Metal Matters: Copper, Iron Ore And Nickel, And Miner Valuations

This story features ILUKA RESOURCES LIMITED, and other companies. For more info SHARE ANALYSIS: ILU

-Copper outlook subdued
-Miners at deep discount to NPV
-Iron Ore oversupply becoming evident
-Nickel players under pressure
 

By Eva Brocklehurst

Base metals are under pressure. Average aluminum and nickel prices are nearly 5% lower and copper is almost 7% lower than the analysts at JP Morgan expected. The economists have recently lowered estimates for GDP in several developed markets that are large users of copper. Incorporating this into the outlook results in more subdued expectations for global copper demand and average copper prices over the rest of the year, albeit still on a trajectory of rising average prices and rising volatility. JP Morgan now expects copper prices to average US$8032 per tonne this year, before rising to US$8750 per tonne in 2014.

Looking more closely, JP Morgan thinks the current quarter will provide the acid test for copper. A seasonal improvement in Chinese copper use would likely trigger drawdowns in the Shanghai exchange and bonded warehouse stocks, as refined material flows towards the downstream domestic market. This could just be the catalyst to bolster sentiment and slow the rate of fall in LME prices, as consumers return to the cash market. The analysts do not think this would be enough to reverse the subdued pace of net exports but could provide a counterweight to other worries, such as Chinese housing policy and Europe's soft economic trajectory.

If such a catalyst doesn't eventuate then the analysts think there's an increased risk of a large price fall, if only temporary, in order to bring cash prices to a point where the market will refocus on building exchange inventories. A price range? The analysts believe US$6500/t to US$6800/t is where consumer should see sustained value and be ready to re-stock. The purchasers may come in earlier, if the analysts are right about the global refined balance moving into deficit next year, in which case a price range around US$7100/t to US$7300/t may be enough to bring out the buyers.

BA-Merrill Lynch has updated net present values for miners and found the majority are trading at deep discounts to NPV, particularly the smaller or more leveraged companies. The only ones trading at a premium are Iluka Resources ((ILU)), BHP Billiton ((BHP)) and BC Iron ((BCI)). BCI looks the most expensive, trading at a 61% premium to core NPV. Comparing BHP with peer Rio Tinto ((RIO)) on the broker's estimates BHP is trading at a 41% premium and RIO at an 8% discount. In gold, Newcrest Mining ((NCM)), Perseus Mining ((PRU)) and Regis Resources ((RRL)) are ranked at the top with the lowest NPV at risk, being 12.5%, 14% and 15.6% respectively. Kingsgate Consolidated ((KCN)) and Saracen Mineral ((SAR)) have the highest NPV at risk of over 30%. On base metals, the lowest NPV at risk is the nickel plays Western Areas ((WSA)) and Independence Group ((IGO)) as well as Alumina ((AWC)).

Credit Suisse is looking for over-supply of iron ore to become evident in the second half of 2013. The broker does not share the view that iron ore juniors will come under pressure or fail in this scenario. The recent sell off has been brutal and the juniors are now at prices that are not justified. Hence the broker has upgraded the rating on Mount Gibson ((MGX)) to Buy, noting the company is fortunate to have a low stripping ratio at Extension Hill and this should keep costs down and generate positive cash flow. Moreover, by the time Extension Hill is exhausted in 2017, Koolan Island will have conducted the pre-strip and be ready to generate cash.

The broker is more cautious about another junior, Gindalbie Metals ((GBG)) as the Karara magnetite project has been very expensive and it is difficult to see how the project can generate enough cash under the iron ore price outlook. In the case of Atlas Iron ((AGO)) cash generation is expected to be firm, with operating cash flow expected around $200m per annum in 2015 and 2016, the years of Credit Suisse's lowest projected iron ore price.

With base metal stocks now cheap what should be bought? This is the question Credit Suisse asks. The broker is concerned that marginal cost producers will be starved of earnings and cash flow in the years to come on the basis of base metal price forecasts, particularly nickel. Credit Suisse has reduced nickel forecasts by 1-7% over FY13-15. Nickel prices are currently at a level where more than 30% of the world's nickel producers are loss making on a cash basis. This seems unsustainable but the broker notes capacity has only been marginally curtailed and inventories continue to rise.

Nickel producers Mirabela Nickel ((MBN)) and Panoramic Resources ((PAN)) now have earnings and free cash flow forecasts which are marginal until a forecast price recovery in 2015/16. As there is no near-term catalyst for either stock Credit Suisse prefers Western Areas and Independence Group. These the broker believes have more than 25% upside to the target price and lower downside risks.
 

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