XRF is a business I have looked at a couple of times in the past, I have some 'circle of competence' in that we used their fusion machines and platinum ware in the Lab when I worked at the Gove Refinery.
XRF manufacture fusion machines for the mining and mineral processing industry, these machines make fusion beads for XRF (X-ray fluorescence ) analysers, these enable the companies to detirmine the chemical composition of samples. They also make the platinum ware which is used in the machines, this hardware depletes over time and is returned to XRF to be reformed and then reused. They also produce fluxes used in making the fusion beads.
I had it drawn to my attention again by a friend on twitter and we ended up having an extended exchange of ideas about the business, here is the bulk of that,
Hey Rick
Cheers for this, always tough as an investor looking from the outside into a technically difficult product/industry.
I’ve attached my notes from the chat with Vance the CEO and my rough P&L financials where I think they can report 2c EPS in FY19 (and grow strongly in FY20).
I guess my apprehension comes from a lack of knowledge around the product/industry. Vance said to me he thinks XRF has an 80% market share for fusion machines in Australia and maybe 20-30% globally (but admitted that is much harder to calculate). Does this sound right to you? If so do you think that it is a legacy dominance where XRF has been the benefactor of inaction from customers, or do they have a genuine edge over competitor products?
I agree with your point that flux/platinum labware are commodity products, and I didn’t think to ask the question about margins on the new customisable platinum products. I might chase that up further with Vance. Do you have any thoughts on the expansion into the non-mining customisable labware?
Obviously you are closer to the product/industry, but here is the brief outline of why it looks interesting to me:
Large investment into new products, acquisitions and expanded factories/offices over the past few years is beginning to normalise. Should see margins head back towards historical levels (confirmed by Vance).
Revenue growth has been accelerating in Capital Equipment, 3% in 1H18, 17% in 2H18 and 28% in 1H19 (all half on half). I may be wrong, but there should be a strong correlation between Capital Equipment sales and subsequent growth in Consumables and a portion of Precious Metals.
Multiple looks really depressed (could be 7-8x normalised FY19 earnings, maybe 5x FY20 if things go as I expect). Given previous reliance on mining (~95% at the peak) multiple may be capped at 10-12x earnings. If they can continue to reduce the mining reliance (58% 1H19) I think the market will pay up a little more, maybe 14-15x.
Also nice work with the LBL buying. I haven’t spoken to Wayne for a couple of months, but I follow him on LinkedIn and they have been postings stuff about new equipment and work. I reckon they are flying, hoping for guidance of $4.5m-$5m EBITDA for FY19 and then some guidance on FY20, particularly on Tech sales.
Hi Luke,
My mate says the 80% market share for Australia sounds about right, he is less sure that it would be as high as that globally. Edge is geographic, Australian mines and refiners bought XRF Scientific because of local support and supply. One fusion machine is much the same as another, I have used several different ones over the years, they are all good when they work well, they are pieces of shit when they play up! (Pouring molten ore and flux into the gas burners and blocking all the orifices is one favourite trick. The Lab trainee gets the job of cleaning them!)
He says Labs usually use platinum ware from same supplier, consumables more likely just from whatever bulk chemicals supplier they use, so could be anyone.
I dont know about the non-mining, customisable labware, I imagine its a tiny market, probably already serviced by someone, tough to break into I would have thought with not much growth potential. But thats just gut feeling. As an example I see they are doing a product for milk producers, well they will already be using someone else's labware at this point, its not stuff that wears out or breaks easily, so why would you buy from XRF?
My questions to your dot points would be,
The expansion, new products, new offices may well move margins upwards somewhat, but were they ever good enough to make it a great business?
I would be careful extrapolating growth in machine sales to platinum ware and consumables, any replacement of old machines wont have that effect. Is it just a short term growth in machine sales, given the life of them and how few new mines or refineries come on line, this could be an unsustainable spike in revenue.
I think the low multiple reflects a basket of stuff, lumpy earnings, not much growth over the years, unpopular sector, small, unnoticed business, I suspect it would have to be able to have more than just one good set of numbers to move the dial much!
Ok, so thats a really negative response to your summary, but I suspect thats what you are looking for.
On the other side of the coin, I have a really quick and dirty set of metrics that i put a company through before I do any sort of deeper research, I end up with a FCF that I then use to feed into a ROIC or (CROIC as some call it). On that basis it sneaks in with an assumed ROIC for the full year in the range of 6%. From there I need to convince myself its going to improve over time from that lowpoint, and that there are reasons to have a level of conviction about earnings growth. I reckon I could work up a case for investment at current prices based on those very rubbery numbers, but so far I actually think there are more productive homes for the capital by adding to positions I already hold.
I have found that is one of the hardest biases to overcome, the thrill of becoming a part owner of a new business as opposed to the boring thing of just adding to an existing part ownership!
Another way I try to think about investments is probabilistically, and XRF looks ok from that perspective, I dont see much downside from here, the market has very low expectations as it is, so its likely that even flat sales and earnings would see the price stay much the same. If they can put a couple of halves of solid growth in revenue and have that flow right through to the cash flow then its certainly not hard to see maybe 50-100% upside over a couple of years.
Thanks again for entertaining my amateur thoughts on XRF and investing in general, I feel I have so much to learn and its a bit awe inspiring sometimes being in discussions with seasoned professionals like yourself - but its great to get a chance to articulate my thoughts to a critical audience!
My very quick and dirty valuation predicts a range around 20c for the full financial year based on a guesstimate of FCF at about 1.5c. I also calculate a ROIC for the full year of about 5.5% (using FCF)
I dont feel they are cheap enough at 16c to justify buying now, but if the full year figures come in around my expectation I may reconsider.
Worked up a full analysis and research on XRF, and still cant see much more upside than 20c - if they execute to expectations, also some downside if they dont meet guidance. Well worth keeping on the watchlist, if they can finish the year strongly may be worth looking at taking a position.