Australian Companies To Survive A Metals Market Correction

Includes: ABX, BHP, RIO
by: The Gold Report

Australian mining companies have been hard hit by falling commodities prices and rising costs. But Petra Capital Analyst Andrew Richards believes his country's resource sector has turned a corner. In this interview with The Metals Report, Richards says that costs are falling and China's need for Australian metals will continue to grow. He also names companies that are well positioned to flourish in the near future.

The Metals Report: Australian miner Newcrest Mining Ltd. [NM-TSX] 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. (NYSE:BHP) and Rio Tinto Plc (NYSE:RIO), 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: 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: There are some zinc-copper and copper-gold projects in Saudi Arabia and 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. (NYSE:ABX). 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: Briefly, are there some 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.

This interview was conducted by Kevin Michael Grace of The Metals Report and can be read in its entirety here.

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.

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.
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3) Andrew Richards: I or my family own shares of the following companies mentioned in this interview: None. Petra Capital has previously raised capital with the following companies mentioned in this interview: None. 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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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.