I. Sector Landscape and Outlook
The Australian economy stood resilient in the face of COVID-19 solid adversities, riding on the back of firm fundamentals of the resources sector. Australia’s resources and energy exports escalated fivefold in the last two decades while footing on the largest reserves of iron ore, gold and uranium. Australia stands fourth-largest in rate earth elements production, holding a 3.4% share in the world’s rare earth resources. The resources sector accounted for ~11% of the Gross Value Added (GVA) in 2020. Australia’s resources sector is the largest recipient of Foreign Direct Investment (FDI) that droves the exports with $360.1 billion, representing 35.5% of the total FDI in 2019, according to The Australian Trade and Investment Commission.
Figure 1: Broad Indicators of the Resources Sector:
Source: Analysis by Kalkine Group
Australian Government’s introduction of full expensing and temporary loss carry-back policies in the FY21 budget has established a tax favourable business environment. Despite COVID-19 impact, total private new capital expenditure inclined by 6.3% in March 2021 quarter on QoQ basis and stood at ~$31.5 billion with ~$8.8 billion contributions from the mining industry, which rose by 4.1% QoQ in the same quarter. Moreover, private mineral exploration expenditure grew from ~$2.15 billion in FY19 to ~$2.46 billion in FY20.
Figure 2: Stable Capex in the Mining Industry
Source: Australian Bureau of Statistics, Analysis by Kalkine Group
The extension of JobKeeper and Boosting cash flows for employers schemes lead to the most significant recorded subsidy in national accounts, in turn, encouraging employment. Despite global disruptions, in November 2020, employment in the mining sector edged up 8.5% relative to February 2020 employment levels. Annual employment in the mining industry fell marginally in FY20 to ~239,000 relative to ~ 247,000 workforces in FY19.
Australia facilitates its principal export partners in Northeast and Southeast Asia with a grid of 15 free trade agreements. Total international export in goods accounted for ~$35.95 billion in Apr 2021, up by 16% on a PcP basis. Metalliferous ores export touched a record high of $16.47 billion in April 2021, predominantly attributed to a 67% surge in precious metal ores and concentrates.
For the December 2020 quarter, world trade widened by 4% (QoQ basis), counteracting the COVID-19 global pandemic and positioning 2020 growth at 1.3%. On the other hand, world industrial output fell 4.4% in 2020, amidst stymied demand and international trade resulting from COVID-19 related worldwide restrictions and lockdowns. China’s industrial output, a decent proxy for commodity demand, recovered from pandemic aftermaths by September 2020.
Figure 3: Strong Global Links delivers Sustainable Growth in International Trade
Source: Australian Bureau of Statistics, Analysis by Kalkine Group
As per the Office of the Chief Economist, Australia’s top five trade partners constitutes 53% of exports in iron ore, wherein the top three importers, with their percentage of world imports, including China (68%), Japan (8%) and South Korea (5%). In 2020, Iron ore annual production stood at ~912Mt and annual export stood at 858Mt relative to ~924Mt and ~818Mt in 2019, respectively. Rising Chinese demand and supply chain disruptions in Brazil closed 2020’s iron ore price at $US140/tonne – highest recorded since 2011. Exploring for the Future program has been extended to support exploration operations across the country. Prices have subsequently uplifted, averaging well above $US150/tonne during January 2021. As portrayed by a 6% uptick in December 2020 monthly production, a significant recovery in global steel production has aggravated iron ore prices and demand.
Figure 4: Production faced Marginal Dip While Exports Improved
Source: Office of the Chief Economist, Analysis by Kalkine Group
In 2020, Global gold consumption was significantly struck by the COVID-19 pandemic, leading to a 14% decline to 3,760 tonnes. Jewellery consumption in India and China nosedived by 42% and 35%, respectively. Moreover, gold consumption in industrial fabrication plummets by 7.4% amidst containment measures in the face of COVID-19 adversities. On the contrary, gold-backed ETFs holdings improved by 120%, which surged gold imports by 8.3% in jewellery, gold bars & coins and ETFs). In addition, gold production inclined to ~329 tonnes in FY20 relative to ~322 tonnes in FY19.
Figure 5: Improved Gold Exploration Outcome Despite COVID-19 Challenges
Source: Office of the Chief Economist, Analysis by Kalkine Group
As a repercussion of the ceased mining operations of Panoramic Resources’ Savannah mine in Western Australia and Hillgrove Resources’ Kanmantoo mine in South Australia, copper production is expected to fall; however, export earnings are expected to incline by 18% YoY amidst price recovery. Nickle production is expected to uplift by 17% in FY21, primarily driven by growth in EV battery manufacturing and low global supply. Moreover, Australia’s mined zinc production was aggravated by 5.4% (QoQ) in the December 2020 quarter.
Index Performance:
The ASX 200 Resources Index has generated a 5-year return of ~100.49% as compared to ~37.46% by the ASX 200 Index. Increasing exports of resources sector, favourable support from the government to boost exploration & mining activities and building macroeconomic links drove the sector gains.
Figure 6: The ASX 200 Resources Index outperformed the ASX 200 Index in the past five years by whooping ~63.03%:
Source: REFINITIV as on the close of 10 June 2021
Key Risks and Challenges:
Australia holds an undiversified portfolio of trade partners, which may result in high systematic risks. The growing use of scrap steel in China is expected to neutralize the soured demand for iron ore which may adversely affect export volume and price. Vale (a Brazilian multinational corporation) has proposed 100 million tonnes additional output by the end of 2023, which may pose a significant competition risk to the Australian iron ore industry. Western Australia is highly susceptible to regular disruptions in transport and production amidst extreme weather conditions.
Figure 7. Key Risks Associated with the Resources Sector:
Source: Analysis by Kalkine Group
Outlook:
According to the IMF, Australia is on track to generate US$1.5 trillion, accounting for 1.6% of the global economy. The Australian Bureau of Statistics estimated ~$36.94 billion in new capital expenditure in the mining industry, a 1.5% increase from previous estimates. In the next five years, 77% of the Australian mining jobs are expected to enhance or get redesigned in-line with advanced technology. Global steel consumption is expected to rebound, with recovering global indicators, and estimated to grow by 3.6% in 2021. Export earnings in iron ore are estimated to grow at 4.1% CAGR (FY20 - FY26). The gold export volume is estimated to fall by 1.8% to 344 tonnes in FY21 and seek steady recovery, reaching 418 tonnes by FY26.
II. Investment theme and stocks under discussion (ZIM, RSG, GOR, S32)
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: ZIM (Zimplats Holdings Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$2.36 billion)
ZIM is involved in exploration and mining activities in platinum group metals, gold, silver, and base metals.
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Valuation
Our illustrative valuation model suggests that stock has a potential upside of 24.48% on 10 June 2021. We believe that the stock might trade at a slight premium compared to its peer average EV/Sales (NTM Trading multiple) given high cash inflows, streamlined redevelopment activities, favourable average prices, and a rebound in global consumption. For the said purposes, we have taken peers such as Regis Resources Ltd (ASX: RRL), Red 5 Ltd (ASX: RED), St Barbara Ltd (ASX: SBM), to name a few. Considering the redevelopment projects, outperformance in H1FY21 and FY20, favourable government policies, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $21.800, down by ~0.729% on 10 June 2021. The stock has delivered an annualised dividend yield of 4.98%.
2. ASX: RSG (Resolute Mining Limited)
(Recommendation: Speculative Buy, Potential Upside: Low Double-Digit, Mcap: A$585.06 million)
RSG is an Australian-based gold mining company with operations in Western Australia and New South Wales.
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Valuation
Our illustrative valuation model suggests that stock has a potential upside of 25.16% on 10 June 2021. We believe that the stock might trade at a some premium as compared to its peer average EV/Sales (NTM Trading multiple) given rising cash flows from operations, significant cost efficiencies, favourable average prices and rebound in global consumption. For the said purposes, we have taken peers such as Regis Resources Ltd (ASX: RRL), Red 5 Ltd (ASX: RED), Perenti Global Ltd (ASX: PRN), to name a few. Considering the establishment of power generation project, outperformance in FY20, increased Syama sulphide gold production, valuation, and trading levels, we give a “Speculative Buy” recommendation on the stock at the current market price of $0.520, down by ~1.887% on 10 June 2021.
3. ASX: S32 (South32 Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$14.05 billion)
S32 is involved in the exploration of Alumina, Aluminium, Coal and Manganese in Australia.
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Valuation
Our illustrative valuation model suggests that stock has a potential upside of 13.46% on 10 June 2021. We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) given appropriate cash position, improving operating margins despite unfavourable price movements and diversified operations in minerals. For the said purposes, we have taken peers such as Calidus Resources Ltd (ASX: CAI), Red 5 Ltd (ASX: RED), Western Areas Ltd (ASX: WSA), to name a few. Considering the initiative to exit low returning projects, diverting capex in Mozal, improving seaborne exports, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $2.980, down by ~0.335% on 10 June 2021. The stock has delivered an annualised dividend yield of 1.06%.
4. ASX: GOR (Gold Road Resources Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$1.26 billion)
GOR is involved in the exploration of Alumina, Aluminium, Coal and Manganese in Australia.
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Valuation
Our illustrative valuation model suggests that stock has a potential upside of 17.75% on 10 June 2021. We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) given appropriate cash position, considerably high EBITDA levels and significant improvement in gold volumes. For the said purposes, we have taken peers such as Alkane Resources Ltd (ASX: ALK), OZ Minerals Ltd (ASX: OZL), Strandline Resources Ltd (ASX: STA), to name a few. Considering 35 – 50% increase in annual production by FY23, improved throughput rates, higher head grades, valuation, and trading levels, we give a “Hold” recommendation on the stock at the current market price of $1.445, up by ~0.696% on 10 June 2021. The stock has delivered an annualised dividend yield of 1.03%
Note: All the recommendations and the calculations are based on the closing price of 10 June 2021. The financial information has been retrieved from the respective company’s website and REFINITIV.
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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