Key points
- The resource sector badly needs consolidation. The mining boom inevitably led to a rush of junior explorers raising capital and listing, and an even wider gulf between small- and mid-cap companies.
- Predators like to swoop on quality assets like South32 that can become significantly more efficient, before those gains are in the valuation.
- Independence Group chose to add more nickel to its portfolio through the acquisition of Sirius, but its ambition could extend to neighbour Gold Road Resources.
Nobody knows for sure how China’s economy will slow or when the commodity-price rout will end. But one certainty from the resources carnage is a spike in mining takeovers.
Conditions are ripe for sharply higher mergers and acquisition (M&A) activity across the sector. Key commodities are trading at near 10-year lows, valuations for many resource companies have been slaughtered, and a lower Australian dollar will attract offshore predators.
Talk that private equity firms and listed companies, domestic and offshore, are running the rule over mining assets suggests the resource sector’s nadir could be in sight. The best time to invest in mining – when new investment slows – is approaching.
The resource sector badly needs consolidation. The mining boom inevitably led to a rush of junior explorers raising capital and listing, and an even wider gulf between small- and mid-cap companies. The “tail” of ASX-listed resource stocks is probably about five times too long.
However, predators might well be sidelined from M&A until the crashing Chinese sharemarket stabilises, the Greek debt crisis subsides, and commodity prices find a firmer footing. Resource assets that look undervalued today could get a lot cheaper in the next few months.
Moreover, M&A in resources is likelier in mid-tier stocks, rather than the majors or junior explorers. The big miners are under pressure to wind back capital expenditure and return more cash to shareholders through higher dividends, although Fortescue Metals Group and BHP Billiton spin-off South32 are possible takeover exceptions.
Here are three takeover ideas for the resources sector:
South 32
The Switzer Report mapped out a positive long-term view for South 32 in May [1], but argued the stock was best left alone until the share register stabilised.
Higher-quality divestments have a habit of underperforming in their first year and outperforming after that. That view has so far followed the script, with South32 falling from almost $2.40 to $1.78.
I was less convinced about South32’s takeover appeal in May, but heavy price falls have put a bigger target on its back. The financial press has speculated that South32 could be a takeover target for private mining venture X2 Resources, led by former Xstrata chief Mick Davis.
South32 should have broader appeal, given it ticks several takeover-target boxes. Predators like to swoop on quality assets that can become significantly more efficient, before those gains are in the valuation. South32’s main attraction is the potential for cost savings and operational efficiencies, under new management, and free from parent BHP Billiton, which had other capital priorities.
South32’s base-metal focus appeals. The bulks, such as coal and iron ore, arguably have a more challenged long-term outlook, and several base metals were smashed early in the commodity rout. Several South32 mines also have potential mine-life extension and higher output. It could be a neat acquisition for a predator that gets in early, before efficiency gains are realised.
Chart 1: South32
[2]Source: Yahoo!7 Finance
Gold Road Resources
Consolidation in Australia’s gold sector, a rare bright spot in mining this year, seems inevitable as a clutch of impressive mid-term producers look to build greater scale. Independence Group chose to add more nickel to its portfolio through the acquisition of Sirius, but its ambition could extend to neighbour Gold Road Resources.
In May, Independence Group acquired a 3.7% stake in Gold Road, sending the latter’s shares sharply higher, and is thought to have lifted it to 4.9%. But Independence’s acquisition of Sirius hosed down speculation of a Gold Road takeover, at least in the short term.
Gold Road fits the model for takeover candidates. It announced in May a 44% upgrade to its 2014 maiden mineral JORC resource at Gruyere, to 5.51 million ounces of gold – ahead of market expectations.
Gruyere looks like a strong deposit and an asset that potentially has significant strategic appeal to a larger gold producer that wants to get its hands on the resource, and benefit from continued strength in the Australian dollar gold price in the next 12-18 months.
Gold Road has eased from a 52-week high of 48 cents to 39.5 cents amid the pullback in Australian shares in June and July. It traded above 70 cents in July 2011.
Among other mooted gold takeover targets, Regis Resources and Doray Minerals stand out. Both have good assets and look undervalued, but Gold Road is the preferred target.
Chart 2: Gold Road Resources
[3]Source: Yahoo!7 Finance
Nickel – Mincor Resources
Known for its high volatility, nickel has been a basket case this calendar year, falling almost 30%. It shed about 5% in one trading day in June and is now trading near 10-year lows. The base metal, hit hard early in the commodity collapse, keeps falling.
But more investment banks are upgrading their forecasts for nickel, amid signs of constrained supply and firming demand in the next 12 months. UBS, for example, tips US$8 a pound in 2016, from below US$5 a pound this week.
Granted, plenty of experts have been too early with their call for a nickel recovery – and the risk of further falls this year remains as China’s economy wobbles. But the sector is starting to look cheap.
Independence Group, Sirius Resources and Western Areas are the key players, followed by minnows Mincor Resources and Panoramic Resources.
Mincor is an interesting idea for speculators who can withstand short-term volatility. In June it announced a 46% increase in its Upper Durkin North Mineral Resource, a maiden resource for its Voyce discovery, and has achieved good exploration results in all four of its growth projects in the Kambalda district in Western Australia.
Mincor is debt free, has a history of paying dividends, and has two mines in Kambalda. The well-run producer could be worth more in the hands of a larger nickel producer that wants to add to its resources and have a rising production profile as nickel strengthens in the medium-term.
Mincor, loss-making at the current spot nickel price, has excellent leverage to a nickel recovery and its recent exploration results suggest further upside.
Mincor has fallen from a 52-week high of 88 cents to 58 cents.
Chart: 3: Mincor Resources NL
[4]
Source: Yahoo!7 Finance
Takeover targets list
Like most stocks, the companies on the takeover target list were buffeted by sharemarket falls in June and July. South32, Gold Road Resources and Mincor Resources are added to the list, and Nearmap, Reva Medical, OntheHouseHoldings and Vision Eye Institute (which recently received a takeover offer from Pulse Health) will be removed.
Each still has takeover prospects, but the list needs to be pruned to make way for more resource companies in this and coming instalments of the takeover report.
[5]Source: Morningstar (for one-year total shareholder return). Return assumes dividends are reinvested. Return over one year to July 10, 2015. SP Dow Jones Indices for ASX 200 total return over one year.
• Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at July 12, 2015.