I Sector Landscape and Outlook
Australia has rich world-class deposits of over 70 types of minerals and more than 23 mineral commodities are being produced from about 300 mines. Mining and exploration accounted for ~10.4% of GDP in September 2020 quarter. Australia is among the top 5 exporters of minerals in the world with significant reserves of iron ore, gold, and liquefied natural gas. The nation scores second in the reserve base for bauxite, nickel, lithium, and cobalt. The Diversified Metal sector serves as a cornerstone for battery manufacturers with rich lithium reserves to contribute to rapidly growing demand for lithium-ion batteries that power homes and electric vehicles.
Figure 1. Australia’s World Ranking in Minerals and Energy in 2019:
Source: Australian Trade and Investment Commission, Table by Kalkine Group
Australia’s iron ore resources are geographically concentrated in the Pilbara region of Western Australia. Almost all black coal resources are in Queensland and New South Wales. South Australia holds significant copper and uranium deposits. Silver, Zinc, and Lead were predominantly held in Queensland.
Figure 2. Distribution of Mineral Deposits by Selected States:
Source: Geoscience Australia, Analysis by Kalkine Group
The Diversified Metal sector provides a cornerstone in economic development supplying rare earth elements for use in everyday and essential products such as mobile phones, flat-screen monitors, wind turbines, solar panels, among others.
Exports of metal ores and minerals stood at $13.91 billion on a seasonally adjusted basis in December 2020 representing ~37.3% of total exports. Australia is the world’s largest producer of iron ore. Export volumes of iron ore is upward trending driven by robust demand from China following government stimulus. Aluminium output grew on the back of a surge in production at Rio Tinto’s facilities in Queensland. The fallout of the pandemic saw a rise in gold prices, but with subsequent vaccine roll-out, gold miners returned to full production. Production at Kirkland Lake Gold’s Fosterville mine and Newmont Mining’s Boddington mine in WA posted expansion. An increase in consumption and ramp-up of capacity by miners led to an increase in copper exports.
Figure 3. Exports Showing Increasing Trend of Selected Metals and Ores:
Source: Data from Australian Bureau of Statistics, Chart Created by Kalkine Group
With increased trading activity and surge in global consumption, Australia saw investments of over $130 billion for developing bulk, base, precious, and critical mineral projects over the last five years. According to the Australian Trade and Investment Commission, the mining sector drew the largest investments from overseas investors accounting for 35.3% of the total investments received in 2019. To strengthen mining exploration activity, the government has forged a bilateral trade agreement with Peru. The aim is to eliminate about 99.4% of tariffs in iron ore, copper, nickel, coal, mineral fuels, and oil. Australian companies made investments of ~$600 million in Peru for exploration and operational activities. The government has 15 free trade agreements in-force with more than 20 partners to open the economy and boost exports.
Much of Australia’s export markets for resources have registered expansion. With gold prices normalized, gold miners across the globe focused on expansion with a pipeline of projects and are keen on extending the life of existing mines. Copper expansion at Oz Mineral’s Prominent Hill mine and BHP’s exploration activity at Oak Dam project are notable mineral expansion off late. Expenditure on Mineral exploration activity increased by 9.0% to $744.9 million in September 2020 quarter. New mineral deposits rose 12.4% over last year. As indicated by the Australian Bureau of Statistics, gold exploration spending recorded the largest rise of 17% in the same period.
Figure 4. Gold, Iron Ore and Base Metals Drove the Exploration Expenditure:
Source: Data from Australian Bureau of Statistics, Chart Created by Kalkine Group
Index Performance:
The ASX 300 Metals & Mining Index generated returns of ~+21.13% in the last one year as compared to negative returns of ~-2.27% by S&P/ASX 200 Index. Expansion by miners following easing restrictions, surge in consumption, and strong exports drove the sector gains.
Figure 5: The ASX 300 Metals & Mining Index outperformed ASX 200 Index by 23.4% over the last one year
Source: Refinitiv (Thomson Reuters) as on the close of 10 February 2021
Key Risks and Challenges:
The second wave of virus infection affected the consumption of copper outside China. However, as copper-intensive stimulus spending picks-up, consumption showed a revival. Export volumes of bauxite volumes are projected to decline affecting aluminium exports by 7.1% in 2020–21 mainly due to softening of prices as per The Department of Industry, Science and Resources. In addition, Guinea has overtaken Australia as China’s largest supplier of bauxite since 2017. Increasing geopolitical risk such as the re-opening of WTO complaint against Japan by the government of South Korea may disrupt the global supply-chain.
Figure 6. Key Risks in The Diversified Metals Sector:
Sources: Analysis by Kalkine Group
Outlook:
The government is spearheading the Diversified Metals sector in Australia with spend of ~$2.3 billion on mineral exploration in 2018-19 as mentioned by the Minerals Council of Australia. Gold exploration drew significant investment. Spending by the government to see traction after the recent pronouncement by the Australian Productivity Commission that government spending on the sector is disproportionately small. The mining industry drew just 4.3% of the total assistance of $12.1 billion by the government in 2018-19. Rapid swift to electric vehicle and residential battery storage to see an increase in demand for lithium, and rare earth metals. In a separate report, investments in nickel, cobalt, rare earths, and lithium showed a 7% increase in twelve months ending to October 2020 backed by an ongoing battery storage revolution. Gold production surged due to higher output in several large gold mines. Australia’s gold exports are forecasted to reach $30 billion by 2020-21, an increase of 23% on a YoY basis according to The Department of Industry, Science and Resources. Exploration activity for silver, lead, and zinc has increased 56% (on a QoQ basis) in September 2020 quarter. Opening-up of mines and surge in production at Queensland may accentuate zinc export volumes to 1.6 million tonnes in 2021-22.
II. Investment theme and stocks under discussion (AWC, AMI, ILU, WSA)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘Price/Earnings’ method.
1. ASX: AWC (Alumina Limited)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$4.90 Billion)
Alumina Limited is an Australian resource company that produces alumina and bauxite. It operates through Alcoa World Alumina & Chemicals, a joint venture with Alcoa.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 22.27% on 11 February 2021. We believe that the stock might trade at a slight discount compared to its peer average Price/Earnings (NTM Trading multiple) as the company is expecting alumina output to remain broadly flat in FY20. Surplus alumina availability in the market may continue to have an impact on the realization going forward. For the said purposes, we have taken peers such as Mincor Resources NL (ASX: MCR), Alkane Resources Ltd. (ASX: ALK), OZ Minerals Ltd. (ASX: OZL). The stock delivered an annualized dividend yield of 5.53%.
2. ASX: AMI (Aurelia Metals Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double Digit, Mcap: A$506.07 Million)
Aurelia Metals Limited is an Australia-based gold and base metals mining and exploration company. The company operates three gold mines - Peak Mine, Hera Mine, and Dargues Mine in New South Wales.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 26.42% on 11 February 2021. We believe that the stock might trade at a slight premium as compared to its peer average Price/Earnings (NTM Trading multiple) as the management believes that the acquisition of Dargues Gold Mine is expected to increase the gold output to 100-113 koz in FY21 (up from 92 koz in FY20). For the said purposes, we have taken peers such as Resolute Mining Ltd. (ASX: RSG), Macmahon Holdings Ltd. (ASX: MAH), Regis Resources Ltd. (ASX: RRL). The stock delivered an annualized dividend yield of 2.43%.
3. ASX: ILU (Iluka Resources Limited)
(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$2.94 Billion)
Iluka Resources Limited operates as a mineral sands company. The company operates mines in the Midwest and Southwest of Australia and the United States.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 18.25% on 11 February 2021. We believe that the stock might trade at a slight premium as compared to its peer median Price/Earnings (NTM Trading multiple) given the fact the company plans to foray into mining of rare earth metals. Demand for rare earth metals is upward trending given the rapid adaption to electric vehicles and growing renewables energy space. For the said purposes, we have taken peers such as Saracen Mineral Holdings Ltd. (ASX: SAR), Calidus Resources Ltd. (ASX: CAI), Imdex Ltd. (ASX: IMD). The stock delivered an annualized dividend yield of 0.60%.
4. ASX: WSA (Western Areas Limited)
(Recommendation: Hold, Potential Upside: Low Double Digit, Mcap: A$693.16 Million)
Western Areas Limited operates as a mining and exploration company. The company mines nickel ore. It serves customers in Australia.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 16.92% on 11 February 2021. We believe that the stock might trade at a slight premium as compared to its peer average Price/Earnings (NTM Trading multiple) as the management is optimistic that nickel battery-based electric vehicles to drive the market going forward. Further, the company secured a contract for supplies to EV battery maker. For the said purposes, we have taken peers such as Strandline Resources Ltd. (ASX: STA), Bellevue Gold Ltd. (ASX: BGL), Red 5 Ltd. (ASX: RED), Mincor Resources NL (ASX: MCR). The stock delivered an annualized yield of 0.79%.
Note: All the recommendations and the calculations are based on the closing price of 11 February 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
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