Shares I looked at over the past week (20 Aug 2024)

Mega-cap Rio Tinto, high growth Beeks Financial, and deep-in-the-red THG. Would you invest in any of these?

Rio Tinto (RIO)

» What

World’s largest producer of iron ore, and also one of the cheapest producers. Absolutely dominates this commodity. Does a smattering of other metal mining as well, as byproducts. Looking to enter into lithium in the future.

Currently ramping up a mine, Oyu Tolgoi in Mongolia, which it owns 66% (the rest by the Mongolian government). Oyu Tolgoi was an above-surface mine, but Rio Tinto has invested to expand underground, where huge amounts of copper is present. This will increase the output of Oyu Tolgoi from around 170,000 kilo tonnes a year to 500,000 kilo tonnes a year. By 2030, Oyu Tolgoi might be the fourth largest copper mine in the world.

» My Comments

#1 Way outside my comfort zone, but I am a sucker for cheap valuations

Rio Tinto is as far as it gets from the usual shares I look at. Its market cap of £77bn is more than 1000x the usual size I look at. However, the valuation is cheap at multi-year lows, due to very weak iron ore pricing ($95/tonne currently vs $140 peak in the last two years).

I reckon it could get back to the 450p-500p yearly dividend mark consistently over the next decade, which at the current share price (4800p) is 9.3% to 10.4% dividend yield, very tempting to lock-in especially as rates start to fall.

#2 Oyu Tolgoi not being priced in?

Looking at the share price chart, it is currently trading near the low level mark (4500p, 4600p) over the last few years, further reinforcing at that it is at the bottom of the iron cycle.

However, it should be trading higher than those multi-year lows, given that the Oyu Tolgoi opportunity was not there in the past. They only just started digging underground in 2023, and by 2028 have an ambition to mine 500,000 kilo tonnes of copper compared to the current 170,000 kilo tonnes run rate.

Oyu Tolgoi delivered approximately 4% of total underlying EBITDA to Rio Tinto, so the near tripling of production by 2028 could mean that an incremental 8% total EBITDA, c$1.8bn, is possible. Current PAT is like $11bn a year, so even after ITDA it could nicely be c10% earnings enhancing.

Therefore, Rio’s SP should actually be c5000p = c10% above the lows of the last few years. It is currently at 4700p.

#3 Pretty safe bet, good downside protection

The key risk with miners are that their margins are completely at the whims of the market price for that commodity. The worst case scenario is if the market price goes below the cost of production.

In the case of Rio Tinto, that is very unlikely to be the case, because it is one of the cheapest producers of iron ore in the world, and will be one of the cheapest for copper too at Oyu Tolgoi. Rio’s cost of production for iron ore is around $25 per tonne, whilst the “low” current price is still at $95 per tonne.

In copper, Rio has stated that it expects to operate in the “first quartile” of the cost curve, thereby being one of the cheapest producers for that commodity too.

There are plenty of more expensive mines, for both iron ore and copper, that will have to mothball before Rio goes into losses.

So even in the worst case scenario, Rio Tinto is unlikely to be EBITDA unprofitable, as many mines will mothball before it gets to that point, supply will be removed from the market, and prices will re-stabilise.

My dreams of huge warehouses of copper mined by Rio Tinto, all to supply the fast growing needs for electricity transmission globally to support the new era of renewables and electric vehicles. Source: Microsoft Copilot Designer.

» My Verdict

Before I started, I thought I’d immediately dismiss Rio Tinto; but instead I think it might have enough to warrant a deeper dive and possible investment.

Recent big selling by some senior directors have me worried; but they were done at prices north of 5700p, so for me maybe that signifies a high water mark. A quick back-of-the-envelope calculation is that I’d be looking for c4380p entry, if goal-seeking a potential gain of 30% (to 5700p). Not too far off the current share price, so Rio goes on my watchlist for any dips to buy.

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Beeks (BKS)

» What

A provider of infrastructure services for asset trading on public exchanges globally. They offer services to a range of client sizes; from small professional investors to global Tier 1 financial institutions to the stock exchanges themselves.

Their offering is built on installing hardware that is “co-located” next to the exchanges’ own servers and hardware. This way, there is minimal physical distance for the wires, thereby reducing any latency and giving the best possible speed/time advantage for trades, especially the high frequency type.

Traders can then upload their trading scripts and algorithms to the Beeks hardware, which is then able to be the fastest order to the exchange because of that distance/latency advantage.

Their offering has probably evolved from this, but this is what I remember from when I started to track a few years back

» My Comments

#1 They are growing at a blistering pace

Pretty good growth so far, with the latest results for FY Jun24 showing revenues up +27%, and PBT up +67%.

No operational gearing on the gross margin level or EBITDA margin level, only on the operating profit level which is interesting.

Recurring revenues also up +18% YoY. However, the growth in recurring revenues between Dec23 and Jun24 (ie H2) was only 5.3% for the six months, which will be a drag on revenue growth in the short term…

#2 However, all the profits are going to management!

At the HY Dec23 mark, they made £1.38m underlying PBT. What did they massage out to get to this number? The share based payments to management… which came to £1.1m! Wow, talk about a company being run for the benefit of management.

Why does management need more shares? The CEO holds 32% of the shares. The CFO has a small shareholding, but has vested options over 1.4% of total shares outstanding already.

#3 They are signing some sizeable clients for a £29m revenue company

Lots of Tier 1 financial services clients, as well as major global exchanges, of which NASDAQ is rumoured to be the latest one. Pretty incredible stuff.

Could they be charging more for their services though? Only producing £29m revenues, and I’m sure the solutions they’ve deployed, each client is seeing hundreds of millions if not billions of transactions depend on Beeks’ hardware.

In addition, the group of Tier 1 clients and Exchanges is relatively small globally. Probably in the tens, not hundreds? Especially those that want to “outsource” the infrastructure bit to Beeks. How many more clients can they sign? I can see a 2x, 3x client base. But is there really a 5x, 10x opportunity?

» My Verdict

I am kicking myself for not buying back when they were c80-90p. They have always seemed expensive, and from time to time the CEO-founder would sell a large chunk of shares, which made me doubt whether there was a big runway of growth in front.

That growth is now being delivered. However, I still have misgivings about how much profits will actually make it to other shareholders, given the large management incentive scheme sucking out the majority of profits to their personal pockets.

In addition, the much-vaunted Exchange Cloud product, sold to stock exchanges, has yet to show it can deliver big revenues and profits. Sequentially, H2 did approximately £2.5m underlying PBT, a big growth from £1.38m in H1. This would have included a full HY contribution from one of the Exchange Cloud contracts, with the JSE. But also many other contracts signed in 2023. So the JSE contract at the most probably drove a few hundred thousand pounds of profit in the half year? OK, but not huge.

Working off statutory profits (which include the share based payments), I can see £6.5m PBT as potentially achievable in the next 24 months. This is a 4p statutory EPS, and at the current 250p share price I struggle to make a case that it is at a good valuation. I think the valuation is up with events, already baking in a rosy future profit growth. So Beeks stays on my watchlist for now.

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THG Group (THG)

» What

An eCommerce specialist that owns a portfolio of online eCommerce websites across Beauty and Nutrition categories. Two of the biggest sites/brands in their portfolio are Lookfantastic and MyProtein.

They also own a B2B service arm called Ingenuity, which provides other brands with a turnkey eCommerce solution. Everything from the front-end website to order management to fulfilment and logistics.

Mostly generating revenues in the UK, but has global sales across Europe, North America, and Asia.

» My Comments

#1 Perennially lossmaking, is there a pathway to profitability?

There’s a sea of red when you look at historical results. But management are now focused on driving profitability. It looks like it is two pronged:

• Driving modest revenue growth; FY Dec25 analyst consensus revenue is 9.5% higher than FY23.

• Driving huge improvements in adj EBITDA margins, to 7.8% by FY25, and 9.0% “medium term” (26? 27?). From 5.6% in FY23.

However, when I do the maths here to see what it’ll take to get to break-even… taking the FY25 revenue, it will require an adj EBITDA margin of 10% just to break even, on a statutory PBT basis. Higher than even management’s ambition in the medium-term of 9%!

#2 Is there revenue growth potential instead?

The other way to get to break-even is of course, healthy revenue growth. I haven’t done the scenarios here, but it might be plausible, if one analyses in detail the three divisions (Beauty, Nutrition, Ingenuity) as there is potential for outsized growth.

In Beauty, the growth potential looks muted, given management haven’t really stated any big strategic initiatives here. Lookfantastic, Cult Beauty, and the other websites are all very mature. Luxury cosmetics is also not a fast growing macro sector.

In Nutrition, there is possibly huge potential. MyProtein is undergoing a massive rebrand, which if successful, could be a growth driver. They are also onboarding “offline” distribution channels, such as supermarkets in the UK and Costco in the USA. There is also growth potential coming from international markets.

In Ingenuity, there has been a major re-organisation in 2022-2023 and a new go-to-market strategy, which they say is starting to pay off from FY24 onwards. It remains to be seen whether there is a good reception to their new GTM proposition. But clearly, this can be a growth driver if it is well received and they sign up many new clients.

#3 can the current share price be justified?

Depends on how you look at it; on an EBITDA basis, £200m EBITDA looks like an easily possible pathway in the next 2-3 years. On an EV of £1.1bn (£850m market cap, c£220m net debt) it is a cheap-ish 5-6x for an eCommerce company?

But EBITDA ignores the huge amount of D&A (c£180/yr). THG’s eCommerce operations are hugely capex intensive, which is probably what makes them market leading and therefore able to generate the revenues they do. Without that continued capex (and D&A) they might lose competitive position. They are still looking to make £100m-£110m of capex in FY24, and no suggestion this will decrease further in FY25 onwards.

» My Verdict

The current share price (61p), for me, only makes sense to buy if they can get to c£3bn revenues and c£250m-£300m EBITDA within the next 2-3 years. That would probably generate a Profit Before Tax of £40-90m. If that happens, I can see the shares re-rating another 30-40% to value THG at a c£1.4bn EV, a good enough reward for waiting.

However, I see the above revenue & EBITDA numbers unlikely for either FY26 or FY27.

It seems that the shorters agree with me too, as there are 3 names declared above 0.5%, and a total short position of 2%. It isn’t a massive short position, but it is notable given that THG has received big approaches in the past, at much more than double the current share price. Takeover offers with substantial premiums are the worst enemy for shorters.

Interestingly, the CFO, Damien Saunders, has dipped into his pockets in May24 to buy £200k of shares at 63p. This is his largest buy so far since joining in Nov20. His previous buys were in 2021, for £50k and £30k only (at much higher prices). So clearly, he thinks the current price is very good value.

I’m keeping THG on the watchlist, as I think they do have some good brands, IP, and a competitive moat. Their eCommerce capabilities are one of the best, and they own several valuable eCommerce brands. The key to unlocking all of this is profitability and sustained revenue growth. If they start to demonstrate either in the next few sets of results, I would definitely be interested.