-- Posted Tuesday, 24 December 2013 | | Disqus
Source: Brian Sylvester of The Metals Report
Forget about the gold price. Forget about the copper, zinc and nickel price. Start searching out companies that can weather another few years of recovery, because it's unlikely mining companies will get any price relief soon. Shane Nagle, a metals and mining analyst with National Bank Financial, talks with The Mining Report about what he considers necessary to carry companies through another few years of pricing pressures to smooth sailing on the other side.
The Mining Report: National Bank Financial (NBF) said in an Oct. 7 report that, when combined with its cautious near-term outlook for commodity prices, elevated multiples suggest the base metal sector is overvalued. Are there exceptions to that statement?
Shane Nagle: Since that time, we've seen a retracement in the multiples. The mining index in general remains near the upper end of historical ranges, as investor interest has gravitated toward large and midcap names with stable cash flow and strong balance sheets. Those companies are the exceptions, not only just within the base metal space, but within the mining space in general. Looking past those elevated cash flow and net asset value (NAV) multiples and focusing on companies with balance sheets sufficient to weather a prolonged downturn are the names that stand out as being most attractive.
TMR: Do you think the downturn will last several more years?
SN: Maybe downturn is the wrong phrase, but I think we're still a few years away from another rally. If I can use copper as a specific example, there's been a lot of investment on projects in the copper space throughout the past few years. About 15% or so of the current global demand is coming on-line within the next two years from the addition of several large projects (Oyu Tolgoi, Sentinel, Toromocho etc.), this is seemingly going to keep the concentrate market oversupplied throughout 2014-2015. There will probably be some general weakness in copper and base metal prices as a result of this.
The good news is the supply cycle tends to come in waves. Copper prices now are relatively low compared to what price levels are needed in order to make a lot of new projects economical. Projects are being canceled, delayed or suspended. Meanwhile, political factors such as permitting challenges are also pushing out production several years.
So maybe not a downturn, but certainly weaker fundamentals for a couple of years. On the other hand, things are looking pretty good long term, as a lot of the projects that would be slated to come on-line by 2017-2018 are not going to materialize in the current market environment.
TMR: Are we going to see similar sideways performance for nickel and zinc?
SN: Both nickel and zinc markets are oversupplied as well, but appear to be trending in opposite directions. There's seemingly no end to the nickel supply, the wild card being the proposed export ban on nickel laterite ores from Indonesia.
People have made the case that there's a great deal of zinc supply coming offline with the closure of the Brunswick and Perseverance mines. However, there are several additional projects, albeit smaller, coming on-line, as well as the extension of the Century and Skorpion mines in Australia and Namibia, respectively. Both markets may stay well supplied in the near term, but long-term fundamentals appear to be more supportive for zinc (which I think is the consensus view).
TMR: What's your price deck for copper, nickel and zinc for 2014?
SN: For copper we're using $3 per pound ($3/lb); zinc is $1/lb; and nickel is $7/lb. We'll be taking a closer look at updating our estimates in the weeks to come.
TMR: Could base metal producers soon be ready once again to spend money on mergers and acquisitions (M&A)?
SN: I don't think M&A is going to heat up within the base metal space. There's been so much consolidation during the last decade that there's not much out there to buy. The type of M&A that could still happen would be optimization of projects within larger mega-cap companies where they carve out assets to the mid-tiers.
TMR: You don't see companies taking advantage of the market for base metals projects that are undervalued?
SN: There are very few projects of that scale that would interest those companies. They also remain under considerable pressure from their shareholders to limit spending. Companies are still focusing on strengthening their balance sheets, limiting and reducing capital costs and optimizing their portfolios by shedding non-core assets. I think that's the type of acquisition we'll continue to see, not an increase in traditional M&A.
TMR: What will be the top performers among the base metals equities during the next 12–18 months?
SN: There's very few companies left in the Canadian mid-tier space, but we're focused on the ones that have stronger balance sheets and executable projects, with the ability to grow within their existing portfolios, having enough funding to complete those projects and still have some level of internal growth.
TMR: Gold fell $213 an ounce ($213/oz) in the Q2 and another $91/oz in the Q3. What's your forecast for 2014?
SN: Our bank uses a $1,300/oz forecast for 2014.
TMR: What's your outlook for silver?
SN: Our silver forecast is $21/oz, and again, we'll be taking a closer look at our metal price forecasts in the new year.
TMR: A Q3/13 report by NBF reported that "despite widespread cuts to exploration and more recently corporate general and administrative expense (G&A) even select high-quality names could yet again show an alarming rate of cash depletion, particularly those mid to late cycle on development projects." Is there a work-around solution for investors?
SN: I think the exceptions are those companies that aren't committing capital to a large-scale project or have all financing in place. That's why we continue to point to the royalty names as a defensive pick in the gold space. They may not necessarily be the cheapest, but you're not going to have a surprising cash strain on a quarterly basis.
TMR: Royalty plays are also trending lower. Why would an investor choose a royalty company over dividend-paying equities outside the mining space?
SN: Comparing them to outside the mining space is interesting, other sectors are paying better yields currently, but the mining royalty companies exhibit relatively strong growth and have the potential for some significant dividend increases in the future. I would say if you have to be invested in the mining space, you want to hold royalty companies because of the stability of their liquidity positions. Current market conditions also make an ideal hunting ground for large-scale royalty companies to put some of that cash to work and generate growth. Some fairly significant dividend increases should materialize as these types of companies harvest cash flow from acquisitions.
TMR: Do you have some parting thoughts?
SN: A lot of the people I talk to on a daily basis are saying it's got to turn around and are picking more leveraged ideas, which a select few will certainly pay off. A more conservative approach would be looking for names that may not necessarily be the cheapest right now, but may present the best opportunity for future growth through M&A, or those companies that have the strongest balance sheets going forward. These names tend to be the large-cap base metal and royalty companies, which will offer exposure to a rebound in prices, but also limit losses should current market conditions persist.
TMR: Excellent. Thanks.
SN: Sure. My pleasure.
Shane Nagle is a metals and mining analyst at National Bank Financial, covering base metals, royalties and junior gold companies. Prior to 2008, Nagle worked as a process engineer within the hydrometallurgy group at Hatch and has an engineering chemistry degree from Queen's University. In 2013, he received the StarMine award for top stock picker in Canada (Metals & Mining).
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-- Posted Tuesday, 24 December 2013 | Digg This Article | Source: GoldSeek.com