Within the universe of junior mining companies, investors need to be choosy, says Ingrid Rico, mining analyst at Toronto-based investment bank M Partners. In this interview with The Gold Report, Rico explains how analysts value miners and reveals how she will be looking at junior mining companies in 2013 - with a skeptical eye, preferring those funded to complete exploration plans for the year and a management track record to deliver results. She shares names of some companies whose projects stand out.
The Gold Report: As of Sept. 30, 2012, Toronto-based M Partners had Buy recommendations on 84% of the 58 companies it covered at that time. There are many brokerages with similar percentages. Have analysts lost some credibility in the mining space over the last few years when companies have vastly underperformed the broad market despite analysts' Buy ratings and high target prices?
Ingrid Rico: The simple way to answer that question is by explaining how we as analysts do our job. We try to do our best to demonstrate that a project makes economic sense. We look at the deposit and review mine plans. We try to get a handle on the operating challenges and the capital requirements for the project. Based on that, we build a model that needs some level of execution by the management in order to be achieved.
Over the last few years, we have seen some hiccups in the execution and delivery in the space, which has made investors grow increasingly cautious on the sector. What we're seeing now is investors needing to get that confidence back. It's not to say that the companies are not a Buy and that the target is not valid because the projects make sense economically. We have also experienced a migration of funds away from the juniors and recent producers as investors looked to mitigate risk during a period of economic uncertainty. That funds flow as much as anything has hurt the share prices of companies in the sector.
TGR: Are you adjusting your models and lowering target prices to reclaim investor confidence?
IR: We continue to look at the inputs and make our assumptions fit the challenges. We're trying to get better at understanding the challenges - the operating challenges, the capital challenges - improving our models every time.
TGR: With ounces-in-the-ground valuations, have you had to reassess those, too, given how the market is valuing these junior mining companies?
IR: Yes, we have a couple of companies under coverage that are purely valued as ounces in the ground. Just a couple of years ago, our valuation metrics were essentially double what they are now.
TGR: What are the essentials of your investment thesis when it comes to junior mining companies?
IR: We look at the jurisdictions, the infrastructure and the prospective nature of the property. Also, grade is key to the project. Desirable high grades make a project withstand the market when it is as challenging as it has been lately. Let's not forget management either. We need to have a highly skilled and experienced group who understand the market and have proven that they can do the job.
TGR: How are you factoring financing risk into your models? What adjustments have you made there?
IR: It depends on the project. We see a number of projects that have economic merit, but the project financing window is fairly narrow right now. We look at the possible financing alternatives that the project has, whether that be a royalty streaming, an offtake or the conventional debt and equity ratio.
TGR: How would you describe the financing market right now for junior mining companies?
IR: It is quite difficult for some companies currently. It's part of the cycle. In the junior space, a lot of money came in at the high of the cycle. But some junior companies fell well short on delivering results. So now the market is saying that we need to see more consolidation.
Quite frankly, some of the juniors that didn't deliver are going to disappear. That is what the market is saying. Again, it's all part of the cycle.
TGR: How does that affect your job?
IR: It makes it interesting and makes me realize that there are projects out there that do stand out. There are many projects unfairly undervalued at this point because the entire sector is suffering from a cautious investor sentiment. It's interesting to get on those companies before people start jumping in, when sentiment begins to change.
TGR: What are some ways investors can determine whether or not a junior mining company is underfunded and possibly going to fold?
IR: For exploration companies, the key metric you can look at is burn rate. You need to have a sense of its exploration budgets, its current cash position and whether it will be able to fund the program for the year or not.
For developers, the technical report gives us guidance as to what a company needs for project funding. With the sector seeing quite a few cost overruns lately, we typically build in a contingency of 15-20%.
TGR: The old rule of thumb was that all good projects will get financed. Is that still the case?
IR: Yes. The good projects that stand out will get financed. It's a matter of timing, though.
TGR: How far into the future do you see a time when the markets are going to open up and start funding companies with fresh equity issues à la 2010?
IR: It depends on the commodity. Supplies are pretty tight right now in the copper sector, and projects are going to have to get funded soon.
TGR: Can you tell us about some of your favorite companies?
IR: A company in our coverage with cash and completing its current work program is Panoro Minerals Ltd. (OTC:POROF). The company is completing a 30,000m drill project at its Cotabambas copper project in Peru.
Cotabambas is actually pretty interesting. It's located in the region where HudBay Minerals Inc. (HBM) is developing its Constancia project and Xstrata Plc (OTC:XSRAF) has started building Las Bambas. Cotabambas has proven to have great exploration upside potential. Last year, its updated resource exceeded expectations by more than doubling the resource. This year, with a 30,000m drill program, we expect another very interesting resource.
TGR: What's your target on Panoro?
TGR: Panoro is a name that often flies under the radar. Not a lot of people are talking about it. Why do you think that is?
IR: A lot of people got really hyped up at the time when many of the copper mergers and acquisitions (M&A) were happening. But copper M&A was pretty quiet last year and that's why Panoro flew under the radar.
We do believe that once that next round of M&A starts happening, this would be one of those names that people should be looking at carefully, especially given its proximity to some other bigger players.
TGR: What is happening in Africa? Are you more concerned about smaller mining plays in Africa than you were a few months ago, given what's happening in Mali?
IR: It brings the valuations lower just having that socio-political risk there. But Burkina Faso has been one of the most stable jurisdictions in Africa.
TGR: There are some companies that you have on your Watch List. These are companies that are not under coverage, but you're following them and you're tracking their news releases. These are companies that might one day graduate to coverage. What are some companies that are piquing your curiosity there?
IR: Temex Resources Corp. (OTCPK:TMXRF) in Northern Ontario is one that offers the significant exploration upside that we look for.
Temex is advancing exploration at its two projects in Northern Ontario. The company has consistently delivered on its resource growth targets. This year, it is going for a global resource of nearly 5 Moz; right now, the company has on its books 2.5 Moz.
Temex is in the right location, with one of the projects in the Timmins Camp and the other one close to where the recent M&A happened with IAMGOLD Corp. (IAG) and Trelawney Resources Inc. The management is sharp, with a good team of exploration geologists who have a handle on the properties.
TGR: Temex has some significant neighbors in the area, such as Lake Shore Gold Corp. (LSG). Would you say there's a greater likelihood of a takeover here than there is with similar plays of this size?
IR: Temex is in a great location with a few "hungry" mills in the area that would be quite interested in that property. The initial resource came out last year, and people are starting to get a handle on the property and what that resource implies, whether it is an open pit or a really high-grade underground mine.
TGR: What sort of year should mining investors expect?
IR: It seems to be shaping up as another challenging year ahead. We expect more consolidation as cash-constrained companies join well-funded partners either by choice or, in many cases, out of necessity.
Again, in the copper space, things are much tighter than people realize. First Quantum Minerals Ltd. (OTCPK:FQVLF) is bidding for Inmet Mining Corp. (IEMMF.PK) - this could be the beginning of the next round of M&A in the copper space.
TGR: Is that an angle investors should be looking to play if they want to get into this space?
IR: Yes, we think so. In the junior space, it's looking at the ones that actually stand out, the ones with cash, that will be delivering, whether that be on exploration resources or on a new resource estimate. That's what mining investors should be looking at right now.
TGR: Thanks for your time, Ingrid.
Ingrid Rico is a mining analyst at Toronto-based investment bank M Partners, covering junior producers and exploration/development-stage companies. She is a graduate of the Lassonde Mineral Engineering program at the University of Toronto.
1) Brian Sylvester of The Gold Report conducted this interview. He personally and/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 Gold Report: None. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Ingrid Rico: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.