Market Update & Important Indicators
U.S. stocks gained ahead of the start of the first-quarter earnings season. The U.S. first-quarter earnings season unofficially begins later Monday with a report from aluminum giant Alcoa. Several large U.S. banks are also scheduled to report earnings this week, including J.P. Morgan, Bank of America and Citigroup. Analysts are projecting weak earnings, with lower oil prices and a stronger dollar taking a toll on corporate profits. Earnings for the S&P 500 are forecast to contract about 8.5% from a year earlier, according to FactSet estimates as of March 31, with particularly downbeat reports expected from the energy sector. Materials companies were among the biggest gainers in the S&P 500, rising about 1%. Newmont Mining rose 6% as the price of gold gained 1.3% to $1,259 an ounce, near a three-week high.
In Europe, the Stoxx Europe 600 gained 0.3%, led by shares of mining companies and banks. Shares of Italian banks soared as the government prepared to meet with banks and Bank of Italy executives to agree on the details of an investment fund to help local lenders shed bad loans and recapitalize. Shares in Banca Monte dei Paschi di Siena, seen as a major beneficiary of the fund, increased nearly 10%.
China shares jumped on expectations that soft inflation leaves room for authorities to stimulate the economy through further monetary easing. But in Japan, where the yen touched a fresh high against the U.S. dollar, the Nikkei Stock Average fell by 0.4%. Shares in China and Japan have diverged markedly in performance over the past one-month period, as the People's Bank of China and Bank of Japan face starkly different challenges. Investors and analysts believe that China's central bank has ample tools to ease policy, including potentially cutting interest rates, but that Japanese officials are running short of options, after already moving to negative interest rates earlier this year. Data Monday showed Chinese consumer inflation rising 2.3% in March from a year earlier, the same as February's tally and remaining below the government's target ceiling.
Australian shares ended slightly lower as continued worries about the financial sector outweighed strong gains among energy and mining stocks. Australia's big banks have been under pressure in recent weeks amid concerns that bad-debt costs are starting to rise as commodities prices remain weak. Also, analysts have suggested the largest lenders will again face regulatory pressure to increase capital buffers against the risk of economic shocks. Energy stocks were the biggest gainer as oil prices continued to rise in the Asia session, driven by expectations for a shrinking global glut after a decline in U.S. inventories and drilling activities. Woodside Petroleum rose by 0.4% and Oil Search advanced 2.3%. Mining shares also rose strongly, with BHP Billiton ending up 2.3% and Rio Tinto gaining 2.4%
The London Metal Exchange's three-month copper contract was up 0.8% at $1,508.50 a metric ton at the PM kerb close, having hit a two-day high earlier in the session at $4,703.50 a ton. Among the other base metals, aluminum closed down 0.6% at $1,495.50 a ton, zinc was up 0.2% at $1,748 a ton, nickel was up 0.2% at $8,525 a ton, lead was down 0.5% at $1,685 a ton and tin was down 0.9% at $16,755 a ton.
Thought of the Day
Small cap mining contractors – where to now?
Ausdrill (ASL): Market Cap $136m | Current Price $0.435 | Valuation $0.85
Macmahon (MAH): Market Cap $142m | Current Price $0.115 | unrated
MACA (MLD): Market Cap $225m | Current Price $0.965 | unrated
NRW Holdings (NWH): Market Cap $46m | Current Price $0.165 | unrated
In early November 2015, after Newcrest announced a move back to contract mining at Telfer, we asked the question: “Is contract mining coming back into vogue”? Our report at the time (“Did the earth move for you?”, 6 Nov. 2015), noted that a torrid operating environment for contractors over an extended period had seen share prices plummet.
Figure 1: Share price falls from peak (over last 5 years) to 6 November 2015
At that time we felt opportunities would start to emerge given significant cost-cutting, write-downs, and underutilization across the contracting sector, in addition to a willingness by contractors to be more flexible and accept smaller margins. We felt most were undervalued. This view has since been borne out by subsequent share price performance (albeit off a very low base) with the 4 small caps up an average 24%.
Figure 2: Share price gains from 6 November 2015 to date
Large, long life, predictable mines (such as in iron ore) still lend themselves to an owner-operator model (FMG is about to go this way at Christmas Creek). However a contractor model that is cheaper and more flexible than before begins to make sense for miners that require flexibility, are exposed to shorter mine-lives, or own an ageing fleet that needs replacement. Further, in capital constrained markets, opex is more attractive.
The small cap companies mentioned in this note have been awarded 6 mining contracts between them since November last year; ASL at AngloGold Ashanti’s Geita gold mine in Tanzania; MAH at Newcrest’s Telfer operations, at PT Agincourt Resources’ Martabe project and at Moreton Resources’ South Burnett project; and MLD under Letters of Intent from Doray for Deflector and from Regis for expansion at Moolart Well.
They may not fly through the door given the dearth of new mining projects in Australia, but in our view more opportunities will be presented. Apart from competition driving down rates, contractors are being more inventive in their contracting styles (through alliances for example) and in ways that help junior miners progress their projects (such as drilling for equity). Anecdotally, there is an emerging trend overseas (where miners can’t hide behind the weaker A$) back toward the contractor model (in Africa for example).
So where to now? Firstly, recent share price gains need to be kept in context. If a share price falls 90%, to regain the lost ground it has to climb 900%. Ausdrill (ASL) for example has climbed 140% off its $0.18 low, but it is still way below prior trading levels.
Figure 3: Ausdrill share price last 5 years
Secondly, multiples are not demanding. According to Bloomberg, even in the current weak earnings environment EV/ FY16 EBITDA multiples range between 2.0 and 3
Figure 4: EV/ FY16 EBITDA multiples
While not for the faint-hearted, given the leverage to an improving environment, we still believe the contract mining sector is undervalued despite recent share price performance. Markets tend to put higher multiples on cyclical stocks during peak earnings, and lower multiples on these stocks during trough earnings. In our view it should be the other way around.
Recent Contacts & Presentations
Evolution Mining (EVN), St Barbara (SBM), Troy Resources (TRY), Explaurum (EXU), Sino Gas & Energy (SEH), Western Areas (WSA), Finders Resources (FND), Carnarvon Petroleum (CVN), Threat Protect Australia (TPS), Austal (ASB), Paragon Care (PGC), Salt Lake Potash (SO4), Peet (PPC), Department 13 (D13), Actinogen Medical (ACW)