Like most mining services companies, XRF Scientific Limited (XRF) was hit hard earlier this year by the unexpected slowdown in Chinese first-quarter economic growth. As the growth rates of Chinese GDP and industrial output slipped, so did the share prices of the Australian miners and the companies that work for them.
From 39.5 cents in March, XRF slid as low as 28 cents. But as Chinese economic data has improved, the shares have stabilised. Chinese industrial production (IP) jumped in July 2013 by 9.7% year-on-year, and followed that with a stellar 10.4% rise in August – the fastest growth rate in that number for 17 months. That pace has largely continued, with a 10.2% increase in IP in September and a 10.3% growth rate in October. That recovery is good news for XRF.
XRF Scientific is a specialised business based around X-Ray Fluorescence (XRF) geochemical analysis, which is a process that bombards material with high-energy X-rays or gamma rays, to generate ‘secondary’ (or fluorescent) X-rays that can be used to analyse the material. XRF Scientific makes testing equipment, patented X-Ray flux chemical formulation (fluxes are used to bind the test-sample material into a glass), precious metal ‘labware’ and several other related products and services.
The company’s three businesses are:
• Labware (41% of FY13 revenue): XRF makes labware used in analysis, for example, crucibles, moulds, mouldables, stirring rods, electrodes, dishes and tongs. This is mainly made out of platinum, which has a range of unique qualities that make it ideal for labware, as well as gold and silver. The Labware division makes half of its sales overseas, and half in Australia. In FY13, Labware profit was down 18%, at $1.4 million.
• Capital equipment (30% of FY13 revenue): XRF makes laboratory and analysis equipment used in sampling preparation, measurement, composition and purity analysis. The capital equipment division made a pre-tax profit of $1.14 million in FY13, up 59%, but it also saw a large drop in revenue in the second half, being the division most heavily exposed to the capital expenditure cycle of major miners and laboratories. The division is about to release its flagship xrFuse 6 electric fusion machine, which makes the ‘bead’ of sample material to be tested. XRF bills the machine as the outcome of 25 years of fusion technology expertise, and a product that minimises contamination, increases operator safety and improves performance, productivity and reliability.
• The Consumables division (29% of FY13 revenue): XRF makes chemical fluxes (standard borate fluxes and customised products) that are used to dissolve ores and other materials so they can be analysed by X-Ray fluorescence. These fluxes are sold to iron ore, nickel and general miners, and commercial analytical laboratories: XRF holds world patents for X-Ray Fluxes for nickel analysis. In FY13, consumables profit was $2.8 million, up 4%.
In FY13, total revenue slipped 10% to $23.25 million, but net profit rose by 7% to $3.821 million, and earnings per share (EPS) by 4%, to 2.9 cents a share. From this XRF paid a fully franked dividend of 1.7 cents a share – comprising a final dividend only – up from 1.5 cents in FY12. This made a payout ratio of 58.8%.
Despite the revenue fall, XRF managed to boost margins, with the gross margin lifting from 38.5% in FY12 to 40.5%, and the net profit margin increasing from 14.1% in FY12 to 16.7%. This shows that XRF has a healthy level of pricing power, thanks to its status as a market leader in its highly specialised – but much-needed – business niche.
The key to XRF’s attraction is that while exploration activity has definitely slumped in the Australian resources industry, the company’s exposure to the production side – particularly in iron ore – is buttressing that decline. In Western Australia alone, iron ore production is expected to rise by at least 20% in FY14. Investment bank JP Morgan reckons the iron ore industry is poised to lift production by 50% over the next five years, to more than 900 million tonnes.
Iron ore has defied analysts’ consensus forecast prices, and while analysts still expect China’s steel industry to make production cuts, the price is now expected to stay in a benign holding pattern, fluctuating around the level of $US125–$US130 a tonne (the spot price is currently US$137 a tonne.) This can be expected to support the demand for XRF’s products.
The fact that many of the big resources projects are showing production increases is an offset to perception of a ‘bust’ to the resources ‘boom,’ which some commentators – most notably former Prime Minister Kevin Rudd – have inferred from the declining investment pipeline of new projects.
This financial year XRF will also have a full contribution from Kitco Labware, formerly a division of Kitco Metals Inc. of Canada, which it bought in June 2013. The company expects Kitco to help it expand in South America, to support the expansion XRF was already undertaking in Russia and Brazil.
Broking firm Blackswan Equities expects XRF Scientific to lift revenue by about 19% in FY14, to about $26.8 million, but to see EPS come down by 0.1 cents, to 2.8 cents a share. However, the broker expects the 1.7-cent dividend of FY13 to be at least maintained.
At the current share price of 30 cents, that places XRF on a prospective FY14 price/earnings (P/E) ratio of 10.7 times earnings, and a dividend yield of 5.67%. Those appear to be good-value numbers.
Although XRF is a small company – it is valued at just under $40 million – it is, as Blackswan puts it, “one of the few businesses within the service sector that has a genuine recurring revenue stream.” The broker takes confidence from the fact that XRF has been profitable every year since it listed on the ASX in 2006, has a strong balance sheet (net cash of $7.2 million) and is leveraged to increased commodity production – particularly iron ore.
