The advice to “Follow the Money” in the investing arena is known as “whale watching”. Investors follow the moves of big money players – private equity firms, hedge funds, and big-name investors like Warren Buffet, Carl Icahn, and James Packer.
On occasion whales make moves that seem contrarian at best and perhaps downright foolhardy at worst. In a surprising move, US private equity whale KKR & Company slipped in and doubled its stake in struggling ASX pure copper play miner Oz Minerals Limited (OZL). KKR now owns 10% of the company, up from a 5% stake. The company reportedly paid around $3.60 per share for 14.75 million shares of OZL on 1 October. KKR made the following statement after the purchase:
· ‘We think that Oz Minerals is a good company that was undervalued in the public markets when we made our investment. We thought it was a good time to accumulate exposure to Oz Minerals shares given the environment. We went out seeking an interest in 10 per cent of the stock at a certain price and were successful in doing so.’
What appears problematic is the phrase ‘given the environment’. The price of copper has dropped dramatically along with other commodities over the past three years. Here is a five year price chart for copper.
On 26 August the price fell below US$2.25, a six year low. On the face of it this hardly appears an appealing environment. However, bullish analysts believe the expanding middle class in China will still deliver rising demand, with an accompanying rise in the price.
KKR is not the only big player with positive sentiment towards the future of copper. A month ago Chinese owned Guangdong Rising Assets Management (GRAM) completed a takeover of another ASX pure play copper miner, PanAust Limited (PAN). GRAM is a major player in Chinese real estate and construction investment.
The takeover comes after PanAust acquired a majority stake in one of the largest untapped copper deposits in Asia, the Frieda River copper-gold deposit in Papua New Guinea. The reported cost for development of the site was in excess of US$1.5 billion, a sum beyond the means of PanAust but well within the reach of GRAM.
PanAust acquired Frieda from mining giant Glencore, a company whose financial condition has been the subject of much commentary over the last weeks. Glencore is cutting its copper production, as are other miners, both major and minor. From its African operations alone Glencore will cut 400,000 tonnes of production, with US copper miner Freeport-McMoran cutting close to 150,000 tonnes from its copper operations.
Cutting production in response to lower prices reduces supply which, in theory, should cause prices to rise over time. What copper producers are doing stands in marked contrast to oil and iron ore producers who are maintaining or even increasing production to keep or increase market share. In short, copper supply could fall enough to generate a price rally in the near term future.
The London Metal Exchange (LME) tracks copper warehouse levels, which had been rising throughout 2015 but are now turning south. Here is a two month chart.
Note the reduction began around the same time the price reached its six-year low. The decrease is not necessarily a hard and fast indication of increased demand but it does support the contention of some analysts that mine closures and reduced production are impacting supplies.
KKR and GRAM can withstand the long run and they may be right about a turnaround in copper, making KKR’s move more understandable. There is speculation as to whether KKR intends to takeover Oz Minerals or perhaps act as funding partner for a potential expansion of the miner’s Carapateena copper-gold project.
Back in April Oz management announced a strategic shift to focusing on copper due to better long term trends. Apparently unimpressed, investors reacted with a 3% drop in the share price. On 6 October the company updated progress on the Carapateena project in South Australia. Oz is considering limiting early development of the project to a high grade deposit to be mined using a new technology called Hydronet (already in use in the company’s Prominent Hill mine). This approach would cost less and lead to faster results.
Anyone following the challenges faced by the mining industry over the last several years knows debt is increasingly becoming a major problem. Oz Minerals is debt-free, with about $410 million total cash on hand as of the most recent quarter.
Oz is not the only ASX pure play copper miner that could be in the cross-hairs of big money investors. The following table includes Oz and three other potential candidates.
52 Week % Change
5 Yr Expected P/EG
2 Yr Earnings Growth Forecast
We included Enterprise Value in the table because it is considered a better measure of what a company is worth and is used by big money players considering acquisitions or major stake investments. Market Cap is simply a measure of current market price times outstanding shares. EV includes common and preferred shares, minority interest ownership, and total debt, minus the company’s total in cash and cash equivalents.
From that measure we can see of the two major miners in the table, Oz Minerals (OZL) and Sandfire Resources (SFR), Sandfire appears to be valued close to its market cap. The stock that jumps off the table screaming “Buy, Buy, Buy” appears to be tiny junior miner Tiger Resources (TGS), with an EV a little more than three times its market cap. The company has an astonishing 2 year earnings growth outlook. Tiger reported $0.04 per share in FY 2014, which is expected to quadruple in 2015 to $0.018 per share and then double to $0.037 per share in 2016. Tiger has the lowest P/B in the table, less than half the current P/E for the Materials Sector, which is at 0.90. And yet the share price has been beaten to a pulp over the last year. However, the company also has the weakest balance sheet, with gearing at 117% with debt at $182 million and cash on hand at $32 million as of the most recent quarter.
What the company has going for it are two 100% owned copper projects and one promising exploration permit, all in the Democratic Republic of the Congo. The projects are in Central Africa’s Katanga Copper Belt, which includes the DRC and neighboring Zambia. Together, the reserves in the two countries are said to be the second largest in the world, behind Chilean copper reserves.
On 30 January the share price fell about 60% in response to troubling news in the company’s December quarterly reporting. After incurring more debt to buy the 40% stake of its partner in its flagship project, the company was forced to postpone its planned expansion. Some analysts questioned the quality of company management, but as of 17 August, the CEO is gone and Tiger is searching for a replacement.
On 28 August Tiger reported 2015 Half Year Results with an impressive 111% rise in revenue, but profit fell 5.6%. The company processes copper into copper cathode for use in wiring, cable, and copper rods. Despite the debt concerns, TGS has an Outperform analyst consensus rating, with two analysts at Buy, three at Hold, and one at Underperform.
Sandfire Resources (SFR) has one operating mine in Western Australia, the Degrussa Copper-Gold Project, along with six exploration projects. The Degrussa mine is a “long-life” operation with production expected to continue till 2021. It is a low-cost operation that produces about 65 thousand tonnes of copper and 35 thousand ounces of gold per year. The company’s total debt stands at $120 million with $107 million total cash, both MRQ, and gearing at 34%.
Although Sandfire has interests in producing mines with other companies, the company needs to begin producing from one of its exploration projects as the clock is ticking on the mine life of Degrussa. The share price has had its ups and downs this year with positive drilling results announcements, but one of the biggest boosts came in response to the news of the KKR investment in Oz Minerals. The following price chart shows the bump.
Avanco Resources (AVB) is a Canadian company that trades on the ASX. The banner heading on the company website states their goal – building a copper company in Brazil. Avanco has two projects in Brazil, one at Antas and another at Pedro Blanco. Antas is expected to begin producing in Q1 of Calendar Year 2016 with Pedro Blanco to follow in Q1 of 2018. Both projects are located in the Northern Brazil mining region with “world class” reserves in copper, gold, and iron ore. Avanco is debt free and is financing the projects with equity financing. US investment management firm BlackRock was one of the major funders. Like Sandfire, investors drove up the AVB share price following the Oz purchase by KKR. Even debt-riddled Tiger Resources followed the pattern. Be it due to the cuts in copper production or the interest of an investing whale like KKR, all three of the stocks have gone up. Here is a one month chart for Avanco and Tiger.