To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.
To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.
Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.
So this series aims to identify appealing FTSE 100 investment opportunities and today I’m looking at Fresnillo (LSE: FRES), the silver and gold mining company.
With the shares at 1130p, Fresnillo’s market cap. is £8,334 million.
This table summarises the firm’s recent financial record:
| Year to December | 2008 | 2009 | 2010 | 2011 | 2012 |
|---|---|---|---|---|---|
| Revenue ($m) | 720 | 850 | 1,410 | 2,193 | 2,157 |
| Net cash from operations ($m) | 415 | 391 | 701 | 1,249 | 736 |
| Adjusted earnings per share (cents) | 18.6 | 43 | 74 | 109.8 | 90.9 |
| Dividend per share (cents) | 13.6 | 21.45 | 44.8 | 102.85 | 57.9 |
All of Fresnillo’s mining operations are in Mexico and, last year, the firm derived around 49% of its revenue from gold, 47% from silver and 4% from zinc and lead. That’s a good business to be in when commodity prices are riding high and champagne corks are popping – witness the firm’s debt-free balance sheet stuffed with piles of cash. Indeed, some lucky investors saw a, roughly 20-fold increase in Fresnillo’s share price between 2008 and 2011.
Lately, things have been tighter. The interim statement revealed that the average realised silver price during the period was down 20.3%, and gold down 10.6%. A list of galvanizing statistics follows as a consequence: revenue down 14.7%, earnings per share down 61% and dividend down 68%. Suddenly, cost control moves into sharp focus, leaving observers wondering how devastating a further 20% commodity-price fall might be for the company – at least, I am. Welcome to the wacky world of investing in cyclical sectors.
With the firm’s operational performance almost kicked into insignificance by volatile commodity prices, it’s essential that investors take a view on where those commodity prices might be heading. My view is neutral, which discourages me from buying the shares.
Fresnillo’s total-return potential
Let’s examine five indicators to help judge the quality of the company’s total-return potential:
1. Dividend cover: adjusted earnings covered last year’s dividend around 1.6 times. 3/5
2. Borrowings:at the last count, there was net cash on the balance sheet.  5/5    Â
3. Growth: recently fallen earnings and cash flow against flat-looking revenue. 1/5
4. Price to earnings: a forward 31 looks well ahead in terms of the earnings cycle. Â 1/5
5. Outlook: poor recent trading and an outlook statement that sounds ‘stoic’.  1/5
Overall, I score 11 out of 25, which makes me cautious about the firm’s potential to out-pace the wider market’s total return, going forward.
Foolish Summary
The one bright spot in Fresnillo’s score is its strong balance sheet devoid of debt. That would be scant comfort if the firm swings into loss. I see too much downside risk here, so will not be investing.
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> Kevin does not own shares in Fresnillo.