21/2/23 Appendix 4D - Half-Year Report

Another fantastic result from XRF, it says a lot that I almost expect it from them at this point.

It's a well covered stock now on Strawman so I will let others break down the headline numbers, but one thing I have been focused on for some time with XRF is how the business is far more capital light than headline numbers suggest.

A simple calculation for XRF shows roughly 22.5% return on equity (rolling 12 months profit before tax of $10.17m on equity of $44.89m). However within that the incremental return on equity is far stronger at 76% for this current half:

$5.67m 1H23 profit before tax minus $4.5m 2H22 profit before tax is $1.17m incremental PBT on $1.54m incremental equity ($44.89m 1H23 - $43.35m 2H22).

Ultimately it is the incremental return on equity that drives share prices rather than the absolute level.

18/10/22 September 2022 Quarterly Trading Report

Playing catch-up here on some Strawman research. XRF's momentum from the 4Q22 continued into 1Q23, year on year numbers were extremely impressive with 32% profit growth and 45% profit before tax growth (the risk higher lithium prices start to bite margins isn't happening yet which is nice). Given the big 4Q22, I wondered whether they could grow quarter on quarter and they did so marginally ($12.6m revenue and $2.4m PBT vs $12m revenue and $2.3m PBT).

While the numbers speak for themselves, the normally conservative XRF management seem extremely bullish on the short term outlook for the business, bringing new products to market and really ramping up the Orbis lab crushers throughout FY23.

I'm expecting $7.5-8m NPAT for FY23 and through the 1Q they are on track.

23/8/22 Annual Report to Shareholders

A fantastic end to FY22 for XRF. After run-rating ~$9.3m for the first three quarters of the year, the fourth quarter recorded $12m in revenue with commentary calling out continued buoyancy in mining and materials as the main driver.

Looking at a divisional level, Consumables continues to perform exceptionally well recording $4m revenue (~$2.7m run-rate through first three quarters) and maintaining record profit margins despite higher lithium input prices.

Capital Equipment was roughly in line with the previous quarters but based on commentary of a record order backlog there is probably some issues with supply chains restricting sales.

Precious Metals had an outstanding final quarter, recording $5.9m revenue compared to a ~$4.1m run-rate through the start of the year.

The market will rightfully focus on the strong revenue growth but it is worth mentioning margins did fall despite the stronger revenue in the 4Q, largely because of the shift to lower margin revenue away from Consumables. Precious Metals is still scaling up as a division but the potential is starting to shine through, particularly from a revenue point of view.

The other weak area was cash flow, largely due to higher inventories. Unlike many other businesses that are physically holding more inventory than normal that may lead to issues in the future, XRF has seen an explosion in the price of the raw lithium they hold in inventory for use in their Consumables products. The important thing to watch here is management are able to continue to pass on the higher costs through to customers. If so, the working capital mismatch will unwind as higher revenues come through, if not margins will take a hit in coming reports. For what it is worth, management remain confident of passing on higher costs.

21/10/21 2021 AGM CEO Presentation

FY22 update at the AGM was extremely positive, 28% revenue growth and 54% NPBT growth in the first quarter. Once again the most positive thing for me was every operating segment is doing well, with Consumables growing revenue 16%, Precious Metals 28% driven by the German office and Capital Equipment up 25% with one new device due to be launched in the current quarter. Also worth noting the recent Orbis acquisition wasn't included in the 1Q results, only completing on 1 Oct.

24/8/21 Annual Report to shareholders

A fantastic FY21 result from XRF, largely pre-guided at the 3Q trading update in April but the momentum continued in the 4Q for a record FY result.

Headline numbers were 8% revenue growth and 41% adjusted PBT growth. Note adjustments is the removal of Covid-19 subsidies and PBT removes the tax effect of these. Credit to management for highlighting that metric.

XRF is a capital heavy business operating in cyclical industries and those characteristics are often looked down on by investors and ignored by the market. This result is a great reminder though how brilliant these businesses can be when cycles align and the immense operating leverage they can achieve.

XRF achieved an incremental $2.2m revenue growth on last year, of which $1.7m fell straight to the adjusted PBT line. In the 2H in particular, this was an incremental $1.3m revenue on the 1H with $1.1m falling to adjusted PBT. Incremental adjusted PBT margins of 77% and 85% respectively.

Cash flow was strong despite cycling some timing differences that benefited last year, with free cash flow of $2.5m after removing all subsidies, capex and lease payments.

It leaves the balance sheet in pristine condition with minimal debt, $5.3m cash, $12.5m inventory of largely precious metals and $8.1m PPE of largely land and property.

Management have been calling out the potential for M&A for some time but my feeling is now with the balance sheet repaired and the share price giving them flexibility to use fairly priced scrip this potential is now more likely than ever.

There was no guidance provided, but I sat in on a conference call with the CEO and he gave some general comments that FY22 has started with a similar momentum to how FY21 ended and they expect further growth in all segments, driven by the now profitable German office and two new Capital Equipment machines scheduled to be released this year.

15/04/21 March 2021 Quarterly Trading Report

Fantastic update from XRF with 3Q revenue increasing 20% on last year and adjusted profit before tax increasing 71%.

A chunk of this strength is a lag from a weak 1H, with Consumables increasing 32% on the 2Q as some customers deferred purchases amid Covid uncertainty.

The most positive aspect of the result is all three segments of the business appear to be doing well at the same time, something the business has struggled with over the last few years. The German office now appears to be consistently profitable which should see further margin expansion as it no longer drags on earnings. The office also grew revenue nearly 50% on the 2Q, though no doubt had some lag as well similar to Consumables. 

Outlook seemed positive, with current level of activity expected to translate into a "strong" result. For a notoriously conservative CEO this is quite an outlandish statement!

After this update I expect XRF will report NPAT in the high $3m range, $3.7-$4m. 10x forward earnings is not a stretch for valuation. With the cash balance growing I think payout ratio will be raised from 60% and dividend could be around 2c or 6%.

23/2/21 Appendix 4D - Half Year Report

A mixed result from XRF, despite end customers (primarily mining and heavy industry) performing well, they suffered from uncertainty leading to abnormal order patterns and deferring of capex decisions.

Revenue fell 5% to $15m though strong cost controls meant profit before tax rose 4% after backing out Covid subsidies and grants. 

Looking at divisions, Consumables revenue fell 13% on last year and profits fell 9% as PBT margin increased from 28% to 30%. Commentary was positive on demand from mining clients and new customer acquisition has continued. This bodes well for profits if revenue growth can return on the increased margin base.

Precious Metals also saw revenue fall, down 14% on last year but profits increased 18% as margin jumped substantially from 10% to 14% driven by the German office now hitting on-going profitability and no longer dragging down segment margins.

Capital Equipment revenue grew 22% and profits grew 20% with a high level of machine sales and impressively the order book also staying at record levels. Production on two new machines is on-going.

The balance sheet remains pristine with $3.4m cash at the writing date and no corporate debt. The thesis of capex/R&D remaining low after a period of heavy investment continues with a combined $398k compared to $461k last year.

On a post-results call with management they were upbeat on the future and highlighted the potential for M&A in the Precious Metals segment in particular.

25/8/20 Annual Report to Shareholders

XRF released their FY20 results today which were pretty much in line with my expectations. Revenue was slightly weaker as Capital Equipment struggled as customers wound back capex as an initial response to Covid, but commentary from management suggests those sales have returned and the current order book is "above average levels".

Great cost controls meant earnings came in at 2.3c, right in my range of 2.2-2.4c. Consumables did the heavy lifting, driven by strong activity in the Australian mining sector. 

Some scattered thoughts digging into the annual report:

The investment thesis of incremental earnings growth on minimal capital re-investment is clearly playing out. Adjusting for the Covid benefits/one-offs, XRF added an incremental $1.05m PBT on incremental capital of $400k.

Balance sheet is pristine as $1.4m debt was paid down. Management has kept $3.6m cash in the business, remaining cash was paid out in 40% higher dividend, though commentary suggests this could outpace earnings growth over the coming years as the management said the 60% payout ratio was "conservative" given the current economic environment. 

Cashflow was brilliant once again, $3.4m FCF after adjusting for Government benefits. Capex was essentially flat, $539k up from $521k last year. I think the business can support growth without major capex for a few more years, meaning the ~8% FCF yield is sustainable in the near term.

The weakness in Capital Equipment was entirely in Australia. Both Canada (57%) and Europe (68%) grew Capital Equipment sales strongly which bodes well for future expansion into those regions and subsequent Consumables sales. Australia makes up 69% of sales so will drive headline numbers over the near term but longer term there is positive signs for international expansion.

17/4/20 March 2020 Quarterly Trading Report

XRF released their 3Q report which was in line with the 1H with low single digits revenue growth and ~40% NPBT growth as margins continue to expand rapidly back to pre-investment levels. The company confirmed that the majority of their business has been operating as normal, with the majority of revenue from mining customers remaining unchanged. There has been some small impact from the international sales offices in Germany and Canada largely because employees have been forced to work from home causing delays closing sales over email and phone.

The one area that will take a hit is new Capital Equipment sales which isn't unexpected as discretionary capex will be wound back across the customer base. Short term this isn't a large concern as it is such a small contributor to profit, but can impact longer term as new sales are a lead indicator to ongoing Consumables and Precious Metals sales.

Management highlighted the strength of the balance sheet with $3.7m cash (an extra $1m since mid-Feb at the half year report) and minimal debt which is asset backed by the Melbourne factory and equipment. Speaking on a conference call after the results, the CEO highlighted the strength of the balance sheet could support M&A activity as conditions normalise.

While management was understandably reluctant to provide 4Q guidance, I wouldn't expect major hits to profits particularly as industry starts to return in key geographies (even if restrictions remain around hospitality and leisure). Given 4Q is seasonally strongest for XRF I suspect they could add another $1-1.2m in NPBT in the 4Q and do ~$3m NPAT for the full year or 10x earnings. Given the defensiveness of those earnings in the current environment that could be cheap, but market may now be looking ahead past the margin revision thesis to where the longer term growth comes from.

I think it is very hard for anyone to accurately predict on a macro level how long the current downturn lasts for and the long term effects of it. What we can and should do though is look at individual businesses and assess the impacts to them from the coronavirus, positive or negative.

For XRF I recently spoke with the CEO Vance Stazzonelli who said they have yet to see any impact from the coronavirus with business remaining as usual. XRF's main clients are in mining and construction which have been deemed essential industries even in countries with full shutdowns. The company's offices in Canada and Germany are sales offices with employees able to work from home and sales closed over phone and email. This is assisted by the fact majority of sales are from existing clients.

Vance sees the big short term risk to the business being a forced closure of their Melbourne factory. If the Victorian Government did implement Stage 4 restrictions Vance hoped they could claim an exemption given their products are critical to the mining industry which would be deemed essential. 

The other point Vance stressed was how conservative the company's balance sheet was, net cash and the small debt on the balance sheet backed by the company's Melbourne land and factory. On top of this, the $9m of inventory is roughly six months worth of operations in case supply chains are disrupted with a big chunk of that being pure platinum. With no changes to business operations Vance said the company would release their planned third quarter update in mid-April and saw no need for a specific corona virus update.

27/8/19

Annual Report to Shareholders

XRF released their annual report which overall was a fantastic result. Record revenue of $29m led to EBITDA of $4.1m and NPAT of $2.1m.

Looking at the segments more in-depth, Precious Metals was the standout with 19% revenue growth and the first signs of scalability after years of investment with a 7% PBT margin. The outlook remains extremely strong and I expect the segment will beat my initial FY20 expectations for $15m revenue and $1.5m PBT as the German office turns profitable.

Consumables was slightly weaker than I expected with the 1H/2H seasonality skew being stronger than previous years. Revenue fell from $4.4m 1H19 to $3.6m 2H19, however promisingly the PBT margin stayed at 27% as lithium prices continued to fall over the year. Outlook was positive and although I have downgraded my FY20 revenue expectations from $10m to $9m, there is more comfort with the 30% PBT margin.

Capital Equipment also had a great year with revenue growth 29% and 7% PBT margin, with management commenting they are seeing a replacement cycle after years of lower capex with some new customers as well. While I am not sure exactly how long the replacement cycle will last, I suspect there is another year or two of solid growth.

Finally, the true highlight of this report was the sharp increase in free cash flow as management confirmed that the major capex investments of the past two or three years is complete with the "team, equipment and facility all in place". Capex + R&D fell from $1.9m in FY18 to $630k in FY19 and free cash flow increased to $3.3m from -$1.1m in FY18. As a consequence, the dividend payout ratio increased from 39% to 63% for a final dividend of 1c (note XRF does not pay an interim dividend).

On my forecasts, if the payout ratio is maintained the FY20 dividend could increase healthily again to 1.7c which would help support my 40c valuation. 

21/2/20 Appendix 4D Half Year Report

A very good 1H report from XRF, headline numbers of 5% revenue growth to $15.7m and 53% NPAT growth to $1.6m. Some nuanced thoughts from digging deeper in to the result:

Consumables continues to grow at double digits, with growth in all geographies but 32% growth in Canada and 23% growth in Europe the highlights. Australia is still 83% of Consumables revenue and will drive short term results but commentary remains positive.

Precious Metals is now beginning to shine through as the growth engine over the next couple of years, with 17% revenue growth and margins growing from 7% to 10%. The incremental PBT margin was 25% which is promising as recent capacity expansion likely allows several million dollars worth of incremental revenue to be generated before further capex is required. 

Further to that point, commentary that "technical breakthroughs" at the Melbourne factory has expanded the potential product lines is interesting and further sets up Precious metals to be the growth engine moving forward.

Capital Equipment revenue was the only negative of the report, driven by a 30% fall in sales to Australian customers. Unfortunately this is just a feature of the business model where Capital Equipment sales will be lumpy over time. Despite that weakness, the positives were 170% growth in Canada and 46% growth in Europe suggesting further improvements in Consumables sales in the future from the international geographies.

Also, despite the fall in revenue, a shift in product mix and more direct sales to customers (rather than through distributors) meant that the Capital Equipment segment was able to grow margins from 7% to 9%. Commentary that two new products are due to be released in the 2H is interesting, as it potentially drives an upgrade cycle and one of the products is in a new industry (likely non-mining/materials reducing cyclicality).

At first glance cashflow looked weak but commentary from management clarified it was largely timing issues with a large receivables balance received after the reporting date. The company has never had issues with bad debts in the past but it is good to get that explanation.

Management discussed a couple of ways they are looking to further drive shareholder value such as M&A and capital returns to utilise their large franking credit balance ($5.8m).

Finally the most impressive part of the result was the overall scalability of the business with total costs and invested capital both almost exactly flat on the prior year. This is key to my investment thesis as the company exits a period of heavy investment and depressed profits. This result was the perfect example of the incremental scale in the business now with 91% of the revenue growth falling through to the PBT line.

Based on commentary from management on production capacity, potential for capital returns and increased payout ratio suggests they are comfortable that another heavy period of investment is several years away with only maintenance capex in the short term ($367k this half on $9.3m PPE). If this is the case, we should see strong incremental returns over the next couple of years and the share price should re-rate accordingly.

FY20 Forecast

As discussed in my Bull Case straw, XRF operates with three segments; Capital Equipment, Precious Metals and Consumables. It is important to understand these three segments and what drives their profitability, as XRF books very little costs to corporate overheads (~$500k a year).

Capital Equipment: Capital Equipment involves the manufacture and sale of x-ray fusion machines and some other general weighing/measuring laboratory equipment. Historically, this division has grown revenues consistently with some lumpiness of large orders in the peak of in the mining boom in FY12/FY13. Margins have varied but historically were anywhere between 5-10%. This changed in FY16 however when the company embarked on some large R&D projects which resulted in the release of half a dozen new/updated machines. Speaking with management, this R&D to update the product suite is now largely behind them, with on-going R&D to offer more incremental improvements.

Capital Equipment generated $7.1m revenue in FY18 and $4.9m in 1H19. Reading between the lines of the March quarterly update I suspect Capital Equipment sales were a bit weaker in the 3Q19 but should still report strong growth over FY19. Assuming $9m revenue in FY19, I think Capital Equipment can maintain double digit revenue growth on the back of new products and do $10m revenue in FY20 at a 10% PBT margin (up from 7.3% in 1H19).

Precious Metals: Precious Metals now consists of two key activities. The first is the historical business of selling new platinum laboratory products that are used with Capital Equipment machines, along with a relatively steady revenue stream of re-manufacturing old platinum products as customers send them back to be melted down and re-manufactured as they wear down over time.

This core business was historically very steady, generating anywhere from $8-10m revenue with 15-17% margins and generating $1.4-$1.5m PBT like clockwork. However again in FY16, XRF embarked on a large expansion activity into “precision” platinum products. Unlike general labware, these products are customised for clients and used in areas such as aerospace, medical devices and high-tech manufacturing.

This expansion has come at a cost, with my estimate being $5m expensed over the last few years across new offices, R&D and operating losses. While management are expecting “material” contributions from this new division over the next 1-2 years it is difficult to forecast exactly how much it will contribute in FY20. My assumption is that with the new German office reaching breakeven at the very least we can model a return to the consistent $1.4-1.5m PBT from the core business. My forecast is for $15m revenue in FY20 with 10% PBT margins. Speaking with management they wouldn’t confirm exactly what margins they expect from precision platinum products at scale but confirmed they wouldn’t be dilutive to the core business (15-17%). This represents the greatest upside post FY20.

Consumables: Consumables are the sale of “flux”, a product used in the Capital Equipment machines. Consumables have historically been the key earnings driver for XRF, with margins of 30%+, with highs of 39% in the peak of the mining boom. Like Capital Equipment and Precious Metals, margins took a hit starting in FY17 from two key factors. The first was the acquisition of Canadian flux producer Scancia, which resulted in additional costs from shifting their manufacturing from Canada to Perth. Secondly, and more importantly, a key input material for flux is lithium, which saw a boom in prices beginning in FY17 and peaking in FY18: https://tradingeconomics.com/commodity/lithium

This brought margins down to 25% in FY17 and 21% in FY18, despite strong revenue growth. However, these two factors are now moderating as we look forward. Consumables did $7.5m revenue in FY18 and $6.3m through 3Q19. Assuming $9m for FY19, I think double digit revenue growth can continue on the back of market share gains from the Scancia products, so I have forecast $10m revenue for FY20, with 30% PBT margins, up from 27% in 1H19. This is due to continuing fall in lithium prices and further scale benefits.

FY20: Putting the segments together we get $10m revenue, $1m PBT from Capital Equipment, $15m revenue, $1.5m PBT from Precious Metals and $10m revenue, $3m PBT from Consumables. This is $35m revenue, $5.5m PBT for the group.

Subtracting the $500k in corporate overheads leaves us with $5m PBT and a tax rate of 27.5% would leave $3.6m PAT. With 134m shares currently on issue this results in 2.7c EPS. While I think XRF should trade at 10x earnings at a minimum, there is substantial upside here particularly as the company shifts away from a reliance on cyclical mining earnings to new industries, geographies and in particular a focus on high margin precision platinum manufacturing.

If XRF can achieve a multiple of 15x earnings it would result in a price target of 40c for FY20.

28/10/19 2019 AGM CEO Presentation

XRF gave a 1Q20 update at their AGM presentation. Revenue only increased 2% to $7.39m however PBT increased 41% to $913k. Note that XRF expensed a one off cost of $103k in the 1H19 last year transitioning their banking to HSBC, and if this fell in the 1Q it has obviously inflated the PBT number. Assuming it did fall in the 1Q19, PBT only increased 22%.

The big highlight from the update was Consumables growing 17% to $2.49m. Unfortunately segment level PBT was not broken out, but given double digit growth and a stable AUD and lithium price since FY19, it is safe to assume there has been further margin expansion.

Capital Equipment was the victim of cycling a strong PCP with the 58% growth in 1Q18 saw revenue fall 25% to $1.70m. The segment can be very lumpy but management did note they exited the quarter with strong orders and have a new machine on track for release in FY20.

Precious Metals was also solid, especially the German office which increased revenue 61% to $789k. There was no comment on profitability, however given further revenue growth it would be close to breakeven at these levels. Total Precious Metals revenue grew 12% to $3.21m, and adjusting for the German office means core labware revenue only grew by 3%, but again commentary was positive on current order levels.

PBT of $913k leaves XRF on track to hit my estimate of $5m for FY20, but it does rely on the German office reaching breakeven (or a small profit) which looks achievable given the rapid rate of revenue growth.

18/4/2019 March 2019 Quarterly Trading Report

XRF provided an update after the 3Q19. Revenue growth was 6% to $6.7m on the prior year, while profit more than doubled to $710k. Despite the March quarter seasonally being the slowest, all three divisions positively contributed to profit.

The highlight from the update was the $1m in cash generated over the period, taking the cash balance to $2.2m. The Germany office contributed a small loss after a profitable January, suggesting that growth may not be as linear as I first expected. This is perhaps explained by a comment of additional "marketing costs from international trade shows" being incurred during the quarter.

However commentary was positive stating that several new customers had been won and will come online in the June quarter. Capital equipment orders remain high, with commentary about a new product set to be launched in 2H20. Finally, high margin Consumables sales remaining strong, up 19%.

XRF is a manufacturer of equipment used to measure the composition and purity of metals, materials and chemicals. Majority of revenue is mining related (58%), but this has been falling as non-mining revenue grows (generally construction materials).

The business operates with an attractive razor/razorblades model, as their low margin Capital Equipment sales feed into high margin recurring Consumables sales. For 1H19, Capital Equipment grew revenue 28%, driven by demand for new products and exited the period with a record level of orders. Consumables grew 29%, though the prior period was impacted by the integration of a Canadian acquisition. Interestingly, management are also expecting to grow their market share beyond just their own equipment.

The third operating segment is Precious Metals which is the sale and re-manufacture of platinum laboratory equipment. This segment has been significantly under-earning for the past couple of years as XRF has invested over $2.5m since FY17 expanding with a new German office and upgrading the existing Melbourne factory. This investment is largely complete as the German office is now profitable (January 2019 first profitable month of $5k) which provides an interesting inflection point for the business. Management expect "material" profit from the segment over the next 1-2 years.

With the period of heavy investment behind them, 1H19 saw strong growth in EBITDA margins from 10% to 14%, thought still well below the historical highs of 25% back in FY11. Management expect to see further margin growth in 2H19, with a goal of getting margins back to those historical highs over the next 3-5 years.