Fenix Resources as a cash cow or small cap miner with growth potential

The sharp fall in the price of iron ore since May has dampened the appeal of the steel-making mineral for most investors but in the dust left by the 50% price plunge nuggets of value can still be found, such as the ultra-small Fenix Resources (ASX: FEX).

In an industry dominated by giants, Fenix is in a category called “blink and you’ll miss it” but it is also a business which scores well on two measures: the quality of its resource and the willingness of management to reward shareholders with generous dividends.

High-grade ore and fat dividends do not mask the reality of Fenix having to watch its costs carefully because, like all iron ore mines, the key to success does not lie in the geology, it ultimately lies in the transport economics of a bulk material.

In the last iron ore boom, which ended six years ago with the collapse of mid-tier producers such as Atlas Iron, the pincer squeeze on profits was a result of companies mining relatively low-grade ore, while relying on high-cost road transport rather than having access to cheaper rail haulage.

Iron Ridge mine

Fenix’s starter project, the Iron Ridge mine near the historic Western Australian gold mining centre of Cue, has one of those drawbacks, a 485-kilometre road trip to the port of Geraldton but it does not have the second problem thanks to a high-quality orebody grading 64.4% iron.

In mining there’s an old saying about grade being king and 64.4% might not seem to be that much higher than the 61% average for ore mined by BHP (ASX: BHP) and Rio Tinto (ASX: RIO), or the 57.4% average of reserves held by Fortescue Metals (ASX: FMG), but there is a world of difference to steel makers who are prepared to pay a premium price for high-grade ore with low impurities.

It’s the quality of the Iron Ridge orebody which has given Fenix a kick start in life, along with a touch of good luck in that the small project was able to catch the last rays of the latest iron ore boom which meant the company has found itself awash in cash.

Just how much cash was revealed in the annual report when the classic small cap miner with a stock market value of $110 million reported a net profit of $49 million and declared a maiden dividend of $0.0525 a share, meaning $24.8 million was returned to shareholders given the 50% dividend payout ratio.

In some ways, Fenix looks to be is a fairytale, almost too good to be true. That’s when critical issues bubble to the surface for a discerning investor, especially the question of operating costs at a time of rising prices for the diesel used to haul ore from Cue to Geraldton, the life expectancy of Iron Ridge which started at 6.5 years and has just used one of those, and the outlook for the price of iron ore.

Dipping prices forecast for iron ore

In reverse order, the iron ore price is highly unlikely to revisit the golden era of earlier this year when it was above US$200 a tonne (A$272/t), at least not in the next decade.

Most investment banks see the recent uptick in the price to around US$117.50/t (A$160/t) a short-term blip which will give way to slide back below US$100/t (A$136/t).

Morgan Stanley in an iron ore update sent to clients this week tipped a decline to US$85/t (A$115/t) in the lead up to Christmas, followed by a modest recovery to US$90/t (A$122/t) next year.

“We are still iron ore bears and it remains our least preferred commodity on a six-month horizon,” the bank said.

So, if iron ore isn’t going to boom again during Iron Ridge’s short life, what’s happening with costs as the price of diesel rises along with shipping costs?

The answer is that even after the big iron ore price fall, Iron Ridge is still comfortably above the cost estimates in its feasibility study of less than two years ago.

Back then, the price of 62% iron ore (the industry benchmark) was US$85/t (A$115/t), good enough for Fenix to proceed with construction of what is a remarkably simple mine, classic dig and deliver by taking the top off a hill and trucking it to port.

The financial fundamentals in the feasibility included annual production of 1.25 million tonnes of ore produced at a C1 (direct) cash cost of US$53.80/t (A$76.86/t) for an estimated pre-tax internal rate of return of 58.9% and annual earnings before interest, tax and other charges of $16.4 million — handsomely higher than the project’s initial capital cost of A$11.9 million.

At the latest benchmark iron ore price of US$117.50/t (A$160/t) Fenix is very much in the money and running well ahead of its feasibility estimates.

If there is an issue to cause concern it is life expectancy, and that’s when two other issues enter the equation because either Fenix scrapes every last kilogram of iron ore out of Iron Ridge and returns the profits to shareholders (a possibility given the recent 50% profit payout) over the next six years, or growth opportunities are pursued.

These could include a plan to drill out the Iron Ridge Extended prospect about 5km south-west, and/or the Ulysses prospect with both inside a tenement held by Scorpion Minerals but included in a joint venture which entitles Fenix to a 70% stake in exchange for funding exploration.

Potentially, the iron ore covered by the Scorpion joint venture could provide Fenix with an expansion opportunity to continue mining and exporting high grade ore, if a resource can be proved by future drilling and analysis.

For investors, Fenix boils down to a small cap stock generating handsome cash flow which should support a generous dividend for the next five-to-six years, which is handy at a time of ultra-low interest rates.

Or it’s a small cap with a proven track record of developing a small but high-grade iron ore project, with the potential to do it again.

But, at a share price of $0.25 and a stock market value of $110 million it looks a winner either as a dividend-paying cash cow, or a small miner with growth potential.