The Gold Report: Your 2014 prognosis for
industrial metals is largely positive, correct?
Adam Low: Yes, although our view is not
universal. We are most positive on copper and zinc, somewhat less
enthusiastic about nickel. We're fairly neutral on iron ore, although we do
expect a bit of softening in iron ore prices.
TGR: Why do you like zinc?
AL: We are starting to see
fundamental changes occurring in the market. This is a supply story. Zinc has
been an unloved metal for decades. As a result, there has been very little
investment, which means that six major mines in operation for decades have or
will soon end production.
The first two, in Canada,
closed in 2013. The next major shut down, scheduled for mid-2015, is MMG
Inc.'s (1208:HK) Century mine in Australia, the
world's second-largest zinc mine.
"TGR: How much global supply will be lost as a
result?
AL: About 10%.
TGR: So prices will rise?
AL: Yes. Visible inventories on the
London Metals Exchange, as well as on the Shanghai Futures Exchange, are down
about 30% over the last year. And zinc demand is increasing steadily. There
are some suggestions that we have a small zinc deficit already.
TGR: What are the supply and demand
fundamentals in copper?
AL: I'd characterize the copper
market as being infected with "short-termism." Mine supply grew
quite spectacularly in 2013: between 6% and 7%. How sustainable is that
growth? In a couple of years, we could easily have the same problem we had a
decade ago, when mine supply lagged behind demand.
TGR: Why would this happen?
AL: One-third of global copper supply
comes from Chile. This country is increasingly constrained by power and water
supplies; labor rates are rising as well. Chile's state-owned copper
enterprise, the Corporaci�n Nacional del Cobre de Chile (CODELCO), produces about one-tenth of
global copper, and it requires something on the order of $20�27 billion ($20�27B) in reinvestment over the next five or six years in order to
maintain both current production and grow its production base. That will be
quite difficult.
TGR: Why are you less enthusiastic
about nickel?
"AL: In the long term, we remain skeptical about
that market. Indonesia, one of the world's largest nickel miners, has
implemented a ban on exports of raw ore, which curtailed a major source of
global supply. Nevertheless, nickel has abundant visible inventories. It also
has growing supply from long-beleaguered laterite projects now finally coming
to fruition: Ambatovy, Koniambo
and On�a Puma.
TGR: Why are iron ore prices softening?
AL: We expect supply growth from mines
to outweigh demand growth, particularly as major mines start up in Australia
and Brazil. At current prices, the industry is making phenomenal margins,
more than 100%. At lower prices, companies at the high end of the cost curve
will struggle, but the others should continue to do very well.
TGR: To what extent are higher base
metal prices dependent on positive global economic news?
AL: Growth is a key factor. The U.S.
economy appears to have improved, although I'm a little bit skeptical about
just how robust or sustainable this growth is, especially now that the
Federal Reserve has decided to reduce its bond buying.
TGR: How do you view the short-term
economic prospects of China and Europe?
AL: In Europe, the latest purchasing
manufacturers' index is at its best since 2011. We are beginning to see some
resurgence from some of the weakest economies, such as Greece. And Germany
still looks good. Even so, I don't think we can count on Europe being the key
driver for world economic growth quite yet.
TGR: And China?
AL: China is still growing and from a
larger base. So while its relative growth may be less impressive than it was,
its absolute growth is still quite extraordinary. Any industrialized Western
nation would be incredibly envious of "only" 6�7% GDP growth per year.
TGR: There is a growing concern that
the equities markets are overheated, particularly with the Fed tapering
quantitative easing. If there is a significant correction, will base metals
equities follow suit, or could we see instead a flight to safety in metals?
AL: If there is a significant
correction, we could see base metals equities follow suit, even though they
didn't enjoy the upside the rest of the market did. In the longer term, the
widening gap between the growing demand and the dwindling supply of many base
metals should spark a resurgence of investor interest in this sector.
TGR: Will base metals equities
continue to lag prices in 2014?
AL: This trend should begin to
correct. Base metals prices have been quite steady over the last year despite
headlines that have generated fear and volatility. This steady price
environment should provide investors with greater comfort about metals
prices, which should, in turn, lead to greater confidence in investing in the
equities.
TGR: What are Raymond James' top base
metals picks for 2014?
AL: In copper, our preferred stocks
are Capstone Mining Corp. (CS:TSX), First
Quantum Minerals Ltd. (FM:TSX; FQM:LSE), Nevsun Resources Ltd. (NSU:TSX;
NSU:NYSE.MKT) and
Rio Alto Mining Ltd. (RIO:TSX.V;
RIO:BVL).
In zinc, Trevali Mining Corp. (TV:TSX; TREVF:OTCQX; TV:BVL), Nevsun and Lundin Mining Corp. (LUN:TSX).
In iron ore, Labrador Iron Ore Royalty
Corporation (LIF.UN:TSX) and Alderon Iron Ore Corp. (ADV:TSX;
AXX:NYSE.MKT).
TGR: First Quantum has announced
production estimates for its Cobre Panama copper
project significantly higher than those of previous owner Inmet
Mining Corp. (IMN:TSX). Will this allay fears over its cost?
AL: The new Cobre
Panama capital expenditure (capex) is $6.4B, only
about 4% higher than Inmet's former guidance. It
has projected a design rate of 70 million tons (70 Mt)/year ore being
processed versus Inmet's 55 Mt/year. It is also
projecting a higher throughput rate. So the capex
is slightly higher, but the cash flows to be generated from the mine have
been increased significantly.
Given the size of this
project and the inflationary nature of this industry, the market has taken
the view that Cobre Panama is actually very well
managed.
TGR: When will Cobre
Panama begin production?
AL: My colleague Alex Terentiew covers First Quantum, and he's forecasting 2017�2018.
TGR: To what extent is the company's
future leveraged to Cobre Panama?
AL: First Quantum is now a fairly
well-diversified company. It has done numerous acquisitions recently, and it
has a base of operations that includes Australia, Africa, Europe and South
America. Cobre Panama is certainly its largest
growth project but not its only growth project; it has many other mines
generating cash flow.
TGR: What distinguishes Cobre Panama from Barrick Gold
Corp.'s (ABX:TSX; ABX:NYSE) Pascua Lama white
elephant?
AL: First Quantum has a phenomenal
record of executing major projects, including those that other companies have
stumbled on. For instance, the Ravensthorpe nickel
mine in Australia, which BHP Billiton Ltd. (BHP:NYSE;
BHPLF:OTCPK), the world's largest mining company, struggled with for many
years. First Quantum bought it and got it operating at the rates it promised.
Unlike Barrick, First Quantum does much of its engineering and
construction in-house. It uses teams it has used multiple times for projects
around the world. It takes lessons from previous successes and replicates
them elsewhere. It leverages a vast amount of experience and thus contains
its costs.
TGR: What's your rating for First
Quantum?
AL: We have an Outperform rating and
a $25 target price.
TGR: Nevsun
has transitioned its Bisha mine in Eritrea from
gold to copper. Has that been successful?
"Cash flow is key to
positive investor sentiment."
AL: Very much so. Bisha
is a polymetallic volcanogenic massive sulfide
deposit that had a gold oxide-rich cap. Nevsun was
fortunate to produce that gold when prices were at their peak. It had a very
successful commissioning period with the new copper plant in late 2013, with
production coming in near the high end of its guidance and exceeding our
estimates. It has already declared commercial production of copper.
TGR: And Nevsun
pays a dividend of $0.07/share.
AL: Actually, it's
$0.07 twice annually, so you're actually getting $0.14/year.
TGR: Why do you say that Nevsun trades at a significant discount?
AL: It trades at a significant
discount relative to its peer group. Its valuation is cheaper based on key
valuation metrics: price/cash flow, price/net asset value (NAV); enterprise
value/earnings before interest, taxes, depreciation and amortization or
price/earnings.
TGR: What explains this discount?
AL: Two key factors. First, country
risk. Bisha is located in Eritrea, which suffers
from a perception problem. I've been to Eritrea twice, and I've been
impressed, both with Nevsun's operation and its
level of cooperation with the government, a 40% partner in Bisha.
"We like companies with strong and stable
balance sheets."
Second, a mergers and
acquisitions (M&A) overhang. This is probably a larger factor right now
than geopolitical risk. Nevsun has about $300
million ($300M) in cash, no debt and it's a one-asset company. This makes it
a likely M&A suitor, and the company has been vocal about its intentions.
M&A always involve risk, and we often see an acquirer's share price trade
down on an announcement, so investors are taking a cautious approach.
TGR: How does Nevsun
overcome these obstacles?
AL: On Eritrea, we believe that the
impressive cash flow accruing to the company over the next couple of years
will force the market to re-evaluate its risk assessment.
With regard to M&A, Nevsun has been very prudent. It refrained from
acquisitions when valuations were much higher than now. It doesn't want to
grow for growth's sake. Its key criterion in evaluating potential
acquisitions is return on investment. So a smart buy now could actually
improve its valuation, as it would no longer be an all-eggs-in-one-basket
company in a country that people don't understand. If we look at recent
examples, some base metals companies have had their share prices perform
quite well after acquisitions, most notably Capstone and Lundin.
TGR: What's your rating for Nevsun?
AL: We have an Outperform rating and
a $5.50 target price.
TGR: Rio Alto's La Arena mine in Peru
is now a gold producer. When will it begin to mine copper, and what effect
will that have on its future?
AL: Rio Alto has a relatively large
copper-gold porphyry deposit at La Arena. Currently, it is a fairly
significant gold producer, about 200,000 ounces per year. It has a gold oxide
processing plant on site. That said, the future of
La Arena really is more in copper. The transition will likely happen in 2016
or 2017. But if it were to find additional gold within its concessions, we
could see the life of the gold mine extended.
We have a favorable view
of La Arena's copper project. We expect it to have a very low capital
intensity, $11,000�14,000
per ton annual copper equivalent, about half the industry average. It can benefit
from existing power and transportation infrastructure. As well, it can use
the existing open-pit oxide deposit for the tailings during the startup of
the copper. At current gold prices, it should be possible to fund the copper
expansion using cash flow from the existing gold mine.
TGR: Will Rio Alto be aggressive in
beginning new projects in Peru?
AL: La Arena is in a very prospective
region of Peru. It is surrounded by many major gold mines, and its concession
is relatively underexplored. Rio Alto most likely will look for potential
gold oxide satellite deposits that could provide supplemental feed to its
existing plant.
Longer term, future
acquisitions wouldn't surprise me, given its cash flow. But Rio Alto could be
a potential acquisition target itself, given that we view it as an
undervalued company with a good organic growth project.
TGR: What's your rating for Rio Alto?
AL: Companies that transition to base
metals from precious metals typically encounter trading volatility because
these different sectors have different investor groups. However, companies
with good projects should weather this volatility well. Nevsun managed a very
similar transition quite well. We have an Outperform rating and a $3.50
target price.
TGR: Not long ago, Peru was seen as a
country not friendly to mining. Has that changed?
AL: It's hard to classify Peru as
being friendly or unfriendly. Projects should be assessed on a case-by-case
basis. Some areas have been opposed to mining, and we have seen violent
protests. However, several mining companies have succeeded in Peru, despite
its pitfalls of left-wing political parties and social community activism.
Rio Alto has flourished
with a concentrated, hands-on, local approach, using a predominantly Peruvian
management team. Even some members of its non-Peruvian management team have
moved to the country.
TGR: Trevali is also in Peru, where
its Santander zinc-lead-silver mine is about to begin commercial production.
AL: Trevali is the only pure-play
producer listed on the Toronto Stock Exchange and one of a few in the world.
By pure-play, I mean it will be generating the majority of its revenue from
zinc. This is an enviable position. Because of the coming zinc scarcity I
mentioned above, investors will be funneled into zinc equities to gain
leverage to the zinc market. I've followed Trevali for about four years, and
it is in a stronger position now than I've ever seen it. The Santander
commissioning process has gone well, and its balance sheet is robust.
TGR: How do you rate its non-Peru
operations?
AL: Trevali has quite a bit of
organic growth potential through its other operations, particularly the
Halfmile and Stratmat brownfield sites in New Brunswick, which it intends to
restart in the next year or so. The bulk of our NAV for Trevali comes from
New Brunswick. That's where we're going to see a lot of the value in this
story start to accrue.
TGR: What's your rating for Trevali?
AL: We have an Outperform rating and
a $1.40 target price.
TGR: Capstone announced that it had met
its overall 2013 copper production targets from its Pinto Valley, Cozamin and
Minto mines in Arizona, Mexico and Yukon. Even so, shares fell 14% in
January. Why?
AL: First, Capstone has been one of
the best-performing stocks in the sector, so it faced some profit taking.
Second, there has been some waning of momentum. Yes, it came in very close to
its 2013 production guidance, but its 2014 production guidance was weaker,
particularly for Minto, than we expected. Third, some lackluster economic
data from China has caused a selloff in many base metals equities in the
early part of this year.
TGR: What's your rating for Capstone?
AL: We have a Strong Buy rating and a
$4.25 target price.
TGR: What's your outlook for Lundin?
AL: Lundin has a solid management
team and a very steady portfolio of mining assets. It also has pretty good
cash flow growth coming in soon from its stake in the Tenke Fungurume
copper-cobalt mine in the Democratic Republic of the Congo, as well as from
the startup of its Eagle copper-nickel mine in Michigan, recently acquired
from Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK).
Like Nevsun and Trevali,
Lundin should benefit from the coming zinc scarcity. It could leverage this
by increasing production at its Neves-Corvo zinc-copper mine in Portugal.
TGR: What's your rating for Lundin?
AL: We recently upgraded it from
Market Perform to Outperform. Our target price is $6.25.
TGR: The various iron ore projects in
the Labrador Trough have been bedeviled by transportation costs. How serious
is this problem?
AL: I think it's been overemphasized.
There are already two existing railways in the region that supply existing
ports, and both have upside capacity potential. Unfortunately, these railways
are controlled by two companies that restrict access. The Cartier Railway is
controlled by ArcelorMittal S.A. (MT:NYSE), and
because it doesn't cross any provincial boundaries, ArcelorMittal is under no
obligation to provide third-party access.
The other route, Quebec
North Shore and Labrador Railway, is owned by the privately held Iron Ore
Company of Canada (IOC), Canada's largest producer of iron ore pellets. That
railway does cross provincial boundaries and is bound thereby to provide
third-party access. But that access doesn't come cheap. The challenge is to
build a new railway to break the monopoly. Access to existing infrastructure
is the reason why our preferred iron ore companies are Alderon and Labrador
Iron Ore Royalty Corporation.
TGR: What do you like about Alderon?
AL: Alderon has a very good project,
Kami, which, as noted, is close to an existing rail line. It has a top-notch
management team poached from IOC and strong backing from China's largest
steel company, Hebei Iron & Steel Co. Ltd. (000709:CH).
We think 2014 is going to be a monumental year for Alderon, as it will
complete many milestones: receiving key permits, bringing on additional
offtake and/or joint venture partners and securing financing for mine
construction.
TGR: What's your rating for Alderon?
AL: We have an Outperform rating and
a target price of $2.60.
TGR: Why do you like Labrador Iron Ore
Royalty?
AL: It owns 15.1% of IOC and gets a
7% revenue royalty on IOC's production. So here you have a company that owns
a stake in a mine that not only operates throughout the commodity cycle�IOC has been operating its current mine for
five decades�but it also owns its own
transportation infrastructure.
We see this company as
one of the safer ways to play iron ore, and it's also a dividend growth story
due to an expansion that is underway at IOC. Its royalty payments should
increase because IOC's capital expenditures will decline, as that expansion
is nearly completed.
TGR: What's your rating for Labrador
Iron Ore Royalty Corp.?
AL: We have an Outperform rating and
a $37.25 target price.
TGR: Any other iron ore companies?
AL: Champion Iron Mines Limited (CHM:TSX) is still at the discovery stage. It has very large tonnage specular hematite
and magnetite deposits at its Consolidated Fire Lake North project, which is
close to the Cartier Railway. The grade for these deposits is close to 30%
iron, which is on par with most of the Labrador Trough, but the larger grain
size of the mineralization should make beneficiation easier. Champion's
challenge is that its transition to production is hampered by a lack of
interest from the capital markets in Canadian iron ore projects and ready
access to infrastructure.
Mamba Minerals Ltd. (MAB:ASX) of Australia intends to buy Champion. Mamba's
chairman, Michael O'Keeffe, sold Riversdale Mining and its Mozambique coking
coal project to Rio Tinto for $4B in 2011. Mamba will bring credibility and
know-how to Champion in its transition from developer to producer.
TGR: What's your rating for Champion?
AL: We have a Market Perform rating
and a target price of $0.45.
TGR: What are the characteristics
common to your top picks in base metals?
AL: Almost all are companies with
current production. Cash flow is key to positive
investor sentiment. We like companies with strong and stable balance sheets,
such as you find with Nevsun, Capstone, First Quantum and Lundin.
TGR: Adam, thank you for your time and
your insights.
Adam Low joined Raymond James Ltd. in
April 2005 and is part of the equity research team covering mining and metals
producers and developers. Prior to joining the firm, he was employed as a
financial analyst with IBM. Low has a Bachelor of Commerce degree from the
University of Manitoba and holds the Chartered Financial Analyst designation.
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