Tim Treadgold: Investors should keep a watchful eye on small miners with high costs
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This week’s collapse of gold miner Millennium Minerals (ASX:MOY), followed by the closure of the Nifty copper mine by Metals X (ASX:MLX), were sobering reminders that even with gold in Australian dollars hovering close to an all-time high, and with copper at close to $US6,000 a tonne, there are always operational risks in mining which can crush a business.
The challenge for investors is finding a way to separate companies able to survive from those heading for trouble, and that’s a knack which requires an understanding of the triggers which can tip a stock into administration, or force the closure of a key asset.
In the case of Millennium, the writing has been on the wall (to borrow a Biblical phrase) for some time and could be clearly seen in the grade of ore being mined, because anything below 2 grams a tonne (g/t) is damnably difficult to convert into a profit unless you have a vast amount of material.
In the latest quarter (to September 30), Millennium’s average grade of ore mined in its open-pit and underground operations at Nullagine in the Pilbara region of WA was 1.69g/t.
To put that into a financial perspective a 50-tonne truck load of ore at Nullagine contains a theoretical 84.5 grams of gold, or 2.7 ounces, valued at $US3,923, using the latest international gold price of $US1,453/oz, or $5,788 in Australian dollars (using the latest price of $2,144/oz).
Given the effort that goes into producing 50 tonnes of ore which has to be drilled, blasted, loaded, hauled, crushed, milled and smelted before it yields a miserable 2.7 ounces of gold, it’s a miracle that the business survived for as long as it did.
For Millennium it has been the ore grade and cost structure which presented insurmountable problems, with the company operating at an all-in sustaining cost of $2,068/oz in the September quarter, just $76/oz less than the latest gold price.
In fact, the true picture of Millennium’s position in the September quarter was worse than that because it was not receiving the full Australian gold price, with the average selling price said to have been $1,866/oz which was $202/oz less than the all-in sustaining cost.
No business survives for long if the selling price is less than what it costs to produce.
Some investors could see last month when Millennium reported those numbers that a crisis was brewing.
Within hours of being filed at the ASX on October 22 Millennium’s share price had dropped by 25 per cent from 8c to 6c.
More cautious investors had started exiting the stock earlier when other tell-tale signs started to point to problems, including the departure of long-term chief executive Peter Cash in August when the stock was trading around 14c.
Nifty is a version of the same issues, high costs and difficult mining conditions which saw a series of owners struggle to post a profit.
The original owner, Western Mining Corporation, barely broke even from first production in 1993, which is why it sold to Straits Resources in 1998, with Aditya Birla buying the mine in 2003 and then with ownership passing to Metals X in 2016.
Four owners in 20 years speaks loudly about the problems with Nifty which were there for everyone to see, and which stood out dramatically in the latest quarter when Metals X revealed a loss of $12.9m over just three months while cash flow was negative $24.4m.
What’s most surprising is that the share price of Metals X actually rose 4c to 21c in the days after the loss was reported even though it was obvious that a small company with a stockmarket value of little more than $100m could not sustain results like that for long.
As the inevitable closure of Nifty became clearer the share price of Metals X has fallen to 12c, taking the decline since the start of last year to $1.05, or 89.7 per cent.
Another, perhaps easy, way for an investor to know when it’s time to duck for cover, is in commodity prices with the best recent examples being lithium and graphite.
These two commodities flew high in the early years of the rush into battery metals and then crashed when it became clear that demand for battery-powered electric cars was not as strong as forecast – at least in the early years.
From more than $US20,000 a tonne, lithium carbonate (one of the ways the material is traded) has fallen by more than 60 per cent to less than $US7000/t, wiping out a number of miners and forcing even the biggest players in that game to mothball brand new projects – which is what Albemarle and Minerals Resources (ASX:MIN) have done at the Wodgina project in WA.
A surplus of graphite has hurt miners of that material, but so too have processing problems which is why Syrah Resources (ASX:SYR) has been one of the biggest disappointments over the past few years, plunging by 93.7 per cent from $6.27 three years ago to 39c today.
Knowing that Syrah would have problems with graphite or that lithium miners faced a supply squeeze was never hard to work out because both are easy commodities to find and produce with the key to success always going to be the cost of production and the ability to meet customer specifications.
Other tell-tale signs to watch out for when assessing a mining potential investment include:
• Small companies rarely (if ever) succeed in developing projects costing $1 billion or more, and right now there are quite a few trying to promote projects with a price tag that high, or higher – but wise old heads know they’ll never do it.
• Small companies also rarely succeed in mining exotic minerals because they never master the marketing involved.
Gold, copper and a few other base metals such as nickel and zinc, are relatively straight forward because they have a deep and well understood market.
Rare earths, lithium, graphite and anything else where there is a small market, or where quality can be variable, will generally prove to be too difficult, and;
• Small companies will also struggle to attract reasonably-priced finance whether from investors or banks, forced to arrange high-cost funding with onerous penalties, which is what eventually forced Wolf Minerals (ASX:WLF) to close the Drakelands tungsten mine in the UK with operational problems compounding the financial drag of high-cost finance.
Big miners can also have problems in specialty commodities, with BHP’s (ASX:BHP) proposed entry into the potash business an evolving case study which will fully test the new chief executive, Mike Henry, and the BHP board.
The problem with potash is that the price is roughly 50 per cent lower than it was 10 years ago thanks to over-production.
And if BHP does bring the Jansen project into production the world will find itself with an extra 8 per cent of supply, a rise which could push the price down further, presenting a major challenge for the crop of small potash producers setting up operations in central Australia.
Rio Tinto (ASX:RIO) is also having cost and operational issues at its Oyu Tolgoi copper mine in Mongolia, but with a big balance sheet boosted by earnings from iron ore it can ride out the storm.
If there is one important consideration for investors with an eye on an emerging opportunity it is that junior companies really struggle with big projects, and find it even tougher when there are issues of quality control, marketing and thin markets for whatever is to be produced.
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