CHEAP RE­SOURCES TIME TO BUY?

Finweek English Edition - - FRONT PAGE - BY TINA WEAVIND

The JSE’s re­sources sec­tor has un­der­per­formed the broad mar­ket for the past five years – in fact, long-term hold­ers of the in­dex are now back to where they were be­fore the start of the com­mod­ity su­per cy­cle in the late 1990s, which was driven by un­prece­dented de­mand from China.

With the sec­tor now look­ing “ex­tremely un­der­val­ued” in com­par­i­son to the rest of the mar­ket, and many min­ing bosses hav­ing adapted their busi­nesses to a lower com­mod­ity price en­vi­ron­ment, in­vestors have to ask: is now the time to buy re­source stocks?

AN­A­LYSTS WEIGH IN

“We think re­sources are a good in­vest­ment,” says Piet Viljoen, chair­man of in­vest­ment house RECM and one of the coun­try’s fore­most value in­vestors. It would be a long-term play though: the lead time to re­alise any worth­while up­side would be in the re­gion of around five to nine years, he says.

Daniel Sacks and Hanré Ros­souw, port­fo­lio

man­agers of the In­vestec Com­mod­ity Fund, say that they be­lieve there is “op­por­tu­nity in the sec­tor at the mo­ment, as we cal­cu­late value in sev­eral min­ing com­pa­nies with div­i­dend and free cash-f low yield es­ti­mates at at­trac­tive lev­els”.

Re­cent re­sults for min­ing com­pa­nies have, in many in­stances, re­ported fall­ing dollar unit costs, thanks to weaker pro­ducer cur­ren­cies (in­clud­ing the rand and the Aus­tralian dollar), de­clin­ing en­ergy costs, labour ef­fi­cien­cies, cost con­tain­ment and higher grades of prod­uct mined, they said in a note to clients on 13 May.

Com­mod­ity prices are also ex­pected to im­prove over time as com­pa­nies con­tinue to re­struc­ture their port­fo­lios, shut­ting mar­ginal mines and ap­prov­ing very few new projects. “We be­lieve that the cur­rent share prices of many min­ing com­pa­nies un­der­es­ti­mate the earn­ings that will be gen­er­ated, with sur­prises com­ing both on the cost and rev­enue side,” they said.

CHOICES, CHOICES…

Sacks says that he prefers gold over plat­inum, even though “we aren’t gold bulls”. The gold price is ex­pected to re­main ro­bust as the US Fed­eral Re­serve would likely “con­tinue to err on the side of cau­tion when it comes to the pace of rate hikes”. China eas­ing mon­e­tary pol­icy to stim­u­late growth could also be a key fac­tor to boost com­mod­ity prices.

Cur­rently though, coal and iron ore − sup­pli­ers to the hap­less con­struc­tion and power sec­tors − were a “ter­ri­ble idea”. Part of the prob­lem was that mar­ginal sup­pli­ers had not shut down de­spite the plum­met­ing re­sources de­mand, while in­creased sup­ply was be­ing pumped into an in­creas­ingly lethar­gic mar­ket.

Peter Ma­jor, min­ing spe­cial­ist at Cadiz Cor­po­rate So­lu­tions, says that many base met­als – com­modi­ties like cop­per, lead, nickel and zinc – cur­rently looked safer to in­vest in than the bulk com­modi­ties, such as iron ore and coal. “There just seems to be way too much pro­duc­tion of oil, gas, coal, iron ore and man­ganese right now. And we don’t seem to have the man­age­ment, po­lit­i­cal, or labour en­vi­ron­ment to make the nec­es­sary changes and im­prove­ments”, such as job cuts or mine clo­sures.”

The op­por­tu­nity isn’t so much in what com­mod­ity you’re pro­duc­ing, Ma­jor says. “It is all about, ‘Are you an ef­fi­cient pro­ducer? Are you lead­ing the in­dus­try in ef­fi­ciency and pro­duc­tiv­ity?’ That is what min­ing is all about; not sit­ting on your hands pray­ing for ab­nor­mally high com­mod­ity prices to bail you out of a poor man­age­ment, po­lit­i­cal and labour en­vi­ron­ment.”

One an­a­lyst, speak­ing on con­di­tion of anonymity, says that lo­cal min­ing stocks are trad­ing at a dis­count rel­a­tive to their peers in the US and Canada, in­di­cat­ing that the mar­ket takes a dim view of the reg­u­la­tory un­cer­tainty in the lo­cal sec­tor (see page 23). This gap could widen, he warned, and it is worth pay­ing a pre­mium to get ex­po­sure to listed min­ing stocks in the US or Canada in­stead.

PRE­CIOUS MET­ALS

South Africa has around 80% of the world’s proven plat­inum re­serves and about half of the world’s gold re­serves. But this ben­e­fit has be­come in­creas­ingly out­weighed by a slew of ob­sta­cles which some an­a­lysts be­lieve threaten sus­tain­abil­ity un­less rad­i­cal pol­icy changes are put in place.

Oner­ous and fluc­tu­at­ing state-is­sued em­pow­er­ment man­dates as well as union de­mands and chronic strike ac­tion, power price in­creases and load-shed­ding are some of the lo­cal is­sues fac­ing gold and plat­inum min­ers. Slug­gish global de­mand − par­tic­u­larly for plat­inum − is an­other.

While Sacks says they are “not gold bulls”, if he had to choose stocks to put money into, he would look at An­gloGold Ashanti, which has cut costs and is plan­ning as­set sales to boost its bal­ance sheet, and Sibanye Gold, of which he is a big fan. While Sibanye was less un­der­val­ued than other gold min­ers, it was “still a good divi[dend] story”.

US hedge fund manager and se­ri­ous gold bull John Paul­son, who holds 6.5% of An­gloGold, has stayed in gold de­spite the dis­ap­point­ing re­turns he has had while wait­ing for the metal to prove its worth as an inf la­tion hedge.

Ma­jor, who is neg­a­tive on re­sources gen­er­ally, be­lieves it is a “stock picker’s mar­ket”. On gold, he sug­gests ex­change-traded funds are a bet­ter bet than in­vest­ing in com­pa­nies. If he were pushed to make sug­ges­tions, Pan African Re­sources and DRD Gold would be the most at­trac­tive op­tions, he says.

PLAT­INUM

As­set man­agers are bear­ish on the metal, as above-

ground re­serves are still too high for prices to make a strong re­cov­ery. De­spite last year’s five-month strike in SA tak­ing sub­stan­tial sup­ply out of the mar­ket, fall­ing de­mand and high stock lev­els have sup­pressed prices, which have fallen by nearly 23% over the past 12 months.

The World Plat­inum Coun­cil is pre­dict­ing de­mand to grow by a miserly 3% to 8.155m ounces. Lon­min, which is plan­ning 3 500 job cuts as it tries to im­prove its f inances, said that it ex­pected de­mand f r om t he au­to­mo­tive in­dus­try – Euro­pean car­mak­ers are the most im­por­tant buyer of the metal – to grow by 3.7% this year. Im­pala Plat­inum is per­haps more bullish on the longer-term out­look, fore­cast­ing the sup­ply deficit to deepen from 805 000 ounces this year to 1.8m ounces in 2023.

It is this in­creas­ing deficit that min­ers hope will push up the price of the plat­inum. An­other pos­si­ble ray of sun­shine for the metal would be quan­ti­ta­tive eas­ing in Europe, which would cut ex­ports costs and push up the cost of buy­ing the metal.

In­vestec As­set Man­age­ment’s Sacks and Ros­souw said that while the plat­inum price is ex­pected to strengthen to a level where it is again trad­ing at a pre­mium to the gold price, “we be­lieve the eq­uity mar­ket is still too op­ti­mistic” and is pric­ing in a much stronger re­cov­ery than is likely, given the high lev­els of above-ground stock. An­a­lysts, even those rel­a­tively bullish about the out­look for re­sources, say that coal and iron ore were no-go zones for in­vestors, at least in the medium term.

Xavier Prevost, se­nior coal an­a­lyst at XMP Con­sult­ing, says that the sur­plus in the mar­ket was “dev­as­tat­ing” the price, par­tic­u­larly as sup­ply wasn’t be­ing cut back.

Worse, the In­sti­tute for En­ergy Eco­nomics and Fi­nan­cial Anal­y­sis said in a re­port re­leased on 18 May that the global coal in­dus­try is in con­tin­ual decline and the num­ber of util­i­ties burning the f uel was drop­ping i n favour of sus­tain­able op­tions.

De­spite this, ex­cess sup­ply con­tin­ues to pour out of Australia from ex­ist­ing and green­field projects. The price for steam coal in China has fallen 59% from its 2008 peak, and the com­mod­ity is trad­ing at the low­est level in nearly nine years, ac­cord­ing to Bloomberg data.

Glen­core, the world’s big­gest ex­porter of coal, closed its Aus­tralian mines for three weeks over Christ­mas in an at­tempt to boost prices. The com­pany has also en­tered into talks with unions about closing some of its lo­cal Op­ti­mum Coal mines as prices con­tinue to plum­met. More than 1 000 work­ers would be laid off.

Lo­cal coal min­ers are bat­tling to get back­ing to ex­pand in prepa­ra­tion for new longde­layed coal-f ired power sta­tions to start up. Medupi power sta­tion in Lim­popo and Kusile in Mpumalanga are ex­pected to re­quire around 14.6m tons a year each. Much of Medupi’s sup­ply will come from the Grootegeluk mine owned by Exxaro Re­sources − a black-em­pow­ered coal and heavy met­als op­er­a­tion that pro­duces around 18.8m tons a year – which will give the com­pany a dis­tinct mar­ket ad­van­tage. How­ever, this boon will only take ef­fect in around three to four years when Medupi fi­nally fires up.

Exxaro, which also owns a 20% stake i n Kumba’s Sishen Iron Ore Com­pany (SIOC) in the North­ern Cape, an­nounced that its half-year earn­ings to the end of June were likely to be at least 20% down from the same pe­riod a year ago, mainly due to re­duced in­come from SIOC, which has been hard hit by the drop in iron ore prices.

Prices for the steel-mak­ing in­gre­di­ent have dropped to 10-year lows as in­fra­struc­ture spend­ing in China has slowed down, while there has been sig­nif­i­cant new sup­ply of iron ore from ma­jor com­pa­nies, in­clud­ing An­glo Amer­i­can’s Mi­nas-Rio mine in Brazil.

The low iron ore prices have made Kumba one of the worst-per­form­ing stocks in 2015 so far. Kumba shares are down 33.24% since Jan­uary. Kumba is plan­ning a re­view of its busi­ness op­er­a­tions, and is con­sid­er­ing closing down its Thabaz­imbi mine to rein in costs and cut sup­ply. Stocks in As­sore, which mines iron ore and chrome, have fallen al­most 23% this year.

THE GLOBAL COAL IN­DUS­TRY IS IN CON­TIN­UAL DECLINE AND THE NUM­BER OF UTIL­I­TIES BURNING THE FUEL WAS DROP­PING IN FAVOUR OF SUS­TAIN­ABLE OP­TIONS.

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