Material Matters: Nickel Ban, Capital Returns And Capital Raisings

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-Upside for nickel from Indonesian bans
-First to pay out, BHP or Rio Tinto?
-Gold miners needing capital
-Alacer stands out with net cash
 

By Eva Brocklehurst

Confusion persists regarding the Indonesian government's moves to force miners to invest in downstream processing capability. The 2009 law has been formally imposed and the strategy has so far been to ban unprocessed mineral exports and progressively lift tax levels aimed at residual trade flows. UBS thinks that expectations the bans might somehow be delayed, given the country's weakened economy and subdued labour market, seem unfounded. Bauxite and nickel-baring laterite exports have stopped. The government has released purity thresholds on exports and indicated concentrate exports can continue for three more years. Concentrate trades are to be taxed at 20-25% currently, lifting every six months to peak at 50-60% by the end of 2016, then banned altogether in 2017.

Miners are engaging with the government to seek clarity, and exemptions. So far only state-controlled miner Aneka Tambang has made any real downstream investment, in response to the original 2009 law. Nickel is the most vulnerable to the trade ban. This is bullish for those pure nickel stocks, ex Indonesia, and for bauxite stocks such as Alumina ((AWC)), in UBS' view. Indonesia's exports of refined coal and gold are excluded. The impact on tin exports is expected to be small. Macquarie is also bullish about nickel as the bans come into force. Macquarie had assumed a partial, not complete, ban in the most recent price forecasts for base metals.

The broker envisaged average LME nickel cash prices of US$16,000/t this year, US$17.500/t in 2015 and US$20,000/t in 2016. If a full ban materialises after the Indonesian elections, and the political rhetoric suggests this is the case, then Macquarie believes these price forecasts are too low. As early as mid 2014 a full ban could lead prices to rally above US$15,000/t and towards US$20,000/t by the end of the year.

Macquarie's conclusions are based on the fact that no other country can readily replace Indonesian ores in the foreseeable future. Stocks of high grade ore in China and elsewhere are around 250-300,000 tonnes of recoverable nickel and will mostly be eliminated by the end of 2014. Macquarie does acknowledge there is a reliability problem with the Indonesian ore export data in that it has consistently been higher than apparent use in China.

Still, Macquarie thinks the supply response outside of China is likely to come from the large projects that have been ramping up in recent years. Yet these have substantially disappointed on estimates. Macquarie had predicted these projects would collectively add 100,000t of nickel in both 2012 and 2013. Instead they added 51,000t in 2012 and 47,000t in 2013. Macquarie thinks, potentially, a higher nickel price may help address this. Another source of supply growth is recycled nickel in stainless scrap. The price of nickel in stainless steel scrap has fallen from near 90% of the LME nickel price to a low of 73% as supply exceeded demand.

Investors in miners have focused on free cash flow yields and capital management options amid uncertain prospects for demand for commodities, observes Credit Suisse. In the case of Rio Tinto ((RIO)) versus BHP Billiton ((BHP)), the broker thinks Rio Tinto is better placed in this regard. Rio Tinto's net debt stands at US$18bn compared to its target of US$15bn, while BHP's net debt is US$27bn versus a US$25bn target.Operations are generating cash and capex is coming down, so they're both placed to increased shareholder returns going forward. For Credit Suisse the main difference is that BHP continues to spend up on shale operations and already has a higher pay-out ratio at 50% compared with Rio Tinto's 35%. The broker thinks Rio Tinto will have US$14.6bn available by the end of 2016 for additional distribution. BHP is expected to have US$12.5bn by the end of FY17. The broker's base cash forecasts suggest Rio Tinto is generating surplus cash flow at a faster rate and earlier than BHP.

It becomes a bit more tricky in terms of the ways to distribute the cash. Apart from higher pay-out ratio the distribution methods include special dividends and buy-backs. Distributions in Australia are more valuable, given the tax credits for Australian investors. BHP has US$10.5bn in franking credits while Rio Tinto had US$7.7bn by the end of 2012. However, Rio Tinto has only 24% of its shares listed on ASX while BHP has a 60% base. Credit Suisse believes, with the bulk of income from Australian iron ore, this problem will only increase for Rio Tinto as buying back the Australian company shares would reduce the value of future tax credits. In the long run, Credit Suisse thinks a buy-back of the UK listed stock is the best way for Rio Tinto to go. This could increase the Australian percentage to 27% and special dividends could begin in 2017 and be 15% larger than under a scenario without buy-backs.

Hence, Australian investors would be better off in the longer term. The broker hastens to add that most investors do not have the 10-year investment horizon in which to realise this. It presents a delicate balancing act for Rio Tinto, in the broker's view.

Moving from capital returns to the subject of capital raising and BA-Merrill Lynch observes Australia's gold sector has a deteriorating balance sheet. A number of high-cost miners need to raise capital. Already, Perseus Mining ((PRU)) and Unity Mining ((UML)) have announced intentions to do so. Screening companies for their debt, cash burn rate and all-in sustaining costs, Merrills puts Newcrest Mining ((NCM)) and Kingsgate Consolidated ((KCN)) on the high list for capital raising, with these two, including Perseus, having the most stretched balance sheets. Saracen Resources ((SAR)), given the recent acquisition of Thunderbox, has a requirement for growth capital in the future. According to Merrills, Alacer Gold ((AQG)) is the only producer with significant net cash. Regis Resources ((RRL)) is generating free cash but, in order to become a low-cost producer, needs to resolve its production issues.

Of course, if gold prices appreciate then the cash consumers can become cash generators and this may limit the need for capital raising, or it may provide an opportunity to raise capital and shore up balance sheets at a less discounted price.
 

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