Once again, Sid Ruttala continues his journey through the ASX20. This week his notes visit and review Woolworths Group (WOW.ASX) and Macquarie Group (MQG.ASX).
Author: Sid Ruttala
If you have missed some of the earlier parts to Sid Ruttala’s latest Talking Top Twenty, you can find them here:
WOW continues to please with its recent announcement of the demerger of Endeavour Group. Shareholders are set to receive about a 70.8% share of the company with WOW and Bruce Matheson holding 14.6% each. For the yield starved investor, the new company is set to have a payout ratio of approximately 70-75% of NPAT.
Numbers wise, group sales were reported at $16.56bn AUD. More pleasingly, online sales growth continued its upward momentum with Q1 sales up 90.5% vs. the 69% reported in my notes six months ago. This is one area that remains a key metric for management given its omnichannel strategy. The big headache seems to be the NZ business, contracting -7.5%, with a -6.9% for transaction growth. However, even here online penetration continued to grow at 37.9%. What surprised on the upside however was the performance of Big W, seeing sales growth of 20%.
Overall, management continues to deliver on its outlined strategy and we remain convinced that it has a better investment thesis/case than Coles.
Woolworths is the anchor tenant in the TAMIM Property Fund: Fairfield Heights
Red Flags & Risks: Management continues to be disciplined when it comes to cost management and balance sheet discipline. The big question mark when we last undertook this exercise was the uncertainty around the divestment of Endeavour. Pleasingly, this has now been resolved. Big W continues to surprise on the upside though we remain of the view that it may be better off sold than remaining a part of the broader group.
In addition, last-delivery remains an issue for the business with much being reliant on management turning existing stores into effective distribution centres (DCs).
My Expectations: In the right context, WOW remains a buy with management continuing to execute on its strategy. Their footprint across regional areas gives them a competitive advantage in comparison to pure-play online retailers. The company’s demerger of Endeavour is, in my view, a good move.
Dividend Yield: The current yield stands at 2.6%, assuming a share price of $43.50 AUD.
We remain convinced that this will stay at $1 AUD per share (give or take 0.2c) for the foreseeable future as the business continues to reinvest in order to keep up with competition and margin pressure.
Macquarie Group (MQG.ASX)
Macquarie continues to deliver with NPAT up 10% to $3.015bn and CET1 ratio of 12.6%, it remains well capitalised with a stellar balance sheet. Nevertheless, guidance from management suggests that FY22 is likely to be flat. Division wise, MAM (i.e. Asset Management) continued to deliver stellar performance fees of $660m AUD. While this was down from the previous year, to the tune of 20%, it was certainly better than expected. The decrease in AUM (Assets Under Management) was slightly concerning; this was probably a result of a strong AUD and the reduction in contractual insurance assets though.
Of particular interest, CGM (Commodities & Global Markets) continued to deliver with operating income increasing by 22% to $4.7bn AUD. BFS (Banking and Financial Services) remained broadly flat however. Again, a strong AUD remains a problem for the institution, given that 69% of their revenues are derived globally, as mentioned in my notes six months ago. A 5% swing in the spot rate will result in a 3.5% swing in the NPAT (either way).
Red Flags & Risks: The big risk for Macquarie is the headwinds faced via a bullish AUD, with AUM remaining a key concern. There continues to be downward pressure on EPS with the need for management to be diligent in increasing AUM going forward. Would also have liked to see more clarity around the strategy for increasing FUM on the MacWrap platform.
My Expectations: Remains a fair substitute for the Big Four with a well-diversified business and is arguably a greater risk-reward proposition. However, at a $149.540 AUD share price at the time of writing, it remains fairly valued.
Dividend Yield: The current dividend yield stands at an exceptional 3.15%, assuming a price of $149.540 AUD.
As long-term investors in Taiwan we prefer to look at the investment flows by Taiwanese companies into China as an indicator of the state of relations and not media speculation regarding the prospect for military hostilities. If China were going to invade Taiwan it would have happened years ago. The financial relationship between China and Taiwan is strong and growing. It is that financial relationship which will ultimately guide China and Taiwan to a sensible compromise regarding political differences.
Taiwan has been in the news a lot recently, especially with media headlines highlighting the apparent threat of invasion by China. In Australia we have seen this being used as a justification for increased military budgets in part to support the defence of Taiwan. We have been investing in the market in Taiwan since it opened to international investors in the early 1990s. Taiwan has some world class companies and was recently awarded four of the top one hundred places in the survey of global innovation published by Clarivate, not bad for a small island population of 23.5m people. We expect to continue to invest in world class companies that are headquartered in Taiwan and prefer to focus on the flow of investment money that takes place between Taiwan and China rather than speculation about imminent invasion.
April was a month of very mixed performance in the Asian region, by far the strongest market was Taiwan where the small to mid-sized stocks increased by 13.1% bringing the return over one year +75.8%. The broader measure of market performance in Taiwan for large capitalisation stocks increased by 7.7% during the month of April and +82.3% over one year. This was despite “The Economist” announcing Taiwan as the most dangerous place on Earth. “The Economist” was highlighting risks of military action by China to seize control of Taiwan. While China has been increasing incursions into Taiwan’s airspace, their way of testing responses, this is not anything new, China has a long history of this behaviour and we do not see this as the move towards an invasion of Taiwan.
In recent months we have seen China objecting to the United States Navy movements through the Taiwan Straits. In February there was tension between China and the United States when the destroyer USS Curtis Wilbur sailed through the Taiwan Strait, with China suggesting that the United States was undermining regional peace and stability. The United States sends their Navy vessels through the Taiwan Strait on a regular basis in a show of support for Taiwan, this however is a token show of support. The official United States policy of formal defence of Taiwan ended in 1979 when it ceased with recognition of the Republic of China as “China” and started referring to it as “Taiwan”. This change of status occurred when the United States recognised the People’s Republic of China as “China” and all relations with Taiwan then became informal.
Late in 2020 Beijing made an explicit warning that independence for Taiwan “means war”. China’s Taiwan problem dates back to 1949 when the Communist Party seized control of the Mainland and the displaced Kuomintang (KMT) government relocated to Taiwan. China has never renounced the use of force to take control of Taiwan, however, overt verbal threats of conflict are rare. The current ruling party in Taiwan, the DPP previously talked about “independence”, however, that word has been quietly removed from the narrative employed by the party. Relations with China tend to worsen when the DPP hold power and improve when the KMT hold power which is somewhat ironic given that the KMT were the original enemy of the Communist Party during the civil war that concluded in 1949. We can expect better progress towards a form of political accommodation between China and Taiwan the next time the KMT hold office in Taiwan.
A good deal of the recent tension regarding Taiwan can be attributed to the former US Administration under Donald Trump due to increased military equipment sales and US Navy activity through the Taiwan Strait. We expect the Biden Administration to adopt a lighter touch with respect to Taiwan. We have already seen Vice President Wang Qishan indicating to a delegation of US representatives that common interest outweighs differences with the United States. A period of relative stability with respect to trade and an end to the arbitrary Trump imposed tariffs will be taken very positively by markets.Taiwan’s President Tsai Ing-wen responded to “The Economist” headline assuring everyone that the government is fully capable of managing all potential risks and protecting Taiwan from danger. President Tsai went on the speak about responding prudently to regional developments and overcoming the challenges posed by authoritarian expansion in a reference to China without naming China. The equity market in Taiwan was much more interested in the news that the local economy grew by 8.16% in the first quarter, the fastest growth recorded in a decade and well above consensus expectations. The positive growth surprise was driven by stronger domestic manufacturing and demand for exports. Two of Taiwan’s major semiconductor manufacturers have recently announced large investment programmes aimed at alleviating the worldwide shortage of semiconductors needed in the automotive industry and consumer products. Taiwan is expected to achieve economic growth in excess of 5% for the full year of 2021.The table shows officially sanctioned investment that have taken place by Taiwanese companies investing in China. From the start of 1991 to the end of 2020 there have been 44,400 investments from Taiwan into China totalling USD 192.4 billion. By way of context, China received a total of USD 141 billion of foreign direct investment in 2019. Typically, “Hong Kong” appears as a major contributor to investment in China and this is usually money from Taiwan that has to be channelled via entities in Hong Kong. China’s official policy position is that Taiwan is a domestic province of China and therefore investment flows sourced from Taiwan should not be treated a foreign source of investment.
Source: Investment Commission, Ministry of Economic Affairste investment funds from Taiwan to China have slowed from the USD 14 billion annual peaks in 2010 and 2011, the figure in 2020 approached USD 6 billion and remains a substantial number. It is also important to note that the 2020 level showed a substantial uplift from the 2019 number which was a response to the then President Trump’s habit of surprise tariff restrictions being applied to China. For a while China was the predominant area of manufacturing investment by Taiwanese companies, the cost savings from manufacturing in China were too tempting to resist. The rising cost of labour in China and then Trump’s trade war prompted a sensible diversification of investments by the Taiwanese to ensure that China did not end up putting their supply chain at risk. The cost savings of manufacturing in China available a decade ago are much less pronounced in the current environment.
An example from our portfolio in Taiwan is Novatek Microelectronics, a leading fabless chip design company specializing in the design and development of a wide range of display driver integrated circuits required for sophisticated flat panel displays and audio/video applications for all digital devices. We originally acquired our position in Novatek at an average price of TWD 102 in late 2018, those shares recently reached the TWD 600 level. We have taken profits along the journey and remain a happy shareholder in a business that is attractively valued especially versus global peers. We acquired the position on a p/e ratio of 11x, since then profits have expanded from TWD 6 billion in 2018 to more than TWD 20 billion in the current year, putting the company on 14x p/e and a net yield in excess of 4%. Novatek has eight of their eleven global sales offices located in China, their relationship with China remains crucial to the prospects of the business. Novatek opened their first office in China ten years ago. Going forward, the company expects to achieve significant growth in Japan and South Korea in addition to ongoing development of sales in China. Novatek typically invests the equivalent of 14% of revenues on R&D, a significant and ongoing commitment to the intellectual capital of the business. In the field of display driver integrated circuits, Novatek has global market share of 20%, second only to Samsung at 30%.
In conclusion, as long-term investors in Taiwan we prefer to look at the investment flows by Taiwanese companies into China as an indicator of the state of relations and not media speculation regarding the prospect for military hostilities. If China were going to invade Taiwan it would have happened years ago. The financial relationship between China and Taiwan is strong and growing. It is that financial relationship which will ultimately guide China and Taiwan to a sensible compromise regarding political differences.
Mixed results from CSL though beats on management guidance, which has historically been on the conservative side. In our previous notes, we had mentioned the likely headwinds to plasma collection as a result of Covid and the associated lockdowns. While the company did continue to expand its collection footprint across the US, it was disappointing to see a sharp decline, coming in at about 80% of 2019 volumes. Numbers wise, stellar growth across profit and revenue with revenue up 15% and NPAT up 44%.
Looking at the results in slightly more depth, this was driven primarily by Seqris and the increased demand for seasonal influenza vaccines (+44%). Importantly, gross margins continue to increase substantially, a clear sign of management discipline. There are signs of renewed life across the Albumin product line with hospitals back to 90% capacity in China and associated increases to elective surgery. Across the hemophilia market, the numbers were a little mixed, with sales flat or in some cases declining due to competitive pressures (this was expected). Ironically, the stimulus packages in the US may have been a headwind for the company (i.e. disincentivising plasma collection primarily in lower socioeconomic households). Nevertheless, management seems to have a clear vision to grow the supply network and add on collection centres (44 to be exact).
Going forward, however, management only reaffirmed earnings guidance of 6-10%, which implies that 12-20% of FY21 earnings will be generated in the second half. This is substantially lower than the 5-year average of 40%. A substantial decline in growth.
Red Flags & Risks: While a decline in collections was to be expected, the scale (i.e. 20%) is still daunting. Especially so when compared to competitors. Grifols (GRF.BME), CSL’s Spanish rival, has made significant strides in its plasma collection infrastructure, especially in mainland China (i.e. Shanghai). No further guidance or elucidation was given pertaining to the Vitaeris acquisition, which had at the time of acquisition been conducting Phase III trials pertaining to organ rejection within kidney transplants. The results across Asia also looked particularly messy with a decline of 9% in the Seqirus product line. Again, we reiterate the crucial nature of the APAC region for continued growth.
My Expectations: The company continues to be a long-term hold for me. But at $274 AUD it remains fully priced and might see some volatility especially as the market digests what is likely to be a less than stellar 2H.
Dividend Yield: 1.06% (Assuming a share price of $274.50). Expectation remains that dividends continue to grow at double digits over the long-term.
Wesfarmers (WES.ASX)
Wesfarmers continues its fantastic performance and showcases the value add of having a diverse portfolio (not many firms can pull off a conglomerate structure, i.e. GE). For those that insist that brick-and-mortar retail is dead, both Kmart and Officeworks seem to be proving otherwise (at least for now). Kmart’s revenues increased by 9% with Officeworks’ increasing 29%. Target remains a problem child, but management seems to be executing on its omnichannel strategy nevertheless with online penetration increasing to 15.9% in 1H. The numbers are similar with Kmart, increasing to 8.9%. What was interesting delving deeper into the numbers was the increased purchase size for online orders (approx. 2x), with the majority of fulfillment taking place in store.
Across the Chemicals, Energy and Fertilizers (CEF) division however, the numbers are a little less stellar with revenues declining 6.6% and an earnings decline of 7.5%. Much of this may be transitory in nature though, not least due to continued weakness in Saudi contract prices. Given our thesis around commodities such as iron ore and gold, we would hazard a guess that we will likely see a revitalisation of demand for ammonium nitrate as well as sodium cyanide (crucial for gold mining). In other news, progress has been made pertaining to the Mt Holland lithium project (JV with SQM).
Red Flags & Risks: CEF division is getting increasingly competitive, especially with Orica (ORI.ASX) opening up a new plant in Barrup. Much will be contingent on continued demand from both iron ore producers and a recovery in gold mining (closed due to Covid measures). For retail, temporary closures and continued diminishing of margins as well as rental pressures remain the key downside risks going forward.
My Expectations: Management continues to deliver. In my previous notes, we mentioned that the failed bid for Lynas (LYS.ASX) was potentially a sign of what management’s focus is likely to be going forward. The Mt. Holland project confirms this. Though, given the trends we have seen, we still feel that Lynas would have been a great addition to the portfolio. We fully expect greater focus to be placed on CEF going forward and turning it around despite increased competition. Nevertheless, kudos to management.
Dividend Yield: 3.31% assuming a share price of $54.29 AUD. Expectation is that this will stay stable on a nominal basis.
Continuing to work our way through the ASX20, this week we visit and review BHP Group (BHP.ASX) and Fortescue Metals Group (FMG.ASX).
Context:
Author: Sid Ruttala
At TAMIM we remain of the view that, given the global impetus for an expansion of fiscal stimulus combined with substantial increases to infrastructure spending, we are about to enter a secular bull cycle in commodities. For those of you unaware of this argument, feel free to refer to previous articles on this particular issue and the rationale behind it. However, there is a caveat. There are certain commodities that are more likely to perform better than others moving forward. Not least because the price action so far may have already baked in some of this future growth.
So what are our favourites at this stage? Copper, aluminium and oil. Not so favourable in the short-run is iron ore (despite our long-term bullish view on the commodity).
The rationale for this view? Let’s examine copper first and why we think that this is one commodity likely to go significantly higher, even in the short- to medium-term, despite spot prices now hitting close to 9, 940 USD per metric tonne at the time of writing. There are two reasons why I believe this to be the case:
The minerals game is heavily capital intensive and requires a long lead time from exploration to first production (an average of 8-9 years for greenfield projects). One of the key issues for Dr Copper has been the scale of the lack of investment in new copper production over the past decade, due almost entirely to its previous collapse in 2015-2016. Five years on, the world has seen very few new tier-1 assets come online outside of Rio Tinto’s Winu and SolGold’s Cascabel, which both BHP and Newcrest remain in contention for (though the company has been doing its best to remain independent).
All this comes at precisely the time when governments globally continue their push for new infrastructure, more specifically green infrastructure, as a way to stimulate growth. A single 660 kW wind turbine, for example, contains approximately 800 pounds of copper and a photovoltaic solar plant requires about 5.5-5.6 tonnes of copper per megawatt generated. If we assume current growth trajectory in output in terms of production and assume current rates of capex, our view is that there could be a supply gap of close to 10mT by 2031. In the short- to medium-term, we could easily see spot prices hit above $13,000 USD even on news flow related to the passage of the Biden infrastructure bill (much more consensus than the minimum wage issue and could be done via reconciliation with the current majority).
Similarly, aluminum should also see some catalysts, not only with the infrastructure spending but also the reflation trade (i.e. consumer electronics and
retail construction). In the case of oil, we have previously written about the likelihood of US shale production declining rapidly through to the end of the year and my overall bullishness due to increased demand as the world comes out of lockdowns. Reiterating my view, oil will see $80 USD per barrel before the end of the calendar year (though this may only be short-lived). For Iron ore, my view is a short-term bear market. This is despite my previous assertions that, even in the expectation of Brazil’s Vale coming back online, the demand generated by fiscal stimulus for steel should see spot prices continue higher. But at $185 USD/tonne, it is looking rather toppy despite China’s continued growth in steel production. We see substantial headwinds for Chinese demand as the CCP tries to reign in steel production and gets rid of export incentives. Long term spot prices should trend higher, but spot prices are now where I expected them to be mid-next year assuming continued global recovery, that is, not quite so soon (i.e. when I previously wrote on this the price was about $112 USD/tonne).
So with that context in mind, let’s proceed to the securities in question.
BHP Group (BHP.ASX)
Stellar results from BHP with EBITDA of $14.7bn USD (up 21%), margin of 59% and, most importantly for the yield hunters, a 101c US p/s dividend. This was pleasantly higher than expected and supports my thesis of the business being an effective substitute for the banks for the income starved investor. On the flipside, the company’s copper production declined 9%, unfortunate given the high demand globally but somewhat expected due to short-term declines in production at Escondida though cost guidance has been lowered going forward. The grades are also likely to lower as the mine continues through its maturity. Somewhat surprising however was Olympic Dam which continues to maintain production. Petroleum production continues higher with about 9%. Importantly, BHP’s increased interest in the Shenzi platform – a deepwater oil and gas field in the Gulf of Mexico with a processing capacity of 100,000 barrels per day along with a handling capacity of 50m cubic feet of gas – should see production continue to increase through ‘21-’22. This is an exciting prospect. That being said, we would have liked to have seen more acquisitions within both petroleum and copper but stellar results so far with costs being kept minimum.
On the coal front, metallurgical (met) coal production increased slightly by 1% while thermal continued its dismal performance, -17% year on year, driven by strikes and labour issues in Colombia. Mt Arthur’s wet weather also didn’t help. There has been little progress on the divestment of the coal assets which, in my view, remains a headache for the company going forward and the sooner this takes place the better. Though any divestment deal would probably have to be sweetened with better performing assets (perhaps even on top of the Bass Strait Gas assets as mentioned six months ago). An IPO/bundle and spin out of the assets could be on the cards but I have doubts that the market would pay a decent multiple given how the space has been tracking recently.
Red Flags & Risks: Many of my red flags remain the same. While BHP remains diversified in terms of commodities, weakening demand for steel production in China could hamper future growth and much will be contingent on maintaining cost discipline. The divestment of the coal assets and a strategy around this still remains the biggest issue. Chile’s recent proposals to change the tax laws pertaining to mining remain a big risk for the company, though we doubt passage is likely with a staunchly conservative President.
My Expectations: Management continues to deliver and has pleasantly surprised on the cost front. We would like to see more corporate development, especially in Copper and especially in LATAM. Ecuador remains a key focus for the firm but we have yet to see significant acquisitions. One would hope to see a resolution on the coal business before the beginning of the new year but I don’t have much optimism. Nevertheless, this is one I would personally continue to hold.
Dividend Yield: Assuming a share price of $48 AUD, then BHP has a great 4.1% dividend yield.
BHP remains a credible substitute for the banks from an income perspective.
Fortescue Metals Group (FMG.ASX)
Fortescue continues to forge ahead but remain too expensive compared to their peers for my liking. Numbers-wise, a mixed to decent result. There was some weaker than expected production in March with shipments flat YoY, a new record EBIDTA of 6.6bn for H1FY21, a gross margin on iron ore of 71%. Importantly for the dividend hungry investor, a $1.47 interim dividend per share, representing a payout ratio of 80% (slightly higher then the 77% mentioned in my previous write up).
In terms of capex and additional projects, the increase is likely to be 10% more than expected. The EnergyConnect project, which aims to decrease the firm’s carbon footprint by investing in hybrid solar-gas transmission infrastructure, though going according to plan is likely to increase capex to around $4bn USD, though the guidance has been to $3.4bn USD. I base this on likely additional cost escalations in Iron Bridge. The firm retains close to $4.3bn in debt. Going forward in the short- to medium-term, FMG remains fair value at $22.26 AUD per share.
Red Flags & Risks: FMG is a leveraged exposure to the iron ore spot price. Personally, I remain convinced that the spot price is relatively overvalued (on a short- to medium-term outlook). FMG also trades at a significant premium to NAV (1.4x) compared to counterparts BHP and RIO. That being said, I remain a big fan of Elizabeth Gaines (and Twiggy), who cannot be faulted in her execution or cost discipline. In the medium- to longer-term the overreliance on Chinese steel manufacturers might hurt prospects. As mentioned, there is a marked push to move production out of China.
My Expectations: While Vale production still remains below market expectations, I remain a little uncertain about the price action for iron ore. FMG remains a good long-term investment but, nevertheless, it might pay to take some profits in order to buy back at a later date (hopefully lower).
Dividend Yield: The current dividend yield stands at an exceptional 13%, assuming a price of $22.26 AUD.
This week we will be talking about a little known Australian micro cap company, K2Fly (K2F.ASX). K2F is an enterprise software company that is looking to capitalise on a major transformation in the mining industry. K2F offers SaaS (software as a service) solutions helping mining companies improve their ESG (environmental, social and governance) standards. They also provide consulting and tailored advice for asset intensive industries including mining, utilities, infrastructure and government.
Why SaaS Business Models Are Attractive
Author: Adam Wolf
SaaS revenue models are especially attractive for investors as their revenue is mainly recurring almost like an annuity. Another feature of SaaS revenue is that it is typically quite sticky. This simply means that their customers will have a hard time shifting away from already integrated software, a costly exercise often requiring consultants, which makes these segments of K2F’s revenue highly sustainable. There are plenty of SaaS companies on the ASX but K2F stands out from their SaaS peers as they offer exposure to both commodities and an emerging thematic.
Key Financial Metrics | K2F
K2F’s annual recurring revenue sits at just under $3m with their total contract value over $9m. After the completion of a $7.25m placement in April, K2F now has $8.75m cash plus $1.5m in receivables with no debt. Their market cap is currently sitting just north of $42m.
Source: Company filings
K2F has grown their ARR 80% from Q3 FY20 to Q3 FY21.
ESG As A Thematic
The shift to ESG practices has become a thematic the world over. We now see a greater emphasis on companies having a plan for sustainability as well as taking responsibility for their societal impacts. As a result, we have seen institutional investors allocate more money towards companies that are more sustainable and have better ESG credentials. On the flip side, this drains capital from companies that are perceived to have poor sustainability and negative impacts on the environment such as oil and coal producers. K2F offers investors an opportunity to benefit from the rise of ESG investing.
Recently we saw RIO Tinto blow up a 45,000 year old indigenous cave system which led to the firing of the CEO and a few other key executives. Losing their jobs due to ethical wrong doings is front of mind for many C-suite mining executives around the world and there is increasing pressure from stakeholders in mining companies to engage with their surrounding communities, disclose mineral resource information and to minimise their impact on the environment. K2Fly is looking to address and capitalise on these issues.
(As a side note, RIO recently entered into an agreement with K2F worth $720,000 to integrate K2Fly’s community and heritage software).
K2F Product Offerings
Over the past few years K2F has a built a well-rounded arsenal of ESG software solutions for mining companies to:
Accurately report their mineral resources in compliance with their respective exchanges
Enable geology teams to streamline and automate pit block outs, spatial data, logging, sampling, and assay results to better understand material grade and behaviour
Help improve compliance and provide the visibility to reduce risks and support accurate disclosure as well as helping environmental, rehabilitation, community and mine management teams globally to improve relinquishment, tracking of closure and achieving rehabilitation targets
Manage their tenements in regard to cultural heritage and surrounding communities (i.e. avoiding a RIO repeat…)
K2F’s Strategy: Land and Expand
K2F have expanded their product offering for mining companies through acquisitions. This has been part of their strategy to “land and expand”, that is to leverage existing relationships with top tier miners to then cross sell their complementary solutions. K2F’s customers are comprised of high profile tier one clients, including 3/4 of the iron ore majors and 5/10 gold majors. Their solutions are used in 54 countries across 45 different commodities.
At the back end of last year, K2F’s solutions were endorsed by SAP, the biggest enterprise software company in the world. K2F is one of just twelve companies globally to be awarded the certification which is an amazing achievement given the size of K2F. SAP have relationships with 98/100 of the biggest mining companies and are now incentivised to sell K2F’s products. This provides K2F with a big runway to execute their “Land and Expand” strategy.
Recently, K2F acquired Decipher which was developed and operated by WesCEF, a subsidiary of Wesfarmers. Decipher offers award-winning cloud-based software-as-a-service monitoring and compliance solutions in tailings management and rehabilitation for mining industry customers. This has not only expanded K2F’s offering but also put Wesfarmers on K2F’s share registry as a substantial (10%) holder .
The sample below highlights the opportunity K2F has to cross sell their products to existing costumers. The grey boxes represent cross selling opportunities. This sample alone shows that only 20% of their products are being utilised. As K2F continues to develop new solutions and seek strategic acquisitions, this opportunity will only get bigger.
Outlook and Thesis
On the back of their endorsement by SAP, K2F can capitalise on the relationships that SAP has with the top tier mining companies and look to cross sell their solutions. The management team has experience across the mining and software industry and is led by CEO Brian Miller who co-founded AMT-Sybex, a software company providing services to the energy and utilities sector who were taken over for $150m+ AUD in 2014 (delivering tremendous shareholder value).
A comparison with geospatial data company Pointerra (3DP.ASX), which K2F is affiliated with through the integration of 3DP into their new acquisition Decipher, and cloud based software IntelliHR (IHR.ASX) is rather compelling and gives some food for thought on K2F’s current valuation. The table highlights how low a cash flow multiple K2F is trading at and what a cornerstone investor like Bevan Slattery can do to a company’s market cap (he took $2.5m positions in each of 3DP and IHR in 2020).
* Note: We used annual recurring revenue for K2F/IHR and annual contract value for 3DP
The thesis here is fairly simple, K2F is at the forefront in benefiting from a major shift in the mining industry whilst also having a positive impact on society, something that investors are beginning to value more and more. At a market capitalisation of just $42m with $9.25m in cash and receivables, K2F offers material upside as they look to add new solutions and use their existing relationships with miners as well as their partnership with SAP to cross sell their products and increase annual recurring revenue. In addition to this, there has also been a run up in commodity prices and a lot of talk about a “commodity super cycle”. This will only benefit K2F as more mines are brought to production, increasing the demand for mining services companies. K2F have provided strong updates to the market and are in advanced talks over further contract agreements. They are cashed up and can use the money for further acquisitions that could expand their product offerings as well as develop their own solutions tailored to the feedback of current customers. We also expect K2F to begin looking for products to offer to the oil and gas sector which will increase their addressable market significantly.
Disclaimer: K2F is personally owned by the author of this piece. It is not owned in any TAMIM portfolios.
