I. Sector Landscape and Outlook
Australia is one of the top five exporters of minerals and fuels in the world. The nation produces 19 most useful minerals from over 350 operating mines. Australia is the global leader in mineral exploration and production with the number one position in the production of bauxite, iron ore, rutile, and lithium. Besides, the nation holds the world’s largest resources for gold, iron ore, lead, rutile, uranium, zinc, and zircon.
The Metals and Mining sector forms part of the resources sector that contributes 11.1% of the Gross Value Added to the economy totalling $202.4 billion in 2019-20. Due to a rich reserve base for lithium and rare earth minerals that are being deployed in the next generation renewables energy requirements, the mining sector topped the nation’s largest destination for foreign investment with $360.1 billion in 2019, representing 35.3% of the total $1.02 trillion received.
Of the total exports of $475.24 billion in 2019-20, iron ore, coal, and natural gas together accounted for ~ 43.1%. The nation set a record gold production during 2019 and Fosterville, VIC boasts the world’s highest-grade gold mine.
Figure 1: Australia is the World’s Largest Exporter of Iron Ore:
Data Source: The Department of Foreign Affairs and Trade, Chart Created by Kalkine Group
Australia has vast unexplored mineral resources. According to Geosciences Australia, about 80% of the continent is untapped and yet to be explored. High-grade mineral resources have been discovered in the regions of Pilbara and Eastern Goldfields in Western Australia, the Gawler Craton in South Australia, and the Bowen Basin in Queensland. Australia is the world’s largest lithium producer accounted for 56% of world production in 2019. On resources base, the nation topped the chart with number 1 ranking for iron ore with resources base of 30,340 MT (measured and inferred resources). This was followed by gold with a 21% share in the world resources, according to the data by Geosciences Australia.
Figure 2: Reserves and Resources of Selected Minerals and Commodities in 2019:
Data Source: Geosciences Australia, Chart Created by Kalkine Group
Exports of mineral resources continue to show upward trending reaching ~$53.8 billion in December 2020 quarter, according to the Department of Industry, Science, Energy and Resources. The surge in iron ore prices to a nine-year high drove the exports. Supply constraints continued in Brazil and a surge in demand from China and advanced economies lifted the iron ore prices. It is worth mentioning prices of base metals have more than recovered from COVID-19 losses. Expansion by major players to benefit iron ore exports like BHP’s plans to achieve full production in its South Flank project, the restart of The Roper Bar Mine in the Northern Territory, NT Bullion’s new Frances Creek mine to enter commercialization are some of the developments to positively impact iron ore exports going forward.
Figure 3: Export Trend of Iron Ore and Total Mineral Resources in Australia:
Data Source: Department of Industry, Science, Energy and Resources, Chart Created by Kalkine Group
Spike in gold prices continues as the UK continue to import gold and strong demand for gold ETFs drew investors in Switzerland and the US. Australia is expected to outpace China as the world’s largest producer of gold in 2021, according to the Department of Industry, Science, Energy and Resources. The COVID containment measures saw a decline in automobile production which had resulted in a fall in aluminium prices at The London Metal Exchange by 6.2% in 2020. But exports recovered subsequently as the economy re-opened. Favourable regulations on green energy and electrification requirements are expected to boost copper prices.
Figure 4: Export Trend of Selected Resources:
Data Source: Department of Industry, Science, Energy and Resources, Chart Created by Kalkine Group
Index Performance:
The ASX 300 Metals & Mining Index generated one-year returns of ~+42.62% as compared to ~+31.90% by the ASX 200 Index. The resurgence of industrial activity following the re-opening of the economy, favourable prices, strong exports of mineral resources, supporting government policies helped to post the sector gains.
Figure 5: The ASX 300 Metals & Mining Index outperformed ASX 200 Index by ~10.72% over the last one year.
Source: Refinitiv (Thomson Reuters) as on the close of 7 April 2021
Key Risks and Challenges:
Declining ore grades and aging mining facilities may lead to higher production costs. Likely closure of many high-cost mines in Brazil and China to hamper global supply of iron ore. The commercialization of mines incurs substantial costs and is largely dependent on the outcome of various feasibility studies. Any delay in projects may create funding pressure on operators. Global demand and supply constraints have a significant influence on the prices of commodities and resources. China accounts for about half of the world’s copper consumption. The sector performance is therefore influenced by geopolitical risks. Import curbs by China and localised shutdowns to counter COVID-19 may halt manufacturing activity and distort the market. Aluminium is widely used in the infrastructure and construction market. The government’s various stimulus package holds the demand for construction activity in China and Vietnam. Rollback of such stimulus to affect demand and supply imbalances.
Figure 6. Key Risks in The Metals and Mining Sector:
Sources: Analysis by Kalkine Group
Outlook:
Australian mining operators resumed their capex plans with mineral and exploration expenditure rose by 2.5% to reach $718.4 million in December 2020 quarter (on a QoQ basis). Exploration activity of selected base metals reported the largest rise (+12.5%) and mineral deposits at existing mines grew 4.2%, according to the data by The Australian Bureau of Statistics. This may positively impact production and uplift exports of minerals in the near term. Favourable policy regulations towards green and renewable energy requirements across the globe will lift demand for new technology commodities such as copper, lithium, and nickel. Base metals demand should rise as industrial activity recovers further across the globe. Rising US bond yields and mass vaccination roll-out will keep gold prices in control in the near term. The Department of Industry, Science, Energy and Resources is expecting export earnings to reach $296 billion in 2020-21 as Australia’s resources sector is poised to capture the demand for new and low emission technologies.
II. Investment theme and stocks under discussion (NST, RRL, BSL, ILU)
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 ‘EV/Sales’ method.
1. ASX: NST (Northern Star Resources Ltd.)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$12.39 Billion)
NST is a gold producer with mining assets located in Australia, the US, and Canada. It owns Jundee, Kalgoorlie operations, Pogo, and Tanami mining assets.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 26.23% on 8 April 2021. We believe that the stock might trade at a premium as compared to its peer average EV/Sales (NTM Trading multiple) as the management is expecting strong performance in its US operation (Pogo mine). The company had sizeable unhedged exposure which may benefit from the current rally in gold price impacting realization and margin. For the said purposes, we have taken peers such as Alkane Resources Ltd. (ASX: ALK), Newcrest Mining Ltd. (ASX: NCM), OZ Minerals Ltd. (ASX: OZL). The stock delivered annualized yield of 2.72%.
2. ASX: RRL (Regis Resources Ltd.)
(Recommendation: Buy, Potential Upside: Low Double Digit, Mcap: A$1.59 Billion)
RRL is engaged in the gold production and exploration of mineral resource. It operates mines in Australia and Africa.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 27.21% on 8 April 2021. We believe that the stock might trade at a slight discount as compared to its peer median EV/Sales (NTM Trading multiple) as the company wind down its exploration budget owing to the pandemic which may affect production growth in the near-term. Delay in Garden Well Underground project may lead to cost overruns and affect margins. For the said purposes, we have taken peers such as Iluka Resources Ltd. (ASX: ILU), Western Areas Ltd. (ASX: WSA), Red River Resources Ltd. (ASX: RVR). The stock delivered annualized yield of 3.85%.
3. ASX: BSL (BlueScope Steel Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$10.24 Billion)
BSL is engaged in the manufacturing of steel slabs, plates, hot and cold rolled coils, and coated and painted strip products for building and construction, automotive, whitegoods, and manufacturing industries.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 17.43% on 8 April 2021. We believe that the stock might trade at a slight discount as compared to its peer average EV/Sales (NTM Trading multiple) as the company is exposed to global commodity prices which are influenced by demand and supply imbalances and geopolitical risks. Its exposure to construction market may weaken due to expiry of various government stimulus. For the said purposes, we have taken peers such as Resolute Mining Ltd. (ASX: RSG), Red 5 Ltd. (ASX: RED), St Barbara Ltd. (ASX: SBM). The stock delivered annualized yield of 0.68%.
4. ASX: ILU (Iluka Resources Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$3.09 Billion)
ILU provides mining, concentration and separation of mineral sands and titanium minerals. Besides, it produces ilmenite and other titani-ferrous concentrates, zircon, and synthetic rutile alongside coal exploration activities.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 18.58% on 8 April 2021. We believe that the stock might trade at a discount as compared to its peer median EV/Sales (NTM Trading multiple) as the company’s realization are influenced by global zircon prices. Depletion in mine reserves and low-grade ores at Jacinth-Ambrosia may continue to affect production costs. For the said purposes, we have taken peers such as Panoramic Resources Ltd. (ASX: PAN), Fortescue Metals Group Ltd. (ASX: FMG), Alkane Resources Ltd. (ASX: ALK). The stock delivered annualized yield of 0.84%.
Note: All the recommendations and the calculations are based on the closing price of 8 April 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.
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