who’s left to sell?

Let us look at the value buffer however to get a measure of our downside v potential upside. At 392p the stock trades on an EV:EBITDA measure of under 2.5 times 2013 and 2014’s figures and, amazingly, less than 2 times for 2015 – this is on pared back figures that are very conservative too. Within the mining sector, this is the cheapest valuation bar none for a larger cap stock. With Kim’s issue over the loan pledge at the current stock price, we speculate that there is in fact a very real chance of a takeover approach – this is not remotely reflected in the price.

Perhaps more interestingly from a potential value investors perspective, the discount to tangible book value has reached a level that has historically (Great Financial Crisis excepted) created a floor and sharp rebounds have come from. At the current market cap of £1.95bn the stock is trading at a discount of almost 60% to its tangible book. Through the cycle, KAZ has traded at 0.3 times (2008/09) to over 2 times this measure. NOTE – In this figure I have also written down ENRC to its market value (and which we also feel is severely undervalued) and so there is also the potential of a double whammy to to the upside should ENRC rebound too.

Take a look at the pie chart below that is a sum of the parts breakdown by BoA in which they use a discounted cash flow analysis to attempt to value KAZ. I am personally wary of DCF analyses as they are so subjective to the WACC rate used and so I prefer the simpler and less malleable methods of EV:EBITDA, Price:Cashflow and Price to Book. The reason for including the chart below however, is to illustrate the potential value of the Power division (Ekibastuz) in which they have a JV with Samruk – Kazakhstan’s sovereign wealth fund. The market seems to have all but forgotten the announcement in early Feb –

“Kazakhmys PLC (the “Group” or “Kazakhmys”) notes media speculation relating to the Group’s 50% holding in Ekibastuz GRES-1, the largest power station in Kazakhstan.

Kazakhmys has entered into discussions regarding the holding, but these are at an early stage and may or may not lead to a transaction.”

If X6 times EBITDA is used as a potential sale value for Ekibastuz and which has been deemed to be a fair value by industry analysts, then a value for KAZ’s stake approaching $2.5bn is derived. With ENRC valued at $1.4bn by the market presently (and excluding any premium for a major stake that an acquirer would likely have to pay if it were to purchase KAZ’s stake – they have alrady put the market at 375p per share in their write down) then the current Enterprise Value of $3.7bn (which includes debt) is less than the relatively transparent values of these 2 divisions alone. What this means is that all the other divisions which account for over 50% of the value of the company are in for free and which are on the books at over 300p per share. In fact the copper businesses peers trade for 12 – 13 times earnings – if a similar value were placed on KAZ’s division then you are looking at a stock price for this division alone of over 400p! That is the opportunity the market is presenting to us today so beaten down is sentiment on the stock.

If I were in Vladimir Kim’s shoes I would be using all my guile and political influence to press this sale through as it is a material value crystalliser and will put the company in a much stronger position to finance the development of their mining assets through 2013/14 and also giving them much more flexibility with regards to their ENRC stake should a right issue occur there.

Here then are a number of potential catalysts for a re rating in the stock price

1. Power sale – as detailed above, this would be a material value crystalliser for shareholders and highlight the embedded value in KAZ’s balance sheet. News could occur any day on this.

2. News on Kim’s stake – the market is looking for clarity here and should the price be pressured lower I would expect an announcement from the company in this respect.

3. A general rebound of the sector and specifically the stock to shake off the extreme oversold status (see chart below)

4. ENRC holding resolution – a possible sale of its stake (we think this unlikely however given the sharp de rating in ENRC in recetn weeks or clarification on any rights issue participation)

5. An ENRC rebound in which KAZ benefits from a double whammy to the upside.

With the stock now down 26 days out of 31 today (Mondau), if you have had Kazakhmys in your sights, the current entry level offered is, in our opinion, likely to be as cheap as they come. We fail to say anymore downside and upto 200p+ upside on any of the catalysts detailed above.

At the current woeful market cap it’s amazing to reflect that Kazakhmys is the biggest copper producer in Kazakhstan and one of the leading producers in the world. The company owns 16 acting mines, 10 mining plants and 2 copper-smelting plants. Kazakhmys also produces gold, zinc and silver. The production process is maintained by local supplies of energy and a significant railroad infrastructure. The company has around 60 thousand employees.

Finally, returning to our friends the “anal”ysts – the ones that put Buy recommendations out at 800p and tell you to sell at 400p and, amazingly, remain in a job… I am encouraged by below that shows one of the largest collective Sell recommendations of any of the miners (makes you wonder if they can read a balance sheet and think beyond 5 mins!) – recall our own analysis that proves that collectively that they are always wrong in the March edition of our magazine (see here page 26 – http://issuu.com/spreadbetmagazine/docs/spreadbet_magazine_v14_generic) – this is a comforting factor to us and means that with their (highly inappropriate) influence that, when the stock price turns, they could addadditional buying pressure as they once more react to price as opposed to anticipating which is what we do. 

The chart here does however illustrate that even the collective bearishness puts a consensus value of 600p on the stock. Remember – nobody ever rings a bell at the bottom (or top) and all you can fall back on is experience, fundamental analsyis and nerve! Prime example our call on the pound at the end of Feb where armaggedon was forecast – since then the currency has actually risen against the dollar and particularly the euro. Do the hard thing is a strategy in the markets that usually works.

If you would like to be exposed to this type of investment analysis – one that looks at fundamentals, sentiment and technicals and applies rigid margin discipline within, uniquely, a spread betting wrapper, then visit www.titanip.co.uk or click the image below to register your interest in our sister company – Titan Investment Partners