Mount Gibson Iron Is Still Trading Below Cash - But What's The Solution?

| About: Mount Gibson (MTGRF)

Summary

Despite the lower iron ore price, Mt. Gibson was free cash flow positive in H1 FY 2016.

The company's 'plan B' is taking longer than I expected, and Mt Gibson is still trading at a 25% discount to its 'net realizeable value'.

You could actually consider the company to be some sort of 'cash fund', but it will be interesting to find out what Mt Gibson expects to do with the cash.

Introduction

It has been a while since I discussed Mount Gibson Iron (OTC:MTGRF), so I thought it was time for an extended update on this company. As you might remember this company has experienced severe difficulties after its Koolan Island iron ore mine has to shut down after a wall failure. As the company was trading below cash value, I was intrigued by the value prospect as this provided the company with optionality.

MTGRY Chart

MTGRY data by YCharts

Keep in mind this is an Australian company and you should trade in the company's shares through the facilities of the ASX, where the company is listed with MGX as its ticker symbol. The average daily volume is in excess of 2 million shares and the current market capitalization of the Company is approximately US$160 million.

Despite the headwinds, Mount Gibson remained cash flow positive

in the first half of the financial year 2016, Mount Gibson mined approximately 3.4 million wet metric tons of iron ore of which 2.6 million tons were effectively sold at an average price of AU$48 per ton ($36/t). This resulted in a total revenue of AU$124 million ($93M), and a gross profit of AU$12 million ($9M) after taking an impairment charge of AU$2.4 million ($1.8M) into account but before an additional impairment charge of AU$21.2M ($16M). This additional impairment charge (which reduced the value of the company's fixed assets) pushed the company's results into the red territory and the net loss was approximately AU$15.4 million ($11.5M).

Click to enlarge

Source: company presentation

This is indeed a disappointing result, but you need to keep two things in mind. Firstly, the majority of the net loss was caused by non-cash charges, so this does not necessarily mean the company was free cash flow negative and secondly, this net loss was a really much better than the net loss of almost AU$870 million ($650M) in the previous financial year. As the iron ore price went south in the first half of the financial year 2016, investors didn't really have high expectations for these first six months of the financial year and the small net loss wasn't entirely unexpected.

Click to enlarge

Source: financial statements

As the total amount of ore that has been sold was lower as well (compared to H1 FY 2015), it shouldn't surprise you to see the revenue come in approximately 30% lower compared to the first half of 2015. That being said, the company's cost-cutting program is really paying off as despite the lower revenue, Mount Gibson was able to increase its gross profit by in excess of AU$24 million ($18M). But as said, this could not prevent the company from reporting a net loss of in excess of AU$15 million ($11M). However, as the total impairment charge was in excess of AU$23 million ($17.5M), it was not unthinkable the company would remain free cash flow positive.

Click to enlarge

Source: financial statements

That's why it always makes sense to have another look at the company's cash flow statements as I truly believe these offer you a better view on how the company really is performing. And indeed, Mount Gibson generated an operating cash flow of AU$6 million ($4.5M). On top of that, the company's huge cash position generated almost AU$5 million ($3.75M) in interest income, resulting in a total net cash inflow of AU$11 million ($8-8.5M). As the total capex was just AU$1.1 million ($0.8M), Mount Gibson actually generated a positive free cash flow of AU$10 million ($7.5M) in the first half of the financial year 2016, and that's a great result.

But what does the company intend to do with its cash position?

Based on the most recent financial results, Mount Gibson had approximately AU$58 million ($$43M) in cash, with an additional AU$287 million ($215M) interim deposits. As the total liability side of the balance sheet has a value of less than AU$103 million ($78M), Mount Gibson is actually in a pretty good shape with a net cash position of in excess of AU$342 million ($257M). Of course, with the additional insecurity of not knowing when/if the Koolan Island operations might reopen (read 'if'), it might be a more prudent move to also take the (short-term and longer term) provisions into consideration. In that case it might be a better idea to just deduct total liabilities from the current assets as I like to remain on the cautious side (and would expect the value of the property, plant and equipment to drop to zero).

Click to enlarge

Source: financial statements

After deducting the entire liability side of the balance sheet from those current assets, the remaining value is approximately AU$275 million ($208M), which is approximately 33% higher than Mount Gibson's current market capitalization. This basically means the company is trading at a discount of approximately 25% to its net 'realizable' value.

And leads us to the main question the market is asking itself. What is Mount Gibson going to do with its huge cash position? It's obviously very nice and it must be a comfortable feeling to have in excess of AU$300 million ($225M) on the balance sheet and cash and term deposits, but I don't really like it when cash is sitting on the balance sheet without generating any decent returns. It would make so much more sense for the company to go out and shop around for a new project, as the returns (both the ROE and ROIC) will obviously be much higher than the interest income on the term deposits.

Investment thesis

So until Mount Gibson decides what it wants to do with its cash, I would expect the company's shares to continue to trade at a discount to the net cash position and the net the realizable value. I would consider Mount Gibson to be a 'safe vehicle' to park some money considering its discount to its net cash position, but investors need to be aware Mount Gibson has the potential to be a 'value trap' that will continue to trade below its cash levels as long as nothing materially changes.

The company has stated it is looking for opportunities in the resources sector, but as long as nothing happens, it is quite likely the share price won't move much.

Disclosure: I am/we are long MTGRF.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.