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What’s Down the Track? October 2013. General Disclosure and Disclaimer.

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slide2

General Disclosure and Disclaimer

  • This presentation and research has been prepared by Argonaut Securities Pty Limited (ABN 72 108 330 650) (“ASPL”) for the exclusive use of the What’s Down the Track Forum and must not be copied, either in whole or in part, or distributed to any other person. If you are not the intended recipient you must not use or disclose the information in this presentation in any way. ASPL is a holder of an Australian Financial Services License No. 274099 and is a Market Participant of the Australian Stock Exchange Limited.
  • Nothing in this presentation or report should be construed as personal financial product advice for the purposes of Section 766B of the Corporations Act 2001 (Cth). This presentation does not consider any of your objectives, financial situation or needs. The presentation may contain general financial product advice and you should therefore consider the appropriateness of the advice having regard to your situation. We recommend you obtain financial, legal and taxation advice before making any financial investment decision.
  • This presentation is based on information obtained from sources believed to be reliable and ASPL have made every effort to ensure the information in this presentation is accurate, but we do not make any representation or warranty that it is accurate, reliable, complete or up to date. ASPL accepts no obligation to correct or update the information or the opinions in it. Opinions expressed are subject to change without notice and accurately reflect the analysts’ personal views at the time of writing. No member of the Argonaut Group or its respective employees, agents or consultants accepts any liability whatsoever for any direct, indirect, consequential or other loss arising from any use of this presentation and/or further communication in relation to this research.
  • Nothing in this presentation or research shall be construed as a solicitation to buy or sell any financial product, or to engage in or refrain from engaging in any transaction. The Argonaut Group and/or its associates, including ASPL, officers or employees may have interests in the financial products or a relationship with the issuer of the financial products referred to in this presentation by acting in various roles including as investment banker, underwriter or dealer, holder of principal positions, broker, director or adviser. Further, they may buy or sell those securities as principal or agent, and as such may affect transactions which are not consistent with the recommendations (if any) in this presentation. The Argonaut Group and/or its associates, including ASPL, may receive fees, brokerage or commissions for acting in those capacities and the reader should assume that this is the case.
  • There are risks involved in securities trading. The price of securities can and does fluctuate, and an individual security may even become valueless. International investors are reminded of the additional risks inherent in international investments, such as currency fluctuations and international stock market or economic conditions, which may adversely affect the value of the investment.
  • Each research analyst of this research material certifies that the views expressed in this presentation accurately reflect the analyst's personal views about the subject securities and listed corporations. None of the listed corporations reviewed or any third party has provided or agreed to provide any compensation or other benefits in connection with this material to any of the analyst(s). The analyst(s) principally responsible for the preparation of this presentation or research may receive compensation based on ASPL’s and / or ASAL’s overall revenues.
  • All share price information is as at 18 October 2013.
slide3

Argonaut’s Perspective

  • Resource sector performance
  • Commodities and the sharemarket
  • Resource service sector – value and performance
  • Funding companies, funding projects
  • Importance of exploration
  • Alternative funding
  • Corporate Activity and Asset transactions
  • Summary and Implications

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Where are we at and where might we go?

slide4

Relative Index Performance in CY2013

S&P/ASX 200

+14%

S&P/ASX 200 Resources

-5%

S&P/ASX Small Resources

-40%

Although Resources as a whole have underperformed the broader market in CY2013, the Small Resources have dramatically underperformed

slide5

As bad as it gets for Small Resources

S&P/ASX Small Resources Index 10-Year Historical Performance

S&P/ASX Small Resources

2277 points

The S&P/ASX Small Resources Index is trading at levels comparable to the depths of the GFC in 2008-09 and as far back as 2005

slide6

Gold

  • Physical gold price remains volatile, largely driven by central bank policies
  • Fundamentals for gold are intact while uncertainty surrounding US tapering continues to lean on expectations
  • Previous buoyant gold price environment resulted in gold companies pursuing increasingly marginal projects
  • Investment paradigm has shifted to cash flow margins, earnings and capital discipline
  • Producers are transitioning to an ‘all in’ cost reporting standard
  • High margin producers offer investors relative safety from a declining gold price

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Relative Performance of Gold Price in CY2013

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3

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5

6

Gold equities have underperformed the physical, with US tapering concerns and the real cost of gold mining weighing on the sector

slide7

Base Metals

Relative Performance of Copper Price in CY2013

  • Base metals prices persist at low levels
  • Cu and Ni remain in surplus and high LME stockpiles are likely to sustain downward pressure
  • Testing times for marginal producers
  • Ni sector focused on cutting costs; unfortunately prices are falling faster making free cash flow generation difficult
  • For many commodity sectors we need to see capitulation of marginal projects before markets can rebalance
  • Improving demand, particularly from China, is important for price turnaround

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Relative Performance of Nickel Price in CY2013

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Outlook for copper OK but nickel looks challenging

slide8

Iron Ore

  • Iron ore market has been resilient, but market volatility may increase in the short-term
  • Iron ore market has maintained relative strength as a key constituent of the Chinese growth engine
  • Seasonal demand weakness is yet to materialise in 2013
  • Australian producers have increased supply by ~10% in FY13, however the capital intensity of new supply remains a key hurdle to growth moving forward
  • Listed Iron Ore producers have been a good place to hide whilst the rest of the resources sector struggled
  • Over supply was prematurely factored into equities; strong earnings helped by weaker AUD

Relative Performance of Iron Ore Price in CY2013

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Current production benefiting from resilient Fe price helped by a weaker AUD, generating significant cash for miners

slide9

Uranium

  • Demand increasing, supply faltering, held back by Japanese overhang
  • Uranium remains a strategic energy commodity which is facing a medium term supply deficit, driven by 65 reactors under construction and a further 167 planned
  • Uranium equities are trading at an average 70% of pre-Fukushima values
  • Uranium is the only non-carbon based energy that can provide long-term clean base load power

Monthly Uranium Prices: Long-term vs. Spot

1

Price (US$ per pound)

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Long-term Uranium Price

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4

Uranium Spot Price

Source: Cameco

Not a matter of if, but when

slide10

Commodity View

Ironically, the decline of resources investment caused by retreating commodity prices will result in future supply deficits

…and so the cycle will repeat itself

slide11

Resource Services vs S&P/ASX 200

S&P/ASX 200

+14%

Argonaut Resource Services Peer Index*

-4%

Resources services stocks have experienced a volatile year, beginning 2013 strongly before plummeting mid-year and more recently showing healthy signs of recovery but have still underperformed the broader market

*Argonaut Resource Services Peer Index is a market-weighted index consisting of: Austin Engineering, Ausdrill, Decmil, Fleetwood, Forge, GCS, GR Engineering, Imdex, Logicamms, Macmahon, Matrix Composites, Maca, NRW Holdings, Pacific Energy, RCR, SCEE and Tox Free

slide12

Resource Services – Value Proposition?

S&P/ASX 200 vs. Resource Services Forward Multiples

S&P/ASX 200

Forward Multiples

Resource Services Forward Multiples

Resource Services FY14 Forward Multiples

Average FY14 forward multiple

10.4x

5-year average forward multiple

9.4x

Although current resource services forward multiples are higher than the 5-year average, the gap between the broader market and resource services forward multiples remains wide

slide13

Raising capital in a challenging equity environment

Equity Capital Markets Activity for WA-listed Resources Companies

Value of ECM deals

Number of IPOs

Source: Business News WA

With clouds of uncertainty still lingering over the resources sector, equity capital markets have run dry as investors keep their hands out of their pockets

slide14

The importance of exploration in the creation of wealth

  • Exploration trends
    • Australian exploration expenditure has continued to lose ground relative to other destinations
    • In spite of higher expenditures Australia’s discovery rate has declined in recent years
    • Since 2003, grassroots exploration has dropped from 50% to 34% of total spend
    • Over the last decade (to 2012) the juniors share of spend has risen from 36% to 53% (non-bulks)
  • Downturn in exploration activity
    • Availability of equity funding for exploration is tight, particularly for juniors
    • High correlation between commodity prices and exploration activity
    • Trend away from Australia
      • Perception as a mature exploration destination
      • Impediments of sovereign risk, red tape, green tape, land access and the time required to achieve approvals and cost of inputs
  • Importance of new discoveries to resource industry sustainability
    • About half of current non-ferrous mines will be exhausted within 7 – 18 years
    • On average it takes 7 years to convert a new discovery into an operating mine
    • In the absence of commodity price driven interest, exploration success can stimulate investor demand and provide capital raising opportunity e.g. Sirius at Nova/Bollinger
  • Exploration incentives
    • WA Government Exploration Incentive Scheme – Co-funding exploration drilling
    • Mineral exploration tax credit
      • Explorers can pass through the tax deduction to all shareholders from genuine exploration expenditure
      • KPMG report suggests a multiplier factor of 2 in additional exploration activity would result in positive ~$280m annual tax revenue, up to ~ 4300 additional jobs and an additional $2.2b across the mining sector

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No substitute for discovery

slide15

Alternative funding solutions

  • Finance Solutions
  • Key Provider
  • Selected Argonaut Transactions

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Territory

Transerv

BC Iron

Latent Petroleum

BC Iron

Otto Energy

Ausdrill (as Provider)

Pacific Energy

Mediterranean Oil & Gas

Sino Gas & Energy

GR Engineering (as Provider)

Indo Mines

Vanilla Project Finance

Commercial &

Investment Banks

1

Confidential

$7,000,000

$50,000,000

$100,000,000

Multiple

$116,000,000

$50,000,000

$40,000,000

$5,000,000

$320,000,000

$20,000,000

$100,000,000

Bridge Finance

Investment Bank

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Short term facility secured with Apollo

Structured Project Finance Facility

Infrastructure Access Agreement with FMG

Bridge Facility with Lehman for supporting CSM Bid

Asset Farm-in with Alcoa

Convertible Royalty Debenture with Anglo Pacific

Structured Bond secured with Stark & Harmony

Funding secured with HK listed oil & gas group MIE

Zero Coupon Exchangeable Bond with Pacific Road

Pre-payment with Henghou for Partial Off-take

Advisor & Broker

Advisor & Arranger

Advisor & Arranger

Advisor

Advisor & Arranger

Advisor & Arranger

Advisor & Broker

Advisor & Arranger

Advisor & Arranger

Advisor

Advisor

Advisor & Arranger

Structured Bond

Fixed Interest

Hedge Funds

2009

Since 2005

2012

2005

2007

2010

2010

2008

2013

2010

2013

2012

3

Loan plus Warrants

Special Situations Investor

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8

Structured Convertible

Industry Participant

5

Exchangeable Bond

Private Equity

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Royalty /

Stream Finance

Royalty Fund

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Pre-Payment

Commodity Trader

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11

Partial Asset Sales

End-User

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Infrastructure Sharing

Infrastructure Owner

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Contractor Finance

Service Provider

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Funding projects with equity at current valuations is difficult and highly dilutive, other solutions are available

slide16

Investor universe

  • Australian and Global Banks
    • Lowest cost form of financing which comes with large levels of due diligence and conditions
    • Hedging may be required
    • Specialised teams focused on resource project financing
  • Specialty Royalty Providers and Streaming Companies
    • To minimise dilution at current equity prices consideration to be made to speciality metal stream or royalty providers
    • Appreciate the longer term aspect of funding
  • Specialist Funds
    • Private equity firms are increasingly focused on resource investments of scale ($50m+)
    • Will take an active , medium term view to realise a meaningful production profile
    • Strong appetite for quality projects
    • Have been very active in the resource services sector
  • Special Situation
    • Flexible mandates with the ability to move quickly
    • Familiar with project finance must be able to see sufficient value to meet financial hurdles
  • Institutions
    • Domestic and Overseas
    • Large cap through to micro-cap institutions
    • Can be fickle depending on fund availability and redemptions
    • Can be early stage

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There is now a diverse universe of capital providers and financing may be a combination of the alternatives

slide17

Corporate Activity

  • Overall Australian public M+A deal numbers fell in FY2013, continuing the fall from the previous year
  • Western Australia leads the way in the quantity of M+A deals in the resources space
  • Gold leads all commodities both in terms of quantity and value of deals, as consolidation continues to be a prominent theme in the sector
  • A significant number of resource projects were put up for sale as stand alone assets by private auction process
  • Opportunities to merge cash rich/project poor with project rich/cash poor

FY2013 Resources M+A deals by location of target

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12

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5

Number of Public M+A Deals FY2009-13

FY2013 Resources M+A deals market value by Commodity

The focus for M+A in recent times has largely been around domestic consolidation of small to medium resources projects

Source: Herbert Smith Freehills Public M&A Report 2013

slide18

Asset Transactions

  • The current metals and mining market has forced companies to rationalise asset portfolios
    • Driven by the majors divesting non-core and more expensive operations and distressed juniors
  • Companies looking to bolster balance sheets via sale of unprofitable and or non-core assets
  • Opportunistic acquisitions exist for companies with cash or strong script driven by solid management and track records
    • Private equity firms are increasingly focused on resource investments of scale ($50m+)
    • Will take an active , medium term view to realise a meaningful production profile
    • Strong appetite for quality projects
    • Have been very active in the resource services sector
  • Recent examples include:
    • Barrick’s sale of WA assets (Granny Smith, Darlot, Lawlers ) to Gold Fields for US$300m
    • Alacer’s sale of its ABU (Kalgoorlie South and Higginsville) to Metals X for $40m
    • Gold Fields sale of the Vivien project to Ramelius for $10m (staged)
    • Mega Uranium’s sale of Lake Maitland uranium deposit to Toro Energy for 415m TOE shares
    • Rio’s sale of it 80% stake in the Northparkes copper mine to China Molybdenum for $820m

Asset Transaction Activity for WA-listed resources companies

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Source: Business News WA

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  • Other potential sales:
    • Reed Resources Meekatharra operations (in Administration)
    • BHP Billiton’s Nickel West business

Individual asset transactions have become more attractive as companies are showing a preference to pick and choose specific assets to acquire

slide19

Summary/Implications

  • Resources
    • Global economic growth is improving, albeit modestly, some improvement in the US, Europe coming off a low base, Japan providing strong stimulus and China continues to grow
    • Stimulus by central authorities and accommodative policy settings will remain in place for some time to come
    • Commodity prices are generally regarded are at low levels and the expectation is for improvement over time
    • Equity market conditions to fund exploration and development will remain challenging
    • Project development may require alternative funding models and groups to bridge some of the financing gap
    • A slow down has its benefits, recalibration of labour and input costs and broader expectations
    • Producers will be prudent with capital expenditure and concentrate on cost cutting
    • Incentives, improved technology and lower input costs to improve exploration outcomes and activity levels
    • Investors, financiers and bankers are looking for resource companies with high quality projects run by high quality management
    • Cashflow margins, earnings, capital discipline and share holder returns (dividends) are key metrics
    • M + A activity, asset divestment and project consolidation at moderated valuations provide opportunity
  • Resource Services
    • Increased competition for fewer projects
    • Margin pressure and low utilisation of gear
    • Preferred exposure to production and higher quality projects
    • Short-term lack of positive catalysts
    • Stocks performed well, sector fully valued

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Reasons to be optimistic, important to be realistic