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In mid-September 2011 commodity prices across the board accelerated the downward slide begun in August, culminating with a sickening vertical fall as end of month approached.  On 26 September copper fell to a 14 month low.

For a country largely dependent on a continuation of the resources boom, sputtering commodity prices lead many investors to reach for the panic button.  In the midst of all this, TheBull pinpointed three analysts who believe there are mining companies that can survive a commodities slowdown, including one stock that has been getting a fair amount of attention lately, Atlas Iron.

According to Richard Batt at Shadforth Financial Group, Atlas Iron (AGO) has the following attributes:

•    The company has expanded its operations after acquiring Warwick Resources, Aurox Resources and Giralia Resources, all delivering tenements and increasing the resources base.

•    Atlas recently announced a full year net profit after tax of $169 million and declared a maiden dividend of 3 cents a share.

•    It shipped 4.6 million tonnes of iron ore for the 12 months to June 30, 2011, and is targeting exports of 6 million tonnes in 2012 from increasing production.

•    Revenue of $85 million in full year 2010 rose to $585 million in 2011.

•    The company ended the year with a cash balance of $366 million.

While this brief list of performance highlights achieved in fiscal year 2011 is impressive, intelligent investors know this is looking in the rear-view mirror.  Certainly past performance is important, but it does not guarantee future performance, especially as a commodities bust is every investor’s fear.

The mining and materials sector involves investment risk even in the best of times and these are hardly the best of times.  The Eurozone is in crisis, with some experts predicting a Greek default, a recession, and the potential collapse of the Euro itself.  The United States, in the opinion of a growing number, may already be in a recession.  Finally, China continues to struggle with inflation and some faint signs of slowing economic growth.

The Eurozone debt crisis is raising the possibility of another credit crisis, with a few bearish forecasters stating a new credit freeze could be worse than the global tumult that followed the bankruptcy of American investment bank Lehman Brothers.  Put it all together, and the bears are making a case for an impending GFC2.

We are in a rare moment in history when we have recent precedent to gauge the capability of AGO in the event GFC2 becomes more than the figment of bearish dreams.  The question is how did AGO weather GFC1, which almost everyone agrees was the worst global economic calamity since the 1930s.

Here is a five year share price chart for AGO:


In the second quarter of 2008 AGO was trading at $4 per share.  By the third quarter of 2011, the share price of AGO was approaching $4.5.  On 27 September 2011 the closing share price was $3.04.  Is it a bargain at that price, or a classic value trap?  First, let us look at how share market participants view AGO in comparison to one of its larger competitors, Fortescue Metals (FMG).

Market Valuation Ratios

  AGO FMG Sector
P/E 10.81 8.61 11.94
P/B 1.45 6.74 1.33
P/S 3.36 2.99 20.34
P/EG .44 .41 .61
Dividend Yield 1.1% 1.6% 4.2%

Although the P/E and P/EG values for both FMG and AGO suggest both may be slightly undervalued, none are low enough to warrant concerns about value traps. Its share price drop is more likely due to macroeconomic concerns over slowing demand than company fundamentals.  Let’s take a look at a 5 year track record on some fundamental performance measures.

5 Year Historical Financial Measures

  06/2007 06/2008 06/2009 06/2010 06/2011
Revenue ($m) 0 0 26.4 84.8 584.9
Net Profit after Tax ($m) -16.5 -38.3 -63.1 -40.8 168.6
Net Operating Cash Flow ($m) -12.89 -29.55 -61.1 -25.06 221.2
Long Term Debt 0 0 0 0 0

There are two factors that make Atlas Iron’s most recent performance even more impressive.  First, although things are definitely getting more worrisome, the Australian economy and the share market has been showing signs of trouble since Woolworths lowered its forecasts back in early 2011.

Second, AGO came onto the ASX in 2004, moving into the ASX200 in 2008 and now into the ASX100.  As the numbers indicate, in their first years in the share market they were still in the exploratory phases of growth.  Along the way their management has made some key acquisitions, expanding their resource asset base significantly and their current production capability is represented in the massive revenue, profit, and cash flow increases in fiscal year 2011.

Going forward, there is reason for continued optimism.  For one thing, their location in close proximity to Port Hedland allows them to truck their own product into the port for shipping, eliminating the need for building rail lines.

They plan to increase their current production of 6 million tonnes per annum to 12 million tonnes by 2012.  Most of their iron resources are located in the Pilabra region of Western Australia and are graded DSO, or Direct Shipping Ore.  This means the ore needs no further processing once it is mined and can be shipped directly.

Their existing inventory of exploration prospects is soon to be supplemented with the announced acquisition of an Australian junior miner, FerrAus Limited.  

Of course, the troublesome little spot in this otherwise unblemished picture is the price of iron ore itself.  Given current macroeconomic conditions, is the mining boom sustainable enough to maintain the price of this commodity high enough to enable profitable production in the near term?

In the longer term, it is doubtful both the Chinese and the Indian economy would collapse to the point those countries would cease their massive urbanisaton efforts.  

In the short term, if GFC2 does rear its ugly head, you can rest assured the bigger players in the commodity space will be out looking for bargains.  With a market cap of about 2.5 billion, the company is large enough to be profitable and small enough to be attractive to giants like Rio, with a market cap of 123 billion; or BHP at 197 billion.

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.