15/09/2014 - 14:18

Painful proof that size matters

15/09/2014 - 14:18

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Investor interest in base metals stocks is rising, as iron ore process continue to slide south.

Painful proof that size matters
COST ANALYSIS: Smaller miners including Mt Gibson, BC Iron, Atlas, Grange, and Gindalbie are coming close to break-even point as the iron ore price continues to fall.

Like ships in the night, two very different parts of Western Australia’s mining industry have quietly slipped past each other, with hardly anyone noticing an event that marked the end of one boom and the possible start of the next.

Heading south at a rapid rate is a flotilla of small iron ore stocks, which are being crushed by the falling price of their commodity.

Heading north at an equally rapid rate is a group of base metal miners, those producing metals with rising prices – including nickel, copper and zinc.

Iron ore – because it is where investors and government are most acutely feeling the pain – is dominating headlines and bar-room chatter of people who failed to recognise that small companies rarely succeed over the long haul in a bulk commodity business.

One example tells all you need to know about the cost advantage enjoyed by big iron ore miners such as Rio Tinto, BHP Billiton and Fortescue Metals Group over small miners – railways versus trucks.

There are other advantages such as ore quality, but shifting a bulk commodity by truck (even if you call several trailers joined together a roadtrain) cannot compensate for the savings possible by using a heavy-haul rail system.

Two items of recent investment-bank research best illustrate what’s happening.

Firstly, UBS published a refreshed version of its table which shows the break-even iron ore price for eight Australian iron ore miners, with the big two (BHP Billiton and Rio Tinto) enjoying substantially lower costs, and the other six being dangerously close to break-even, or worse.

Rio Tinto’s break-even price is said to be $US45 a tonne for 62 per cent ore. BHP Billiton is $US50/t while FMG, the third big producer, is said by UBS to have a break-even price of $US74/t, which is only $US9/t below the recent iron ore price of $US83/t.

The others, in ascending order, are: Mount Gibson Iron, $US78/t; BC Iron; $US81/t. Atlas Iron; $US85/t. Grange Resources (which operates a mine in Tasmania); $US88/t; and Gindalbie Metals, $US100/t.

The day before UBS rang the alarm bell on break-even costs, investment-banking rival Deutsche Bank was holding a ‘base metals corporate day’ in Sydney, with the major participants being WA nickel and copper producers.

Stars of the Deutsche day were Independence Group, Western Areas, Sandfire Resources and Panoramic Resources, all of which earned ‘buy’ tips from the bank, with a fifth, Sirius Resources, qualifying for a ‘hold’ recommendation.

You might think that it hard to measure the gap between the troubled group of small iron ore stocks analysed by UBS and the buoyant group of base metal stocks analysed by Deutsche Bank, but there is a way – the stock market.

Share price movements are an easy test and the result predictable. Small iron ore stocks have been in freefall all year as the major producers of low-cost ore have expanded output because they are immensely profitable even at today’s low iron ore price.

A better way is to look at the market capitalisation data, which measures how much a company is worth; and that’s when the analogy of ships passing in the night rings truest, as these two calculations show:

• the collective value of five prominent iron ore stocks has plunged to a collective $1.7 billion; and

  • • the collective value of five well-known but often overlooked base metal miners has soared to a collective $4.8 billion.

As a piece of analysis, that comparison falls into the rough-and-ready category, but it sits very comfortably alongside the advice from Deutsche Bank: “Base metals are the place to be”.

In detail, this is how the individual values of the companies looks: Mt Gibson (as at September 8) had a market value of $694 million; Atlas Iron $532 million; BC Iron $263 million; Gindalbie Metals $64 million; and Iron Ore Holdings $155 million … total $1.7 billion.

The base metal values looked like this: Sirius $1.3 billion; Western Areas $1.2 billion; Independence Group $1.1 billion; Sandfire Resources $961 million; and Panoramic $265 million … total $4.7 billion.

If the trend continues with iron ore prices staying low (or even falling further as the big producers continue to expand) and base metal prices rise, then the gap will widen.

Cats and pigeons

TALKING up takeovers is a game often played by stockbrokers and investment bankers when there’s not a lot happening on the market, which is a reason to discount the latest observations about the Australian media industry from Citigroup.

However, the fact that a big US-based financial group has invested time and spent money to produce a 36-page report on who might buy what in a theoretical feeding frenzy in the Australian media sector is worth noting, especially as a few WA assets cop a mention.

According to Citi, “the battle lines are being drawn” for a period of intense merger and acquisition activity, which it believes boil down to three possible scenarios.

• Nine Entertainment (the Channel Nine network) moving first to secure a radio network, putting Seven West and News Corporation on the back foot given cross-media rules.

  • • News and Seven West “negotiating the transfer of certain assets”.
  • • Fairfax going on the offensive, selling radio assets and then bidding for Nine.

Bankers loves this sort of stuff because it earns fees by stirring investor interest, while possibly egging on media company managers to move quickly for fear of missing out.

For WA, the key Citi observation is on page 13 of the document, because that’s where it says that: “It could make sense for Seven West to sell The West Australian newspaper to News”.

If that happened, and this could be merely a banker’s thought bubble, News could then consolidate its Sunday Times with The West, expanding its national footprint and delivering cost synergies across the local operation.

As an exercise in putting a cat among the pigeons that’s not a bad effort from Citi.

STANDING BY BUSINESS. TRUSTED BY BUSINESS.

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