The New Criterion: two alternative exposures to the commodities recovery

Tim Boreham

There are more ways to gain exposure to commodities than buying the miners themselves. Here are two alternatives

Zenith Group (ZEN) 77c

Investors convinced of a sustained resources recovery (and that appears to be the case) face an internal dilemma. Should they ride the cycle with an exposure to the actual producers, or invest in the handmaidens that help the miners get the stuff out of the ground?

After all, the real smarties during the 1880s gold rushes were the ones who invested in pots and pans and built a sustainable business.

In the case of remote mines – in other words, most Australian ones – power is a key input cost and there’s an unhealthy reliance on inefficient diesel generators.

Zenith, which listed in May last year, supplies or operates gas, solar or diesel hybrid plants for a clutch of mining’s famous names.

This month Zenith won a contract from Newmont Australia to build own and operate (BOO) a 62 megawatt power station at the gold miner’s Tanami project in the NT. That deal took Zenith’s BOO capacity from 125 megawatts to 185 megawatts and its total installed capacity to 380MW across more than 30 projects.

Other contracts are with Newcrest Mining’s OK Tedi mine, Independence Gold’s Nova nickel project and Incitec Pivot’s Phosphate Hill.

But Zenith’s biggest customer is with Northern Star Resources, covering the gold producer’s Plutonic, Jundee and Kundana mines.

Zenith also uses a manage operate and maintain (MOM) model. But BOO accounts for 65 per cent of revenue and is the preferred arrangement because Zenith is protected by ‘take or pay’ arrangements, not to mention a wider involvement in the process.

A key advantage of remote generation is that once the client has installed the plant it’s unlikely to change supplier.

“The business has never lost a client and we don’t intend losing them now,” chairman Doug Walker says.

Zenith was founded in 2006 by Walker and director Gavin Great, Zenith initially with a contract to power Chevron’s Barrow Island base.

Walker has form in the remote power game, having founded StateWest Power before selling it to Wesfarmers in 2001. Wesfarmers then renamed the business Engen and sold it to Energy Developments, which in turn was acquired by the utility DUET.

In a key test of strength, Zenith endured the fallout of the global financial crisis on the resources sector and its shares are now well above their listing price of 50c a share.

“The GFC was a test of our resolve and our strength,’’ says managing director Hamish Moffat. “But at least it focused our clients on the real cost of energy.”

On that front, nothing much has changed given the relentless emissions debate and concerns about blackouts and gas shortages. While the recent-ish Finkel report focused on utility scale generation, off-grid users such as miners are not immune from emission target reductions as per the Paris Agreement.

We’re still bound by that accord, which requires us reducing emissions by 26-28 per cent (relative to 2005 levels) by 2030.

Zenith, which reports its half-year results next week, has flagged a full year net profit of $9.5-11m and ebitda of $12-14m, on revenue of $33m.

That’s quite a step up from the 2016-17 full year profit of $3.1m and ebitda of $9.84m, on revenue of $30.9m. But investors hankering for a dividend should look elsewhere.

Zenith accounts for about 12 per cent of the remote generation market, competing with the DUET-owned Energy Developments as well as bigger fellow ASX listee Pacific Energy (PEA).

K2Fly (K2F) 28c

Is that the time?

Partygoers tend to suddenly remember the babysitter or an early morning appointment when the conversation turns to consulting systems integration for infrastructure and asset-heavy industries.

But for K2fly investors sitting on a 300 per cent plus gain over the last two months, these topics are even more riveting than house prices and whether Bernard Tomic is simply a twat or a lost soul deserving of sympathy.

With its dominant client base of miners, K2fly can be seen as an exposure to the recovering resources sector, yet one not dependent on the commodities cycle. A bullish December update- which sent the stock (K2) flying, vindicates the board’s decision to buy the private Infoscope in July last year.

The purchase price --$625,000 and $275,000 of K2fly scrip – represented a stingy ebit multiple of 1.56 times.

Infoscope’s software enables miners to manage land issues such as tenement tracking, cultural heritage and ground disturbance in a seamless manner. Clients include Fortescue Metals, iron-ore mine operator API Management, Metals X, Westgold Resources and The National Trust (via The Keeping Place, funded by Fortescue, BHP Billiton and Fortescue).

But what’s spiked the punch bowl is Infoscope’s recent tie-up with the German based enterprise software provider SAP, which globally has 770 mining clients (including most of the majors).

This raises the prospect of K2Fly receiving monthly licensing fees from SAP off a much wider customer base, as SAP moves its clients to ‘cloud’ computing..

K2Fly exec chairman Brian Miller says that with a market cap of $10m, K2Fly would not normally be big enough to get a seat at the SAP table.

Proving the adage that it’s not what you know but who you know, Miller leveraged his previous history as an SAP executive.

“SAP is especially important in relation to moving customers from on-premises software to the cloud,” he says.

“Because we have leveraged our previous relationship with SAP we have been able to be the first cab off the rank.”

The Infoscope platform is currently being “ported to the SAP cloud and its s4 Hana environment”. This is geek speak for saying that when someone plugs in the right cable, Infoscope and SAP will run seamless together.

When this happens by the end of the current quarter, SAP’s salespeople will be able to sell K2Fly products to its own client base, generating recurring monthly licensing revenue for K2fly.

“SAP has very aggressive targets in terms of how they will move their client base. In the mining sector we should play very well in the space,” says Miller, who believes that most clients would be good for annual fees of at least $500,000.

Otherwise, K2Fly has reseller deals with other IT industry leaders including OBI Partners and Kony of the US, Sweden’s ABB and Capita PLC of the UK.

K2F re-sells Capita’s Fieldreach, a mobile based management tool for blue-collar workers on physical assets. In November K2Fly struck a deal to supply Fieldreach to Arc Infrastructure, which operates WA’s 5500 kilometre freight network.

K2fly also consults to the water, electricity, rail and power sectors.

As always, K2Fly doesn’t exactly have the field to itself. In the tenement management sector it competes with the private C2 Land and Land Assist, or miners who build their own system using Indian programmers.

But there’s no doubting the revenue momentum. In the December half just announced, K2Fly chalked up $937,396 of revenue for a loss of $2.68m, compared with $798,066 of turnover and a $1.3m deficit last time around.

The company has also submitted for seven proposals and tenders, “some of which are for the multi-year provision of software and services.”

On Feb 5 K2Fly announced a contract with a “tier one utility company” that would be material to 2017-18 revenue.

The company then went on trading halt, after which the company clarified that it would be a WA-based electricity company and involve revenue of $250,000-300,000.

Spark up the party!

Tim Boreham edits The New Criterion

tim.boreham@independentresearch.com.au

Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

ENDS


About this contributor

Tim Boreham

Tim Boreham

Editor of New Criterion, Independent Investment Research

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

Expertise

small caps ASX:K2F ASX:ZEN

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