Commodities | Jul 07 2011
– Citi initiates on Aussie gold midcaps
– Macquarie identifies key bulk and base metal midcap picks
– Coal and steel price estimates revised
– Steel transaction values expected to decline further
By Chris Shaw
In 2004 there were only four gold companies in the ASX200 index, a number Citi notes has subsequently increased to 10 such companies now. While the number of companies has increased, the issue in Citi's view is a lack of scale and size to compete in the international mid-cap gold space.
At present Newcrest ((NCM)) is the only Australian producer with annual output of more than 400,000 ounces, so Citi suggests the creation of a company producing more than 500,000 ounces of gold each year and with a value in excess of $2 billion would create a genuine rival for international fund manager investment dollars.
One other issue for the Aussie mid-cap gold plays is short mine life, something Citi expects will keep sector consolidation on the radar. For Citi, the key variable with respect to any consolidation activity is asset quality, as this will separate those companies most likely to become targets.
With this in mind Citi has initiated coverage on six Australian mid-cap gold plays – Alacer Gold ((AQG)), Beadell Resources ((BDR)), Gryphon Minerals ((GRY)), Perseus Mining ((PRU)), Regis Resources ((RRL)) and Resolute Mining ((RSG)). Of the six, the first three are rated as Holds by Citi, while the last three are its preferred exposures and so are rated as Buys.
Running through the stocks, Citi suggests Perseus, price target $3.70, has the best West African asset base in the class given good growth and exploration potential. There are some risks as projects start up but Citi rates the company as a quality name offering value at current levels.
Regis, price target $3.05, is not the cheapest of the companies Citi has initiated on but remains attractive given the potential for exploration and production upside as operations continue. Asset quality is also high, which supports a positive view on the stock.
Resolute, price target $1.60, is attempting to get operations at its Sayama project right, but if this can be achieved Citi sees potential for big upside. That said, delivery of the project will be required for this value to be realised according to Citi.
For Alacer and Beadell, value is not particularly attractive at current levels in Citi's view, especially relative to peers. Gryphon's issue is more gold needs to be found to justify a project at the group's West African project. Citi sees some potential for a 200kozpa asset if exploration is successful.
To compare Citi's views with the broader market, the FNArena database shows Sentiment Indicator readings for the six companies of 0.7 for Gryphon, 0.5 for Beadell and Regis, 0.4 for Perseus and 0.0 for both Alacer Gold and Resolute.
Elsewhere in the Australian gold sector, Citi rates Newcrest, Kingsgate Consolidated ((KCN)), Medusa Mining ((MML)) and OceanaGold Corporation ((OGC)) as Buys, Newcrest having been upgraded from Hold following a review of the sector. Citi rates St Barbara ((SBM)) as a Hold.
Macquarie has similarly looked at emerging resource stocks, the result being Northern Iron ((NFE)), Independence Group ((IGO)), Grange Resources ((GRR)) and FerrAus ((FRS)) are the broker's key picks in the sector.
For Northern Iron the attraction is a de-risking of the investment equation as the Sydvaranger ramp-up continues to deliver improvements in product quality and volumes. Balance sheet tightness has also been mitigated and Macquarie sees scope for a share price re-rating as production of on-spec product is ramped up.
The quality Kambalda nickel assets are a major attraction for Independence, while Macquarie also sees significant exploration potential and imminent gold production from the Tropicana joint venture as likely to attract investor interest.
Value is a key factor in Macquarie's Outperform rating on Grange Resources, the broker estimating the stock is currently trading at a discount to net present value of around 55%. While some work must still be done on funding for the Southdown project, Grange is better positioned than most magnetite project peers in Macquarie's view.
FerrAus is currently under a takeover bid from Atlas Iron ((AGO)) and Macquarie sees this as offering small cap exposure to Atlas, which is also rated as Outperform.
In the bulk sector, Citi continues to prefer thermal coal, expecting demand from the energy and steel sectors will remain strong for the foreseeable future. This is expected to support elevated prices for coal and thermal coal in particular.
To reflect this view Citi has lifted thermal coal prices by between 13-45% over the next 10 years, the average increase coming in at 24%. This implies average prices of US$122 per tonne this year, US$139 per tonne in 2012 and US$148 per tonne in 2013. Citi's new long-term price forecast is US$105 per tonne.
Shorter-term Citi expects China will likely need to increase imports given recent power shortages, while Indian demand should also rise strongly as while power station capacity has increased in recent years domestic Indian coal production has not kept pace.
Another boost to coal demand is likely to come from uranium's issues following the Japanese nuclear crisis, which when added to ongoing supply side constraints suggests to Citi the thermal coal market's fundamentals will remain tight.
Elsewhere in coal, Citi has lifted hard coking coal forecasts by an average of 15% across the next decade. The increase reflects the expectation of ongoing strong demand and high barriers to entry, which should support prices above Citi's long-term forecast of US$200 per tonne for some time.
Elsewhere in the commodities sector, Deutsche Bank has similarly conducted a quarterly review of the steel and coal sectors. The result is no major changes to iron ore estimates and more significant adjustments to steel price expectations.
For Far East HRC (Hot Rolled Coil) Deutsche now expects an average price of US$729 per tonne, down from a previous forecast of US$762 per tonne. Estimates for Far East HRC have increased by 5.1% in 2012, by 10.8% in 2013 and by 14.3% in 2014.
The US HRC price is now forecast to average US$848 per tonne in 2011, down from Deutsche's previous estimate of US$864 per tonne. As with Far East HRC, US HRC price forecasts in coming years have also increased. These increases have been by 6-15% through 2014.
In stock terms the biggest impact of these changes has been felt by BlueScope Steel ((BSL)), Deutsche lowering FY11 underlying net profit after tax (NPAT) by 7%. Increased steel price expectations mean NPAT forecasts increase by 16% in FY12 and by 10% in FY13.
Deutsche continues to rate BlueScope as a Buy, while both OneSteel ((OST)) and Sims Group ((SGM)) are rated as Holds.
Still on steel, industry consultant MEPS notes transaction values for North American flat steel products declined last month on the back of a softening in domestic mill activity. Customer orders also slowed leading into the traditional summer holiday period.
Short-term, MEPS expects mills may announce transaction value increases as a way to stop any further price erosion following falls in May. But with weakening demand MEPS doesn't see such moves as being successful.
If current high prices in the North American market continue MEPS expects an increase in import volumes, something that would pressure steel selling figures. Given such an outlook MEPS takes the view there will be further decreases in transaction values in coming months.