The Resources sector overall has had a strong second half of 2017, with the broader Metals and Mining Index up approximately 15% over the half year. This re-traced a loss of 1.3% in 1HCY17 for a 13.2% gain over the year to December 13th.
The continuation of interest in the renewable energy/lithium-ion battery thematic saw it gain momentum and emerge as the hottest sector in the space. Demand forecasts based on Electric Vehicle production are being revised ever-upward and cobalt (a key ingredient for lithium-ion batteries) is the commodity most exposed to this. Its price has appreciated 129% year to date and driven a rush to market by cobalt exploration and development companies. Lithium is also a key beneficiary and contract pricing has strengthened over 2017 as has interest in the sector. While there is potential for a medium term supply response to dampen price growth – particularly for lithium - there is a structural change to demand supporting prices that we expect to be maintained into 2018.
2017 has been a good year for base metals. Copper, zinc, nickel, aluminium and lead have all posted strong gains over 2017. Tin has also consolidated at higher levels. The supply demand balance has become tighter across the board with most metals in deficit or facing a deficit. Underpinning this on the demand side are positive fundamental indicators such as manufacturing PMI’s across key global economies all evidencing co-ordinated global growth.
Iron ore continues to confound bearish forecasts, having maintained an average price for CY17 above US$71/t. We remain above consensus with US$60/t price forecasts. What has surprised the market is the increased spread between benchmark 62% prices and lower grade 58% grade product. Typically ~10-15% this has blown out to in excess of 40% on some measures. Whether this is structural or temporary remains to be seen, but with positive data underpinning demand fundamentals we remain optimistic on this exposure.
Gold has suffered from a distinct lack of interest in 2HCY17 but still gone up 9% in US dollar terms over CY17 and while only up 3% in A$ terms is still above A$1600/oz: very healthy levels for Australian producers. In our view now is a good time to be accumulating gold exposure.
With this in mind we are looking for company specific drivers to guide our latest top-picks for the sector.
Aeon Metals (AML)
AML is focused on the exploration and development of its 100%-owned Walford Creek Copper-Cobalt-Zinc project in NW Queensland. Following the delineation of a small, high grade Resource of 6.6Mt at 1.25% Cu, 0.76% Zn and 1,630ppm Co named the Vardy Zone, AML has developed a robust geological model for the Walford Creek deposit. This model was used to target a recent 9-hole diamond drill program which successfully intersected high grade extensions of the Vardy Zone and together with evidence from historic drilling points to the potential for significant Resource growth over 22km of prospective strike length. In the near-term the drilling is expected to drive a material Resource upgrade. However, with a $30m capital raise now completed AML is in an exceptionally strong position to complete a major drill-out in 2018. In our view AML has entered an exciting period of cost effective discovery and growth which we expect more of in 2018.
Speculative Buy, Valuation $0.43/sh
Pantoro Limited (PNR)
PNR is a growing gold production company, operating its flagship, 100% owned, Halls Creek Project (including the Nicolsons Gold Mine) in the Kimberley Region of Western Australia. After delivering positive free cash flows in 2HFY17 in ramp-up phase we have since seen the share price pull back ~20%. This is in contrast to increasing production, dropping costs, a strengthening balance sheet and ongoing drilling results pointing to further Resource growth and mine life extensions. Furthermore, successful testing of ore sorting technology is now going to enable expansion of production to +80kozpa for CAPEX of ~$2m (previously estimated at $10m) offeing an extremely value accretive growth option.
Buy, TP $0.31/sh
Fortescue Metals Group (FMG)
Despite the current headwinds from wide price discounts FMG is well placed to generate strong free cash flows and shareholder returns. The balance sheet continues to strengthen, with cash of US$2.3 billion, net debt of US$2.1 billion at end September 2017 and the earliest debt maturity in CY2022. Even at 30% discount to benchmark iron ore prices, we estimate FMG will generate US$1.3 billion Free-Cash-Flow (after US$910m CAPEX), US$1.2 billion (A$1.6 billion) NPAT and be able to pay ~A40cps fully franked dividend (A$1.2 billion). In our view the market has taken an overly bearish outlook and FMG is good buying at these levels.
Buy, TP $6.65/sh
Gold Road Resources (GOR)
GOR is a largely de-risked attractive new gold development situation in WA. The 50% owned large (average of 270kozpa with scope for early production of 300+kozpa), low cost (average AISC of A$945/oz), long life (over 13 years ) gold operation at Gruyere being built by 50% JV partner, Gold Fields (which owns 10% of GOR), is scheduled to produce first gold in early 2019. GOR is fully funded for its share of Gruyere’s capex and it is also funding major regional exploration programs in its large Yamarna tenement area, where it has had considerable success. Several new gold camps such as Corkwood and Ibanez have been identified in the 100% owned North Yamarna area and the 50% owned South Yamarna JV continues to target 2+Moz deposits under cover.
Speculative Buy, Valuation $1.01/sh
Orocobre Limited (ORE)
ORE is a lithium carbonate producer based on its 66.5% interest in the new Olaroz brine facility in Argentina that is in the final stages of ramping up to nameplate capacity of 17.5ktpa, after overcoming considerable hurdles and rectifying some initial production issues. The Olaroz facility is underpinned by a large, high quality Resource and even in ramp-up it has one of the lowest operating costs for lithium carbonate in the world and is expected to sustain multiple expansions that should result in even lower unit operating costs. ORE is studying the near term doubling of output at Olaroz which includes a component for lithium hydroxide (the higher value and favoured feed for battery production) and is very well placed to develop a major strategic alliance with its partner, giant car maker, Toyota.
Buy, Target Price $6.95/sh
Xanadu Mines (XAM)
XAM is an advanced copper-gold exploration company based in Mongolia. Recent drilling at XAM’s effectively 74.2% owned Kharmagtai Copper – Gold Project in the South Gobi porphyry district has discovered significant higher grade extensions outside the existing Resources at the White Hill and Stockwork Hill Prospects. The latest drilling has benefited from recent detailed structural studies that have given XAM new insights into the nature and extent of the porphyry mineralisation, and has indicated potential for high grade bornite-rich mineralisation at depth, confirming the Project is one of the most attractive undeveloped copper-gold prospects in one of the most pro-mining jurisdictions in the world at a time when there is a dearth of quality new copper projects. Recent drilling at XAM’s other Mongolian project, Red Mountain, continues to discover significant new zones of high grade copper-gold porphyry mineralisation.
Speculative Buy, Valuation $0.55/sh
Danakali Ltd (DNK)
DNK has a tier one potash project, the largest, likely lowest cost and highest quality undeveloped project in the world thanks to its unique geology. Our outlook for sulphate of potash is favourable and at current pricing the project operates at margins of > US$300/t on phase 1 production output of 472Ktpa. 2018 should be a company making year as DNK is expected to secure offtake which should then lead to a funding solution for the US$300m in capex to build the project. Given the project’s location in Eritrea, concerns about funding are likely a big part of the reason the stock looks so undervalued and favourable news on this front should represent a substantial de-risk and potential re-rate milestone.
Buy (Speculative), Valuation $1.10/sh
West African Resources (WAF)
WAF is exploring and developing the Sanbrado Gold Project in Burkina Faso. We believe the exploration success achieved since February 2017 and the recent resource upgrade to 2.7Moz has transformed the project with high grade underground ore (575koz @ 22g/t Au) likely to complement bulk tonnage open pit operations. The blending of high-grade open pit and underground ore creates significant flexibility and diversification. The high grade M1 South Resource remains open at depth and is currently being drill tested. 2018 should be a significant year with news flow dominated by high grade drilling results, resource upgrade and a Definitive Feasibility Study that will likely culminate in decision to mine.
Buy (Speculative), Valuation $0.62/sh
Sovereign Metals Ltd (SVM)
SVM is looking to develop its unique Malingunde Graphite Project in Malawi. The natural advantages of the deposit, particularly as the mineralisation is very shallow and soft, yet still extremely high grade, give it major mining and processing advantages over its peers. Sector leading low costs are underpinned by low strip ratios, high grade and the lack of higher cost crushing or grinding of the soft ore. Development capital expenditure of just US$29m reflects the scale of the project thanks to its high quality. Low capex is boosted by the absence of a crushing circuit and the proximity to infrastructure including rail. In terms of flake size and purity Malingunde has high value premium product.
Buy (Speculative), Valuation $0.33/sh