Profit from Rising Raw Materials Prices Without the Risk
Saul is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
(Note: The original version of this article contained incorrect dividend per share and dividend yield numbers for Foraco. This post has been updated with the correct data.)
Foraco (NASDAQOTH: FRACF.PK) is a small to medium-size company (market cap about $300 million) that you probably have never heard of, but which provides a valuable service for mineral and metal mining companies. They do exploratory drilling for them, in difficult, hard to get at places, to help the mining companies evaluate whether or not they want to invest the large sums of money necessary to develop mines.
They work for a lot of the major mining companies in the world, mostly under long-term contracts that guarantee that their rigs will be fully utilized almost all the time. They list companies such as BHP Billiton (NYSE: BHP), Anglo-American (London: AAL), Barrick (NYSE: ABX), DeBeers, Rio Tinto (NYSE: RIO) and GoldCorp (NYSE: GG) among their customers. Contracts with majors make up 82% of their business.
Most of the low-hanging fruit has been found, and exploration now is often in very remote places. When working with the above companies and others, Foraco specializes in doing exploratory drilling in some of the most inaccessible and technically challenging environments in the world, which allows them to charge above average prices and keep above average margins. 42% of their drilling is for gold, 24% for copper, 11% for iron and 7% for nickel. Another 4% is for water, and they have done water drilling for such internationals as the European Union and the World Bank. The remaining 12% is divided between drilling for diamonds, uranium, coal, potash and oil and gas.
Since developing a mine takes two to five years to bring online, the major mining companies don’t care very much about transient fluctuations in the price of the raw materials that they mine. They have to do the exploration anyway and rely on the long-term price trends, which are up.
A recent reduction in the price of minerals and metals has caused Foraco’s price to fall from over $5 to under $4, in sympathy with the producers. However, while the producers make less money with lower prices, Foraco indicates that they still have more business than they can handle and that they still have to turn away customers. In fact they have been profitable in every quarter since their IPO in 2007, in good times and bad, with record revenue and earnings in 2011, and again in the March quarter.
Their revenue has grown every year since their IPO, with the exception of a slight decline in 2009 at the peak of the recession. Their compound annual growth rate (CAGR) is 31% over this time. They recently acquired 86 more rigs with the acquisition of the Brazilian mining company Servitec, which they expect to be accretive to earnings.
They currently have a side business doing exploratory drilling for water. This is currently only 4% of their revenue, but if drought and water shortages continue, this could grow into another major business.
Current trailing earnings are 39 cents, which gives them a PE ratio of just under 10 at today’s reduced stock price. Estimated earnings for 2012 are 55 cents, which will be a PE of 7, for a company that has had a CAGR of 31% right through the recession. On top of that, the company pays a dividend of about 7 cents per year, or a 1.7% dividend yield at current prices.
Foraco is a French company, headquartered in Marseille, but they chose to list on the Toronto exchange (Toronto: FAR), feeling that Canadian investors were more conversant with the mining industry than French investors (they also trade in the US under FRACF). Only a miniscule part of their business comes from Europe however (6%), so they will only be minimally affected by a European slowdown. Their major sources of revenue are drilling in South America and Africa, and they also have smaller operations in North America and Asia Pacific (which they are hoping to enlarge). They are currently the world’s third largest minerals and metals drilling company, the second fastest growing (the fastest, percentage-wise, is a tiny company), and they have the highest revenue per rig and the highest EBITDA margin.
I think that this company has been poorly understood and grouped with the mineral and metals producers, whose earnings will actually fall with reduced raw materials prices. Foraco is currently greatly underpriced and is an interesting investment for both value and growth-oriented investors.
SaulR80683 has a long position in Foraco. The Motley Fool has no positions in the stocks mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.