Quality will win out, says Levi Spry, senior resources analyst at GMP Securities Australia. In this interview with The Gold Report, Spry contends that funding project capital expenditures is a problem only when the underlying economics are marginal. In other words, high grades plus low costs ensure victory, and he suggests a handful of Australian companies, in gold, lithium, copper and nickel, that boast the quality needed to earn high margins.
The Gold Report: Australia has a new Liberal Party government under Prime Minister Tony Abbott. Parliament's lower house has voted to repeal the previous Labour government's mining tax. Is this a done deal?
Levi Spry: We're expecting repeal, even though both the Labour Party and the Greens currently oppose it. The bill to repeal the mining tax has passed in the Lower House of Federal Parliament but current opposition means it will likely be blocked until the Senate changeover next July. I should mention that this tax affects only Australian iron ore and coal producers.
TGR: Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) has accused the state government of Western Australia of a stealth plan to raise its own royalty rates. Could you explain the Australian federal system and its relation to the mining industry?
LS: The way the royalties work in Australia is that the states claim them as revenue-based rent when the ore is mined. Federal profit-based taxes come in on top of that. So it appears Western Australia is looking to grab more before the federal government gets its take.
TGR: How important is Western Australia to Australian resources as a whole?
LS: All the iron ore and the majority of the gold production are in Western Australia, with coal in Queensland and New South Wales. Western Australia accounts for over half of Australia's mineral and energy exports.
TGR: The share price of Newcrest Mining Ltd. (NCM:ASX), the leading Australian gold producer, has fallen 80% over the last two years. Is Newcrest a one-off in the Australian gold industry, or do its problems affect the industry as a whole?
LS: It's a trend across our gold sector. Many of the smaller- or mid-cap gold producers are down similar, if not greater, amounts over that same period; having seen their cost line run up to meet the gold price, they are now experiencing lower prices and a stubbornly high Australian dollar.
TGR: Newcrest has, of course, slashed costs. Which gold producers have done a particularly good job in expenditure reduction?
LS: Cost-cutting is happening across the sector, but we're still waiting to see that reflected in the quarterly results, to be honest. Broadly speaking, GMP remains very much focused on the quality of deposits.
TGR: Which Australian gold company stands out on grade?
LS: Doray Minerals Ltd. (DRM:ASX) is our preferred gold exposure on the Australian Securities Exchange (ASX). It has the Andy Well gold project, a new gold mine in a historical province near Meekatharra in Western Australia. Production began in August. This is a small-scale underground mine and is mining ore grades of 15 grams per ton (15 g/t).
We expect FY/14 production of 70,000–80,000 oz (70–80 Koz) at cash costs of A$500/oz and an all-in costs of A$730/oz. We've given it a Buy rating with a price target of $0.90/share.
TGR: Will production increase beyond 70–80 Koz?
LS: Doray's processing plant can probably handle increased production once it increases its resources and reserves. Now that the mine is built, and it is ramping up, the focus will move back to exploration. Doray has some pretty attractive targets to add mine life. Once that's done, there's a chance to increase its production profile as well.
TGR: Will Doray have enough cash for the exploration necessary to increase its resources?
LS: We think its funding should be fine.
TGR: What other ASX-listed gold producers do you like?
LS: Alacer Gold Corp. (ASR:TSX: AQG:ASX) has the Çöpler gold mine in Turkey. It's heap leach and low cost. The company should produce around 270 Koz this year at less than $425/oz all-in costs. In mid-2014, Alacer will deliver a bankable feasibility study on a potential sulphide operation. That's when we'll see the costs associated with that, capital expenditures (capex) and operating expenditures, going forward. Çöpler has a large resource base, highly prospective exploration ground and good operating parameters.
Beadell Resources Ltd. (BDR:ASX) is doing a very good job currently at its Tucano mine in Brazil. The company had a new discovery called Duckhead, which means it is processing higher grades than originally planned. That means higher production and lower costs. We have a Buy rating and a price target of $1.10/share.
TGR: Australia is one of the top two lithium producers in the world. There are 14 ASX-listed lithium companies. How significant do you consider the just-announced joint venture (JV) of Rockwood Holdings Inc. (ROC:NYSE) taking 49% of Talison Lithium Ltd. (TLH:TSX) and Chengdu Tianqi Industry Group Co. keeping 51%?
LS: The deal could be very significant for the lithium space. It points to more consolidation on the supply side in a high-growth sector, which is very positive on where the price is going to go. Also significant is the potential for Tianqi to become an investor in Rockwood itself.
TGR: So you anticipate higher lithium prices?
LS: Yes. Lithium demand is growing at about 10% per annum, and supply is limited.
TGR: Are increased prices dependent upon newly emerging technologies?
LS: Yes, as those technologies become more mainstream. The obvious one is electric cars. You've probably seen the good growth numbers put out by industry leaders like Tesla Motors Inc. (TSLA:NASDAQ). This points to quicker-than-expected uptake, considering that the company is already profitable at such low-production volumes.
TGR: Which Australian lithium companies do you like?
LS: There is only one with a real project: Orocobre Ltd. (ORL:TSX; ORE:ASX). Its flagship project, Olaroz, is located in the Argentinian Andes. It is a JV with Toyota Tsusho Group (TYHOF:OTCPK). Construction is advanced, and the company is talking about production in mid-2014. It will be very low on the cost scale (~US$2,000/ton) and has a $229 million ($229M) capex. High grades and good chemistry mean production costs will be low, and there is a readily expandable resource base. It is well funded with the package Toyota brought to secure its 25% share.
We've given Orocobre a Buy rating with a price target of $2.85.
TGR: Argentina has been troublesome for a lot of mining companies. Olaroz is in Jujuy. How does this province rate on mining friendliness?
LS: Everyone's interests are aligned there. Toyota's funding is Japanese government backed, and the local Jujuy government owns 8.5% through the joint venture. Olaroz is going to have a good impact on that region with jobs, royalties and future dividends.
TGR: When you consider Australian projects outside that country, what qualities are paramount?
LS: First, we look at the geology. Second, we look at the political and fiscal regimes involved. In many cases we are willing to take on higher jurisdictional risks for the orebodies.
TGR: With that in mind, is there any foreign copper project you're keen on?
LS: We really like Hot Chili Ltd.'s (HCH:ASX) Productora copper project, which is 500 kilometers north of Santiago in Chile. Productora is near surface, near the coast, at low altitude and has significant infrastructure advantages. Importantly for a Chilean project it has access to power and water.
Nearby it has a second project, Fronterra, which is adjacent to the Payen copper-gold project that Coro Mining Corp. (COP:TSX) optioned 70% of to Freeport-McMoRan Copper & Gold Inc. (FCX:NYSE) in August for $35.5M.
Hot Chili may partner with Compañía Minera del Pacífico S.A., its largest shareholder, which will ensure access to infrastructure and low-capex intensity. Lundin Mining Corp. (LUN:TSX) also owns over 8% of the company, so it has done a bit of due diligence for us, if you like, and we think it is a good judge. We've given Hot Chili a Buy rating with a price target of $1.15/share.
TGR: When will Productora go on-line?
LS: The company is just completing a prefeasibility study, which should be published in mid-2014. A bankable feasibility study should follow in mid-2015, with commissioning in late 2017. We are looking at 60,000 tons per annum (60 Ktpa) copper production at cash costs of $1.30-1.40/pound for 20 years.
TGR: What's the capex?
LS: We think it will come in around $650M. Low capex intensity terms (~US$10,000/ton of annualized capacity) because of its infrastructure advantages and grades.
TGR: How does financing look?
LS: That's yet to be sorted out. We're not expecting it to be finalized for another 12–18 months, but what we would say is that good projects find financing.
TGR: Coming back to Australia, which nickel project stands out?
LS: Sirius Resources NL's (SIR:ASX) Nova-Bollinger nickel-copper project in Western Australia. This is one of the most exciting new nickel projects in the world: high grades with costs in the lowest quartile. A feasibility study is due in mid-2014, and production could begin in mid-2016. Anticipated production is 28 Ktpa nickel and 12 Ktpa copper at cash costs of US$2.84/lb nickel.
We've given Sirius a Buy rating with a price target of $3.20.
TGR: How firm is Nova's preproduction capex of $471M (with a $51M contingency)?
LS: There is still some work to be done refining that number, and we think Sirius can probably reduce it. Again, good projects find funding, so there are plenty of funding routes open to that project because its economics are so robust.
TGR: In recent years, there has been a strong reaction against high capexes. Is there any kind of cutoff point beyond which a capex dollar figure comes to be seen as critical?
LS: I would say no. In the mid-cap space, we've seen companies chase scale in order to use economies of scale to reduce costs and build marginal projects. Now, we're seeing that unwinding. The gold sector is a good example of this. It's now all about margin as opposed to volume. Doray is a good example of that because it's quite small scale but very high grade and high margin as opposed to the kind of large, low-grade operation that so often comes with high capex and more risk.
TGR: The bear market in precious metals equities has lasted so long that many investors have become gun shy. What should investors be looking for in mining companies?
LS: Asset quality. Mines that will produce through the cycles. Grades, all-in costs, balance sheets and management. Those are our four criteria.
TGR: Levi, thank you for your time and your insights.
Levi Spry is senior resources analyst at GMP Securities Australia, covering the gold, base and specialty metals sectors. Previous, he worked for Deutsche Bank Australia and as a mining engineer with Newcrest Mining Ltd., Harmony Gold Mining Co., Western Metals Ltd., Barminco and SRK Consulting. He holds a Bachelor of Engineering (mining; Honors) and a Bachelor of Applied Science (geology) from the University of South Australia, a Graduate Diploma in Applied Finance and Investment from the Financial Services Institute of Australia and is currently completing a masters in mineral economics at Curtin University. In 2010 and 2011 Spry was ranked Top 3 in his sector in the Peter Lee surveys and, in 2012, Spry was named one of the Top 10 equities research analysts by the Sydney Morning Herald.
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1) Kevin Michael Grace conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
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