What’s Down the Track?October 2013
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.
2
Argonaut’s Perspective
3
Where are we at and where might we go?
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
1
2
7
3
4
8
6
5
Relative Index Performance in CY2013
4
Although Resources as a whole have underperformed the broader market in CY2013, the Small Resources have dramatically underperformed
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13-60%
-50%
-40%
-30%
-20%
-10%
0%
10%
20% S&P/ASX 200 +14%
S&P/ASX 200 Resources -5%
S&P/ASX Small Resources -40%
As bad as it gets for Small Resources
5
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
Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 Oct-08 Oct-09 Oct-10 Oct-11 Oct-12 Oct-130
1000
2000
3000
4000
5000
6000
7000
8000
S&P/ASX Small Resources 2277 points
S&P/ASX Small Resources Index 10-Year Historical Performance
Gold
6
Gold equities have underperformed the physical, with US tapering concerns and the real cost of gold mining weighing on the sector
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-1390
95
100
105
110
115
Spot Gold (AUD) Gold Stock Composite HUI Index
ASX 200
Relative Performance of Gold Price in CY2013 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
1
2
4
3
6
5
Base Metals
7
Outlook for copper OK but nickel looks challenging
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-1340
50
60
70
80
90
100
110
120
Copper Price (USD /lb) Copper Stock Composite ASX200
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-1340
50
60
70
80
90
100
110
120
Nickel Price (AUD /lb) Nickel Stock Composite ASX200
Relative Performance of Nickel Price in CY2013
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
1
2
4
3
5
6
Iron Ore
8
Current production benefiting from resilient Fe price helped by a weaker AUD, generating significant cash for miners
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-1340
50
60
70
80
90
100
110
120
Iron Ore Price (AUD CFR 62% Fe) Iron Ore Stock Composite
ASX200
Relative Performance of Iron Ore Price in CY2013 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
1
2
3
5
4
6
Uranium
9
Not a matter of if, but when
Price (US$ per pound)
Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13$0
$5
$10
$15
$20
$25
$30
$35
$40
$45
$50
$55
$60
$65
$70
$75
$80
Long-term Uranium Price
Uranium Spot Price
Monthly Uranium Prices: Long-term vs. Spot
Source: Cameco
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
1
2
4
3
Commodity View
10
Ironically, the decline of resources investment caused by retreating commodity prices will result in future supply deficits…and so the cycle will repeat itself
PRECIOUS Gold
Expected tapering of monetary easing and lack of inflation places downward pressure on the gold price
Continued financial uncertainty in key markets (USA, Japan, Eurozone, China) may provide support
Strong physical demand in Asia Central Banks (India & China account for ~50% physical demand)
However equities have underperformed bullion by >30% in 2013
BULKS Iron Ore The market has maintained relative strength in 2013
The threat of looming seaborne oversupply has been prematurely factored into equities. Mid-cap producers with competitive cost structures remain positioned for earnings growth. The impact of lower AUD FX will increasingly favour Australian producers
ENERGY Uranium
Prolonged low prices have not incentivised the supply required to meet the growing global reactor fleet (from 345 currently to ~660 in 2030)
With new mine lead times of 4-8 years, and numerous project cancellations/deferrals this decade, supply is unlikely to meet increasing demand
The supply-side is temporary in surplus (Argonaut estimate 30Mlb) related to idled Japanese reactors, however the overhang will not prevail under a market that is propped up by secondary sources which will soon cease, namely the 24Mtpa Russian megatonnes for megawatts program
BASE METALS
Copper
LME inventories have plateaued, however they remain high (620kt). With the development capital committed on large projects, the medium term market is tipped marginally into to surplus, however project delays and cancellations are expected under current price conditions
Declining grades, deeper resources and higher sovereign risk will ultimately lead to high production costs. New projects will not be incentivised at current prices
Nickel The market is currently in oversupply and will remain so until there is capitulation on the supply side – most likely from low grade and laterite sourced ores
Resource Services vs S&P/ASX 200
11
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
Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13-30%
-20%
-10%
0%
10%
20%
30%
S&P/ASX 200 +14%
Argonaut Resource Services Peer Index*-4%
*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
Resource Services – Value Proposition?
12
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
Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-130.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
ALQ MCEW
ORTO
XCLO SK
EIM
DMRM
MND LYL
WDS
UGLBKN
SDM AAX
ANGRQL LE
ITS
EDOW RCR
GNGW
TP LCM
FWD
PEA SXE
SWK
MIODCG
COFMLD
NWH
FGE
MAHGCS
ASL BYLCGH
0.0
2.0
4.0
6.0
8.0
10.0
12.0
14.0
16.0
18.0
20.0 18.7
x
16.0
x
15.6
x
15.4
x
14.4
x
14.1
x
12.9
x
12.8
x
12.7
x
12.2
x
11.7
x
11.2
x
11.2
x
11.1
x
11.1
x
11.0
x
10.8
x
10.7
x
10.7
x
10.4
x
10.4
x
10.3
x
10.3
x
10.2
x
10.1
x
9.5x
9.1x
9.0x
8.6x
8.5x
8.0x
7.8x
7.0x
6.5x
5.7x
5.5x
5.5x
4.9x
4.8x
Average FY14 forward multiple10.4x
5-year average forward multiple9.4x
Resource Services Forward Multiples
S&P/ASX 200Forward Multiples
Resource Services FY14 Forward Multiples
S&P/ASX 200 vs. Resource Services Forward Multiples
Raising capital in a challenging equity environment
13
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
Equity Capital Markets Activity for WA-listed Resources Companies
Source: Business News WA
FY2011 FY2012 FY2013 FY2014 to date0.0
2000.0
4000.0
6000.0
8000.0
10000.0
12000.0
14000.0
0
5
10
15
20
25
30
35
40
45
50$13,131.5b
$6,198.7b
$3,619.7b
$875.7b
34
39
22
Value of ECM deals
Number of IPOs
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
14
1
2
3
4
No substitute for discovery
Alternative funding solutions
Funding projects with equity at current valuations is difficult and highly dilutive, other solutions are available
Exchangeable Bond
Pre-Payment
Loan plus Warrants
Royalty /Stream Finance
Structured Convertible
Contractor Finance
Partial Asset Sales
Bridge Finance
Vanilla Project Finance
Infrastructure Sharing
Structured Bond
1
2
3
4
5
6
7
8
9
10
11
Finance Solutions Key Provider
Service Provider
Private Equity
Fixed Interest Hedge Funds
Industry Participant
Commercial &Investment Banks
Commodity Trader
Royalty Fund
Investment Bank
Special Situations Investor
Infrastructure Owner
End-User
Selected Argonaut Transactions
$40,000,000Otto Energy
Structured Project Finance FacilityAdvisor
2013
$320,000,000Territory
Bridge Facility with Lehman for supporting CSM Bid
Advisor & Arranger
2007
$20,000,000Mediterranean Oil & Gas
Structured Bond secured with Stark & HarmonyAdvisor & Arranger
2005
$7,000,000Transerv
Short term facility secured with Apollo
Advisor & Arranger
2012
$100,000,000Sino Gas & Energy
Funding secured with HK listed oil & gas group MIE
Advisor & Broker
2012
$50,000,000Pacific Energy
Zero Coupon Exchangeable Bond with Pacific Road
Advisor & Arranger
2009
$5,000,000Indo Mines
Convertible Royalty Debenture with Anglo Pacific
Advisor & Arranger
2010
$50,000,000BC Iron
Pre-payment with Henghou for Partial Off-take
Advisor
2010
$100,000,000Latent Petroleum
Asset Farm-in with Alcoa
Advisor & Broker
2008
$116,000,000BC Iron
Infrastructure Access Agreement with FMG
Advisor
2010
ConfidentialGR Engineering (as Provider)
Advisor & Arranger
2013
MultipleAusdrill (as Provider)
Advisor & Arranger
Since 2005
1 2 3 4
5 6 7 8
9 10 11 11
15
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
16
1
2
3
4
There is now a diverse universe of capital providers and financing may be a combination of the alternatives
5
Corporate Activity
17
The focus for M+A in recent times has largely been around domestic consolidation of small to medium resources projects
FY2013 Resources M+A deals by location of target
Source: Herbert Smith Freehills Public M&A Report 2013
125
4
1
1
Gold Iron Ore Other Coal Uranium Total
$1.74b
$1.35b
$0.88b
$0.41b
$0.01b
FY2013 Resources M+A deals market value by Commodity
FY2009 FY2010 FY2011 FY2012 FY2013
72
95104
83
59
Number of Public M+A Deals FY2009-13
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
1
2
4
3
5
FY2011 FY2012 FY2013 FY2014 to date
$1,263m
$1,913m
$1,584m
$520m
Asset Transactions
18
Individual asset transactions have become more attractive as companies are showing a preference to pick and choose specific assets to acquire
Asset Transaction Activity for WA-listed resources companies
Source: Business News WA
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
1
2
4
3
Other potential sales: Reed Resources Meekatharra operations (in Administration) BHP Billiton’s Nickel West business
5
Summary/Implications
19
Reasons to be optimistic, important to be realistic
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
1
2