SIF Folio: Should I buy Central Asia Metals?

This week I’m looking at copper, zinc and lead producer Central Asia Metals. This AIM-listed stock has appeared in my stock screen as a potential buy for my rules-based SIF folio. 

This company owns and operates sites in Kazakhstan and North Macedonia. But it’s a UK-based business that’s been listed since 2010 and has solid institutional ownership. CAML has also paid regular dividends since 2013. It’s a stock I’m happy to consider for SIF.

Indeed, I have held CAML in SIF previously, back in 2016/17. You can read my sale review on the stock from September 2017 here. 

The shares are now trading slightly ahead of the level at which I sold previously:

CAML stock has also provided a total dividend return of 25% since the end of September 2017:

Overall, I don’t think this has been a bad stock to hold over the last five years.

A low-cost European miner

Central Asia Metal is a profitable and cash generative producer of base metals. Its core business is a copper recovery plant at the former Kounrad mine site near Balkhash, in central Kazakhstan. This facility produces copper cathode from waste dump material that accumulated during open-cast mine operations from 1936 until 2005. 

CAML’s Kounrad business has proved to be a low-cost and successful producer of copper. The company estimates that 140,000 tonnes of recoverable copper remain. That’s just over 10 years’ production at current rates.

Profits are expected to hit record highs this year:

This is due to the price of copper, which has surged higher since the start of the pandemic:

Source: IG

Group revenue rose by 41% to $106m during the first half of the year, while pre-tax profit rose by 72% to $42m. Free cash flow for the period doubled to $48.9m. This funded a further $20m reduction in net debt, which fell to just $10m.

These are excellent numbers, in my view. But most miners are doing well at the moment. If demand for copper eases, CAML’s profits could fall fast. Given this risk, why am I willing to consider buying CAML stock at what might prove to be a market peak?

One answer to this question is simply that CAML shares qualify for the stock screen I use to select shares for SIF. As SIF is a systematic portfolio, I try not to make too many macro calls. 

However, in this case I am already attracted to CAML. The group’s copper focus and low costs – which I’ll return to shortly – seem like a resilient pairing to me. CAML’s consistently high margins, strong cash flow and 6% dividend yield have already put it on my radar as a possible buy.

Interestingly CAML also qualifies for two Stockopedia Guru Screens that I’ve found to be a useful source of ideas:

Stockopedia’s algorithms have a broadly favourable view of the stock too, awarding a StockRank of 76 and a style of Contrarian – a winning style.

Let’s drill down into these factor scores in a little more depth.

Value: plenty to like

CAML’s ValueRank of 83 suggests that the stock could be attractively valued on several key metrics. This certainly seems to be true:

• Price/earnings ratio: 10.8

• Price/book ratio: 1.5

• Price/free cash flow: 7.1

• Earnings yield (EBIT/EV): 13.8%

• Dividend yield: 6.5%

Of course, cyclical stocks often look cheap when they’re close to cyclical peaks. But these figures are not unusual for CAML. When I added the stock to SIF in December 2016, the stock had a P/E of 12, an earnings yield of 12.8%, and a dividend yield of 4.6%. 

This is not a business I’d want to buy at a high valuation. But the underlying fundamentals look sound to me. CAML’s net asset value has risen from $1.92 to $2.24 per share since 2017, despite generous dividend payments. 

Net debt has fallen from a peak of $139m to $10.9m, according to Stockopedia data. This shows the company repaying the debt used to fund the 2017 acquisition of the Sasa lead/zinc mine in North Macedonia.

As things stand today, I don’t see anything to dislike in terms of value. The only caveat is that the company’s recent profits have been boosted by strong copper prices.

Quality: low costs, high margins

CAML’s QualityRank of 93 suggests a highly profitable, cash-generative business. I think that’s a fair description. But before looking at the big picture, I want to take a moment to look at the group’s cost structure and profitability. 

Miners’ profits will always be cyclical. That’s why I prefer to focus on low-cost producers who will still be profitable even if commodity prices collapse. I think CAML falls into this category.

Kounrad produces copper at a C1 cash cost of around $1,225 per tonne. With copper prices currently above $9,000/tonne, the copper business generated an EBITDA margin of 80% during the first half of this year. However, Kounrad would clearly remain very profitable even if the copper price fell back to its pre-pandemic level of c.$6,000/tonne.

The Sasa mine, which produces lead and zinc, is slightly less profitable. However, rather than focusing on a narrow measure of cash costs, I think it makes more sense to look at a more inclusive measure of costs for the whole group.

According to CAML’s half-year accounts the group’s fully-inclusive copper equivalent cost of production (including sustaining capex and local mining taxes) was $4,229 per tonne (H1 2020: $3,216/tonne). 

The increase over the last year seems alarming at first sight, but I don’t think it’s as bad as it looks. While higher energy and raw material costs played a predictable role, tax charges accounted for nearly half the increase in costs. The reason for this is that the mining tax paid to the Kazakh authorities is linked to the price of copper. That dampens gains on the upside, but it also provides a cushion to the downside — if the price of copper falls, tax paid will fall too.

This structure may help to explain why CAML’s operating margin has been so stable in recent years, despite fluctuations in commodity prices:

The figures above indicate that CAML has generated consistent strong profitability in recent years. 

Free cash flow has also been healthy, providing a comfortable level of cover for the group’s dividends:

I’m not concerned about the current quality of this business. 

What might worry me as a long-term shareholder is that Kounrad only has around 10 years of production left. The company is looking for acquisition opportunities, but management say that it’s not easy to find productive assets at reasonable prices at present.

The acquisition of Sasa in 2017 appears to have been successful. But there’s no guarantee the company will be able to repeat this trick and find other good, low-cost assets. 

In my view, CAML’s dependence on Kounrad’s finite earnings is the main risk for long-term shareholders.

Momentum: Unclear

The price of copper has risen by 50% since the start of 2020. The bull case is that copper will benefit from structural demand growth for the foreseeable future, due to the electrification and renewable energy trends. 

A more cautious view is the old commodity sector adage that the cure for high prices is high prices.

I think it’s fair to say that the outlook is somewhat uncertain at the moment. In my view, this is reflected in CAML’s weak MomentumRank of 25. As usual, I’ll break down this score into its two main elements.

Price momentum: A recent spate of buying has lifted the 10d/3m volume indicator. One-year relative strength is also positive. I see these as bullish indicators, but other metrics are less positive:

Earnings estimates: Consensus forecasts have been upgraded several times over the last year. But earnings are expected to be broadly flat next year. I’m not sure how likely that is – in my experience, mining profits rarely stand still. 

In my view, the current forecasts are more likely a statement of uncertainty – we don’t yet know how the post-pandemic demand boom will evolve.

My decision 

I have a favourable impression of Central Asia Metals. As a potential long-term buy, I can see risks relating to the durability of the company’s earnings. However, that’s not a major concern for SIF, which has a default holding period of nine months.

Ultimately, CAML passes all of my screening tests comfortably and does not obviously duplicate any of the other stocks in the SIF portfolio. For these reasons I will add CAML shares to SIF and my personal holdings this week, after this article has been published.

As always, I’d love to hear your thoughts on CAML, copper and the wider outlook for miners. Let me know what you think in the comments below – your contributions really do help to shape my plans for this experimental portfolio.

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