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A disappointing first half report, including a dismal forecast for the balance of the year, drove the share price of the Eurasian Natural Resources Corporation Plc (LSE:ENRC) down 29.50 pence from 414.70 to 385.20 this morning, a 7.11% decline. Except for the past three weeks, the stock has experienced almost constant decline since mid-January when it was selling for 746.50.
The Report – Looking Back
Total revenues for the first six months were down 19.1% year-on-year, whilst cost of sales increased by 4.0% from $1,690 million US to $1,757 million. Revenue declined to $3,246 million from $4,011 million. Operating profit was down 52% from $1,667 million in 2011 to $800 million. Pre-tax profit for the period fell 59.1% from $1,631 million to $667 million. EBITDA dropped 40.6% from $1,927 million to $1,144 million. Net cash from operations fell nearly 40% for $1,184 million to $724 million.
The company was able to maintain a dividend payout ratio of 18%, which is a nice way to say that the actual interim dividend dropped nearly 60% from 16 cents to 6.5 cents. With results like these, the company should consider distributing the dividends enclosed in sympathy cards.
The Report – Looking Forward
ENRC management expects the second half of 2012 to reflect a continuation of the issues of the first half. Despite current global economic conditions, the company is pinning any hope for improvement on “being one of the world’s lowest cost producers” and for demand for its core products to be robust. The report pointed to single digit percentage production growth potential over the next five years in China.
The Underlying Issues
ENRC pointed to unscheduled repairs and maintenance combined with a temporary decline in iron ore quality and a supply chain issue with soda ash required for alumina production as underlying reasons for the poor operational performance. The declining commodity prices and poor sales were cited as the basic reasons for the poor financial performance.
Strategic Issues
The company has already been in a strategic review, the results of which are, at this point speculation. Divestitures and “splitting” of some of the company’s assets is almost certainly a major strategic component. Now, according to today’s report, the company is going to bring capital expenditures under review, including reducing cap ex by $300 million over the next six months.
Some Concerns
Whilst the board has tried to put some positive spin on its lacklustre results, several things, when combined, should stir some concern. They are unscheduled repairs and maintenance, reduction in capital expenditures, and investment in expansion outside of Kazakhstan. Experience teaches that the first two items, when mentioned together, indicate a corporate interest focused getting ore out of the ground quickly as opposed to more efficiently. Unscheduled repairs and maintenance, according to ISO philosophy, most often occur because a company does not have or recognize the need at the executive level for a scheduled preventative and predictive maintenance program. Such companies tend to advertise themselves as “low cost producers” whilst their actual costs, including time lost when equipment is down, are much higher than budgeted. When cap ex is reduced, the reduction is typically taken at the expense of upgrading and adding new equipment and directed, instead toward other areas of expansion. This usually compounds the problem of “unscheduled” downtime. ENRC may be at the top of a slippery slope if its cap ex and strategic reviews fail to recognize these principles.
Company Background
ENRC is one of the world’s leading diversified natural resource development groups. The company operates six divisions which include, in addition to divisions focused on resource types, Energy, Logistics, and Sales & Marketing. ERNC is the world’s largest producer of ferrochrome (based on chrome content) and the ninth largest producer of aluminum on a trading volume basis. Although the company has operations in eight different countries, its primary operations by far are in Kazakhstan where 93% of its 70,000 employees are based.
