Facing facts: Q&A looking at the financial climate of the mining industry
Can you provide an overview of the mining financial climate in 2016?
Who would have thought it? Less than a year after the Federal Reserve started raising interest rates and which is the best performing sector on the UK market? Mining! The Industrial Metals & Mining index, if one wants to be strictly accurate – which has risen 89% so far this year. But that is anyway followed by the pure Mining Index, which is up a still impressive 53%, beating out Tech Hardware (+49%), software (+23%) and oil (+22%) and eons ahead of sectors such as mobile telecoms, banks, food producers and general retailers (all of which have fallen). In fact, with zinc up 40% in US dollar terms, year to date, silver up 37% and iron ore up 31%, most metals have outperformed these other sectors. Even the laggards, such as lead (+5%) and copper (-2%) have outperformed the FTSE 100 (-8%) index in US dollar terms. Not surprisingly therefore, four of the FTSE 100’s index’s top five performers so far this year are miners – Anglo American (+172% in sterling terms), Fresnillo (+128%), Glencore (+102%) and Randgold Resources (+76%) – and, with BHP Billiton (+31%) coming in at number nine, five of the top ten. In fact, the only companies missing in this tier of UK industry are Rio Tinto and Johnson Matthey.
Why has mining been the best performing sector on the UK market?
Much of the performance can be attributed to the macro-environment. Nine months ago, the Federal Reserve had just raised interest rates and was confidently predicting four more rises during 2016. And while the market continues to expect one rate rise this year, the bare facts of the matter are that, to date, precisely none of those interest rate rises have yet come to fruition. Partly, this is to do with economics.
What does the industry look like across the world, in the U.S and China for example?
The US is growing, but it’s hardly the sort of robust growth that the world was conditioned to expect in the years before 2008/09. By contrast, conditions in the rest of the world look distinctly parlous, with Europe reaping the pain of its erstwhile strong currency strategy and China trying to avoid a hard landing. Japan remains in its own, unique slough of despond, as if standing as a permanent rebuke about the limits of government and central bank power when trying to stimulate growth. If an easy metaphor for the world economy is the US as the engine of growth trying to drag the rest of the world out of recession/depression, the current situation is a salutary reminder that there have been several instances in history when the trailer has dragged the truck back into recession, rather than the other way around – all of which has led to a situation in which governments are trying ever more novel ‘solutions’ to the growth problem and populations are finding ever more diverse (desperate?) ways of showing their disapprobation.
How much of a role has governments and politics played in this?
As a result, migration is endemic, the UK has voted to leave Europe and America is in the midst of its most bitter election battle for decades. With the central bank arsenal now roundly depleted and with a debt-deflation purge of the system regarded as politically unpalatable, not surprisingly, politicians are adopting ever more outlandish strategies to try to spur growth. But with government finances now the worst since most countries were last involved in a major war, almost the only option open to them (whatever route they chose) is to create money – which is where the opportunity lies for the mining companies, as producers of the ultimate real asset.
Can you provide some examples of mining companies and their contribution to the Industrial Metals and Mining index?
While past performance of the majors has been impressive however, it leaves the sector looking less than cheap, at the moment. The P/E on the FTSE Mining index is negative and its dividend yield is the fourth lowest in the market (out of 39). That makes the second tier of companies look much more interesting. Four that Edison would highlight are Pan African, KEFI, Euromax and Cradle.
Pan African has two gold mines in South Africa – Barberton, which is a hundred years young and Evander, which is the most youthful of the Witwatersrand fields. Pan African’s interim results to December 2015 were ahead of our expectations, with strong performances at its surface operations complementing a solid recovery in the underground head grade at Evander (effectively portending its exit from a low grade period of mining). Subsequently, management reported that production for the full year to June 2016 was 213,267oz gold and platinum (cf Edison's expectation of 213,934oz and management’s prior guidance of 209,000oz) and that normalised, headline EPS (excluding financial instruments) will be 208-228% higher than in FY15 at 2.00-2.13p. Our valuation of PAF (excluding its Uitkomst colliery) is 23.6p at Edison's long-term gold prices. In the meantime, it continues to have the sector's third highest forecast dividend yield, globally, of over 5% (NB FY16 results are scheduled for 21 September).
KEFI and Euromax by contrast are in the process of developing their mines. KEFI is in the closing stages of financing its Tulu Kapi gold mine in Ethiopia and intends to present a syndicate-approved plan to shareholders in H216. Edison’s value of the dividends that investors can expect from the successful development of the underground and open pit mines is 2.45p/sh (in current money terms). However, it rises to 3.94p/sh in FY21 and, even further, to 5.85p/sh in the event that management can leverage cash flows into other value-enhancing exploration opportunities on the Arabian-Nubian shield (eg in Saudi Arabia where it also has highly prospective exploration ground).
Similarly, Euromax is in the final throes of financing and permitting its mine in Macedonia. Ilovica’s resource comprises 2.9Moz gold plus 1.2bn lbs Cu (5.0Moz gold equivalent) and a recently completed DFS envisages a conventional 10Mtpa drill & blast, truck & shovel operation, followed by a consecutive flotation and cyanide leach process flow route. Since then, Euromax has announced a number of developments to further de-risk the project, including 1) convertible financing by the EBRD; 2) submission of its Environmental Impact Assessment (EIA) to the Macedonian Environment Ministry; 3) German government confirmation of UFK eligibility for the debt financiers of Ilovica; and 4) moving its listing to the main board of the TSX. Considered just as a resource, Edison estimates a value of Ilovica of US$52.0-78.8m (vs EOX's market cap of c US$38m). On the basis of the DFS however, Edison's valuation of EOX is C$1.05 (fully diluted). Note that the majority of Ilovica's costs are denominated in euros, making it a beneficiary of euro weakness.
In Panda Hill meanwhile, Cradle has a 50% interest in a unique asset in Tanzania that is poised to become only the world's fourth producer of niobium – a metal so unique that its price did not fall during the 2008/09 global financial crisis. Principally used to harden steels (but with a plethora of high technology applications as well), niobium is deemed ‘strategic’ by the US and ‘critical’ by the EU. Moreover, it is almost the only metal in the world in which China’s consumption is below trend for its GDP per head. Not only Panda Hill’s geology, but also the majority of its metallurgy is entirely conventional. It has excellent nearby infrastructure and three potential sources of plant water. Cradle has now advanced the project to definitive feasibility (DFS) stage. In the meantime, its partner, Tremont, has been conducting off-take and financing talks, with a view to making a final investment decision in Q416. Assuming a long-term ferro-niobium price of US$35.15/kg, Edison calculates a project value for Panda Hill of US$365m, or US$1.11 per share for a 50% interest. This reduces to A$0.70/sh assuming full dilution at a A$0.26 share price, but could increase to A$1.42/sh in the event of debt funding of its joint venture obligations.
