The Metals Report: Australian mining Newcrest Mining Ltd. (NM:TSX; NCM:ASX) has announced huge layoffs and capital expenditure cutbacks. Does this signify a crisis in the space?
Andrew Richards: "Crisis" is certainly a strong word, but there is definitely a correction occurring in the market. Gold and iron ore in particular have come off their peaks. What we are seeing in Australia is a lot of cost-cutting across the board. That's probably something that needed to happen because labor costs had risen significantly over the last few years due to competition for personnel. The big companies, such as BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) and Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), have said that Australia has become relatively uncompetitive because of very high labor and engineering costs.
With the fall in some of the commodity prices, companies have had to lay off people where they can and put a stop to some of the planned growth projects. Newcrest was an example of that. Companies are now focusing on cash flow rather than just growth. They want to maintain or improve margins where they can. But I will say I think Australian costs have peaked and are already on their way down.
TMR: Australian mining billionaire Gina Rinehart last month accused Prime Minister Julia Gillard of treating the mining industry like an ATM. How much of a threat to the industry is the Labour government's mining tax?
AR: The mining tax, at this stage, affects only iron ore and coal. And companies need to make a profit of at least $75 million ($75M) before that tax kicks in. It certainly has an impact on big companies, such as Fortescue Metals Group Ltd. (FMG:ASX), BHP and Rio Tinto. Having said that, the government had estimated significantly higher revenues from the tax than it has received. Maybe that's a reflection of the pullback in commodity prices, particularly iron ore.
Moving forward, there is an election in Australia in September, and the polls are saying that the current government will lose. The incoming government, should they win, has said publicly that they would remove this tax. So we'll wait and see what happens in September.
TMR: Let's talk about some of the companies you cover. Alkane Resources Ltd. (ANLKY:OTCQX; ALK:ASX) has zirconium, niobium and gold. What are the challenges of managing a company that has such diversified resources?
AR: Alkane's Dubbo zirconium-niobium project is certainly unique. With these sorts of projects, you have to make sure you have a flowsheet that works and is proven. Alkane has had a pilot plant operating for over four years now, so it has actually proven that flowsheet and sent product off to customers. It has signed an offtake agreement with a significant Japanese company, Shin-Etsu Chemical Co. Ltd. (SHE:Fkft). Obviously, there are always risks as you scale up from the pilot plant to the major plant, but I think the company has mitigated them as much as possible. The key now is getting Dubbo funded.
TMR: In April, Alkane came out with a revised feasibility study for Dubbo with a capex of $996M. How is this new feasibility study better than the previous one?
AR: Alkane did reduce the capex by around $70M. It made some improvements with the water recycling, which means that it could reduce the size of the evaporation ponds required. That was quite positive. Also, it slightly improved the costs, and the company has some improvements coming through on recoveries, which could help on the revenue side.
TMR: How does Alkane intend to raise this nearly $1 billion ($1B)? How important are offtakes and cash flow from its Tomingley gold project in this regard?
AR: Tomingley will produce 50,000-60,000 ounces (50–60 Koz) annually starting early next year. It's a nice little cash flow generator: At current gold prices, the project should generate about $20–25M/year. Alkane may well look to do some hedging should the gold price find support and have a bit of a run up over the next three to six months.
The plan with Dubbo is to sell up to 15% at the project level for anywhere from $150–200M. I mentioned Shin-Etsu, which has signed a memorandum of understanding (MOU), and there is strong interest from other companies in Asia and North America. The company is also talking to government agencies, which could provide cheap debt, up to $400M at low interest rates. So that adds up to around $550–600M. Alkane has appointed Credit Suisse and Sumitomo Corp. (8053:TKY; SSUMF:OTCPK) of Japan to help facilitate the project selldown and negotiate government debt. All together, that could mean $800M in funding. The balance would be equity, and Alkane is targeting a maximum of $200M. The first thing we'll see will be the selldown, hopefully by the end of this year.
TMR: How crucial have offtakes become to companies involved in setting up nonprecious minerals projects?
AR: They are important; there's no doubt about it. I think there is a window open over the next four to five years for companies such as Alkane to lock in long-term offtakes. Shin-Etsu is a major player in the rare earth element industry. It has a separation plant in Japan, and it will be treating the concentrate that Alkane produces. The market will be looking to see these MOUs convert into offtake agreements over the next six to 12 months.
TMR: How confident are you that Alkane is a winner going forward?
AR: I think it is in a great position. I'm confident that it will get the funding for Dubbo and deliver on what it has said it is going to do. Dubbo's economics are very attractive. The $1B capex should be paid back within five years. Dubbo's current reserve equates to a mine life of over 30 years, and the resources equate to over 70 years. And it will be providing not just light rare earths but a majority of heavy rare earths, which are in short supply, as well as the zirconium and niobium. It is certainly far more advanced than a number of other competing projects globally.
TMR: Let's talk about Crusader Resources Ltd. (CAS:ASX). It has the Posse iron ore project and the Borborema gold project in Brazil. Posse just went into production. How does this affect Borborema?
AR: Posse is a small iron ore project. It started producing at 300,000 tonnes per annum (Ktpa) and recently just got the environmental approval to expand to 1 million tonnes per annum (Mtpa). What distinguishes Posse is its cash costs. It is targeting $12/tonne, which is bottom quartile globally. Current iron ore prices are around $110/tonne. It will be selling high-grade ore for anywhere between $75–100/tonne. So the margins are quite good. That will start generating some good cash flow: at current production rates, probably at least $1M/month. At the expanded rate of production, it could be three times that.
Posse provides cash flow to Crusader, which can then be used to move Borborema forward. Crusader is currently doing a bankable feasibility on Borborema. We're talking about production of about $100 Koz/year at cash costs of around $750 an ounce ($750/oz).
TMR: Is that all in?
AR: All-in cash costs are probably more like $950/oz, so it's still attractive at current prices. We won't get the final numbers until probably later this year, so these are my estimates. It has 1.6 Moz in reserves and 2.4 Moz in resources. It is open-pit, and the costs should be low because of the cheap labor and power available in Brazil.
TMR: Where do you see iron ore prices going?
AR: What I've read from some of the larger brokers is that prices are close to the bottom right now. We'll wait and see. Commentators say that stockpiles in China are falling, and there is a real possibility they could look to restock in the second half of 2013, which might help support prices.
TMR: Alara Resources Ltd. (AUQ:ASX) has the Khnaiguiyah zinc-copper project in Saudi Arabia and the Washihi-Mullaq-Al Ajal and Daris copper-gold projects in Oman. Is the Gulf Region particularly mining friendly?
AR: It is. Saudi Arabia, obviously, has a long history with oil and gas. However, it is now looking to develop its mining industry to create employment and a more diverse economy. We've seen some companies move into Saudi Arabia in the last five to six years. Citadel Resources Group had a copper-gold project that Equinox Minerals Ltd. bought, which was then bought by Barrick Gold Corp. (ABX:TSX; ABX:NYSE). There is another zinc-copper project to the south called Al-Masane, and there are some government-owned gold projects. Saudi Arabia is a good place for investment. Corporate tax for 100% foreign-owned entities is only 20%. There are no royalties. Diesel is just $0.08/liter.
Oman has a longer mining history. It is copper rich and has a copper smelter on the coast. Fuel is only slightly more expensive there than it is in Saudi Arabia but is still very cheap.
TMR: What are the highlights of the Khnaiguiyah feasibility study released in April?
AR: The feasibility study showed a 13-year mine life, production of 80 Ktpa zinc and about 6 Ktpa copper. Cash costs are attractive at $0.46/pound ($0.46/lb) zinc. That's after copper credits in the first seven to eight years. Life-of-mine cash costs are $0.50/lb. So at current prices of around $0.85/lb, it looks good. Longer term, I think it should be quite exciting, as most groups forecast that zinc will be in a deficit within two to three years because of some large mines shutting down. That could be very good timing for Alara with first production targeted to begin by late 2015.
The capex is $257M. The Khnaiguiyah project has access to the Saudi Industrial Development Fund, which has billions of dollars and can provide up to 75% of the capex. The application process to this fund is underway, and the company is targeting completion of that by the end of this year. So Alara is in a much better position to get its project funded than some of the other juniors.
TMR: What do you think about the copper-gold assays that Alara has been getting at Washihi?
AR: They're very good. It has been getting big, thick intersections of 70–80 meters (70–80m) and over 100m of over 1% copper plus gold, at reasonably shallow depths as well. It looks like it could be an open-pit operation with quite a modest strip ratio. More important, the deposit is still open along strike and also at depth. The current resource is around 9 million tonnes (Mt), and I think that will be upgraded in the next couple of months. I think Washihi will start off small, but Alara could get it up and running within two years, so the company could have two projects running by late 2015.
TMR: How would you rank Alkane, Crusader and Alara?
AR: All three offer significant upside. Crusader has just started generating cash flow, which is attractive to investors in the current market. Alkane is not far behind, with its gold project starting up early next year. And Alara has its low-cost zinc project in Saudi Arabia and upside from its copper project in Oman.
TMR: Briefly, are there any other Australian mining projects (not necessarily ones that you cover) that you think are particularly noteworthy?
AR: In this market, everyone is looking at projects that have low costs and can make money throughout the cycle. In gold, Regis Resources Ltd. (RRL:ASX) is one that stands out. It certainly has low costs and an appealing growth profile. In copper, PanAust Ltd. (PNA:ASX) and Sandfire Resources NL (SFR:ASX) are certainly making very healthy margins. In iron ore, BC Iron Ltd. (BCI:ASX) has been a standout. It has been one of the best performers of the past few years with very healthy margins at current prices.
TMR: How much does the economy of Australia depend on Chinese industrial expansion?
AR: Australia is quite dependent on China because we are still a commodity country, and China now consumes around 40% of metal production across the board. It's a big consumer of our iron ore and coal. There is concern at the moment that China is slowing, but with growth figures of 7–7.5%/year, it still looks pretty healthy. And, of course, China's base is a lot bigger than it was even a few years ago.
TMR: How do you stand on the debate over the so-called commodity supercycle? Do you think we can expect it to last for a while longer?
AR: Yes, I do not think that the cycle is over. Our view remains that China still has a lot of growth ahead of it, and it looks like the U.S. is starting to pick up as well. Hopefully, we'll start to see that come through in the next six to 12 months. Europe still has its issues, but if the U.S. and China continue to grow, then the outlook is pretty positive.
TMR: Do you think that the Australian economy's best days are ahead of it?
AR: Good question. Australia has done well for quite some time. A number of mining companies said that our resource market has become uncompetitive, but we're starting to see improvements. Also, the Australian dollar had been very strong for a couple of years now, but it's now back down to around $0.94 to the U.S. dollar. A weaker currency really positively impacts revenue in the Australian resources industry because commodities are priced in U.S. dollars. And Australia remains a very attractive place for investment given its low geopolitical risk. Looking ahead, there is a lot to be positive about, and I expect better times from the second half of 2013 onward.
I think that investors just have to be a bit more selective. There are a number of projects that are high cost and will struggle, but there are also plenty of attractive projects, including the ones I've mentioned, that will make good money throughout the cycle. And when the cycle picks up again, these projects will do extremely well.
TMR: Andrew, thanks so much for your insights.
AR: A pleasure, Kevin.
Andrew Richards is a rated analyst in gold and base metals with Petra Capital of Australia. He is a geologist and has worked for such major miners as Newcrest Mining and Western Mining. He has over 15 years experience as an analyst, including for such leading firms as Merrill Lynch and Shaw Stockbroking.
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1) Kevin Michael Grace conducted this interview for The Metals Report and provides services to The Metals Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Metals Report: Alkane Resources Ltd. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Andrew Richards: I or my family own shares of the following companies mentioned in this interview: Alkane Resources, Crusader Resources and Alara Resources. Petra Capital has previously raised capital with the following companies mentioned in this interview: Alkane Resources, Crusader Resources and Alara Resources. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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