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What’s Down the Track? GLEN COLGAN October 2014

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What’s Down the Track? GLEN COLGAN October 2014. General Disclosure and Disclaimer.

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What’s Down the Track?


October 2014


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 20 October 2014.

Argonaut’s Perspective

  • How did we go?
  • The Broader Market vs Resources
  • Australian Economic Performance
  • Resource Sector Performance
  • Commodity Prices
  • Funding Companies + Funding Projects
  • Corporate Activity + Asset Transactions
  • Resource Services
  • Summary and Implications










Where are we at and where might we go?


How did we go?












Resource Services





The score card – a self assessment


The Broader Market vs. Resources

S&P/ASX 200


S&P/ASX 200 Resources


S&P/ASX Small Resources


Although Resources as a whole have underperformed the broader market in CY2014, the Small Resources in particular have dramatically underperformed


As bad as it gets for Small Resources...yet to get better

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

S&P/ASX Small Resources

1789 points

The S&P/ASX Small Resources Index is currently trading at 10 year lows


Australian Economic Performance

  • Interest rates remain at historically low levels
    • Having a benign effect on growth as the global economy continues its slow recovery
  • AUD is trending downwards as demand for commodities retreats
  • Key commodity prices have fallen in recent months – most prominently iron ore and gold
    • Softer AUD is providing somewhat of a cushioning effect for Australian producers
  • Australian economic growth has been slightly below trend

Economic Update

Australian Real GDP FY2009-14

Iron Ore Spot Price vs. AUD:USD Exchange Rate (YTD)


  • Australia’s economic outlook remains opaque as weak growth in key developed economies is expected to persist in the medium term
  • The RBA remains bound as it balances managing the exchange rate with preventing a housing bubble from inflating

Australia has outperformed the majority of developed economies although question marks remain over commodity prices



  • Physical gold price decline has accelerated over the past two months although the coinciding AUD depreciation has provided some relief for Australian producers
  • The US economic recovery is beginning to take hold with interest rate expectations driving a firmer USD providing a headwind for gold: it is still premature for investors to turn to gold as a hedge against inflation
  • The geopolitical situation in the Ukraine and the Middle East may be providing the gold price with some support
  • Producers continue to concentrate on reduction of unit costs per ounce, reporting an “all-in” cost - the sub $1,000 AISC per ounce club is quite exclusive
  • Despite some operational failures and margin compression, gold equities look good value, although investors should stick to quality projects run by quality management

Relative Performance of Gold Price in CY2014






Gold equities have demonstrated their leverage to the physical, having outperformed early in 2014 and more recently underperforming as the gold price experiences weakness


Other Metals

  • After a strong rise from February following the Indonesian ban on unprocessed mineral exports, nickel has declined; Philippines threatening with a similar ban
  • Ni producers making good returns following difficult conditions and a period of belt tightening
  • Commitment to brownfields exploration


Relative Performance of Key Metal Commodities (YTD)






  • Soft price assumes a large surplus
  • Supply response is invariably over-estimated
  • LME stocks are at the lowest levels in 6 years


Relative Performance of Metals Equities (YTD)

  • Looming deficit pushing prices higher with up to 10% of supply slated for closure in the next 3-4 years
  • Lack of capital & exploration to limit supply


Iron Ore

  • A combination of lower demand and a surge of supply from the major mining houses has been the driving factors behind the commodity’s decline
  • Rollercoaster likely to continue with re/de-stocking cycle while macro themes and uncertainty to keep pressure on prices
  • Higher cost producers appear increasingly marginal, hard decisions to come



Nickel and zinc look positive, copper expected to improve, iron ore remains challenging


Other Metals – Recent Performance

Relative Performance of Key Metal Commodities

(Financial Year to Date)

Relative Performance of Metals Equities

(Financial Year to Date)








Commodity prices and resources equities have struggled so far in FY15



Oil & Gas

  • The uranium market remains in surplus despite the cessation of the Russian HEU program in 2013. This is largely due to Japanese reactors remaining idle
  • Restart of Japanese reactors has been much slower than anticipated with all 48 operable reactors still offline
  • The uranium spot price remains below many producers’ cost of production, leading to some operations being placed onto care and maintenance i.e. Paladin’s Kayelekera operation
  • Triggers for a price recovery remain on the horizon as utilities resuming contracting


  • Weaker Chinese and European growth in combination with growing supply of West African and North Sea crude has seen the price of Brent fall relatively rapidly
  • Potential for US self sufficiency threatening to remove a substantial volume of demand from the market although China has balanced out the impact so far with increased consumption
  • Widespread geopolitical risks have so far failed to have any material impacts on the supply side
  • Gas is restricted to localised markets; demand for energy overseas has led to the development of a burgeoning LNG industry in Australia









Brent Oil Price (USD/bbl)

Monthly Uranium Prices: Long-term vs. Spot

Price (US$ per barrel)

Price (US$ per pound)

Uranium Spot Price

Energy markets have not remained immune to economic headwinds

Source: Cameco


Raising Capital in a Challenging Equity Environment

Equity Capital Markets Activity for WA-listed Resources Companies

Value of ECM deals

Number of Resources IPOs

Resources sector players have taken advantage of buoyant market windows to raise capital

Source: Business News WA


A cash crisis among small explorers

  • Small developers and exploration companies are experiencing a “cash crisis” as equity investors have become increasingly risk averse
    • 212 metals & mining companies listed on the ASX currently have less than $500k in cash
    • A further 101 companies currently have less than $1m in the bank
  • Lower commodity prices experienced over the past 12 months forced the industry into cost cutting and led to a 12 per cent decrease in exploration expenditure
    • Western Australia has endured the largest fall in exploration expenditure, dropping 17 per cent
    • Greenfields and brownfields exploration fell equally, suffering a 33 and 32 per cent decrease respectively



Exploration Expenditure, by State

Mineral Exploration Expenditure, by deposit type

Exploration activity has been subdued and a cash crisis has developed among small explorers


Funding Projects

  • A number of projects continue to attract significant interest from equity investors, financiers and corporates alike
    • Gold Road Resources (ASX: GOR) : $10m + $23m
    • Sirius Resources (ASX: SIR) : $189m
    • Northern Star (ASX: NST) : $100m
    • Orbis Gold (ASX: OBS) : $20m (currently subject to a $160m takeover proposal from SEMAFO)
    • Poseidon Nickel (ASX: POS) : $30m
    • Saracen Minerals (ASX: SAR) : $61m
    • Macphersons Resources (ASX: MRP) : $8.8m
    • Phoenix Gold (ASX: PXG) : $16.8m
    • Rox Resources (ASX: RXL) : $4.5m


Gold Road Resources (ASX: GOR) YTD

Sirius Resources (ASX: SIR) YTD

Good projects continue to attract equity capital


Corporate Activity

  • Australian public M+A deal numbers rebounded in FY2014, driven by a surge of activity in the oil & gas sector
  • 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

Key Commentary

FY2014 Resources M+A deals by location of target









Resources M+A deals market value by Commodity

Recent Resources M+A Transactions

The focus for M+A in recent times has largely been around opportunistic acquisitions of quality assets

Source: Herbert Smith Freehills Public M&A Report 2014


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
    • Quitting idle or exploration assets as company austerity initiatives take effect
  • Recent examples include:
    • Northern Star’s purchase of Jundee from Newmont for $82.5m, 51% of EKJV and Kanowna Belle from Barrick for $75m, and Plutonic from Barrick for $25m
    • Saracen’s acquisition of Thunderbox and Bannockburn from Norilsk for $20m plus a royalty
    • Poseidon Nickel’s purchase of Black Swan and Lake Johnston from Norilsk
    • Metals X’s $7.7m purchase of the Meekatharra gold operations of Reed Resources and its $40m acquisition of Alacer Gold’s Higginsville and South Kalgoorlie operations
    • Cassini Resources’ acquisition of BHP’s West Musgrave Project for $250k upfront and $10m after the first year of production
    • Talisman’s acquisition of the Sinclair Nickel mine from Glencore for $8m upfront
  • Other potential sales:
    • BHP Billiton’s Nickel West business
    • Cliffs’ Koolyanobbing iron assets

Asset Transaction Activity for WA-based Resources Companies



Source: Business News WA


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


Resource Services – FY14 Results and Commentary

  • The majority of resource services companies saw a decline in profit in FY14
  • “As bad as it gets” view in the industry – remains to be seen
  • Conditions still very competitive
  • Focus on balance sheet and cash flow, weak earnings forgiven if balance sheet remains strong
  • Pursuit of diversification
  • Many investors have abandoned the sector and are taking a “wait and see” attitude to future investment in resource services
  • Upgrades to earnings needed to drive share prices higher

Key Themes

FY14 Profit compared to FY13

Outlook Commentary

Resource Services Contracts Awarded

The Resource Services sector experienced a difficult past 12 months as mining investment tailed off and the industry entered into the production phase


Resource Services – Historical P/E Multiples

Historical Forward P/E Multiples

Price and earnings downgrades have kept resource services stocks within their 3 year trading band



  • Resources
    • Global economic growth remains subdued, Europe increasingly precarious, US improvement continues, China rebalancing
    • Accommodative policy settings remain, however US QE measures winding down
    • Commodities: Bulks continue under pressure; Base metals to improve; Precious metals to remain volatile
    • Weaker AUD providing some relief
    • High quality assets will attract significant equity funding; debt funding available for robust projects; specialist funds active
    • Junior resources sector to remain cash deficient
    • Producers will be prudent with capital expenditure and concentrate on cost cutting, putting pressure on service providers
    • Key themes of cashflowmargins, earnings, capital discipline and shareholder returns will remain central to investor focus
    • Undervalued assets and companies remain vulnerable to opportunistic acquirers
    • The Resources sector represents the best value in decades, with opportunities across the spectrum from producers, developers and advanced explorers
  • Resource Services
    • Highly competitive environment
    • Margins tight and low utilisation of gear
    • Construction in decline with limited visibility of project pipeline
    • FY14 results a cyclical low, outlook commentary suggests “not getting worse”… remains to be seen
    • Investor sentiment towards the sector remains negative, focus on cashflow generation and balance sheet strength
    • Deep value but a continuing lack of positive catalysts



Deep value, patience required