Four With More

Here are three emerging resource company ideas, and one exploration idea. There are no mainstream brokers publishing research on any of the companies I write on below, and that is a good thing at this stage.

The current market caps range from Gindalbie Metals at $200 million through to Straits Resources at $700 million, yet all three have the potential to be multi-billion market cap companies over the medium-term. The market cap of our exploration play, Minotaur Exploration, is a tiny $40 million, yet as you saw this week, significant discoveries in a high commodity price environment can have enormous market-cap ramifications.

Gindalbie Metals (GBG) -

For a market cap of $200 million you are buying an amazingly cheap option on what will become one of Australia's top five iron ore producers within four years. The company is well run, with Portman Mining founder George Jones as chairman, and it's his strong relationships that will drive Gindalbie to a company with a market cap north of $1 billion. Gindalbie has already agreed to sell 50% of its magnetite project near Geraldton to the second-largest Chinese steel company, Ansteel.

I don’t believe Ansteel would be backing this company if the project was high-risk, and you have seen other Chinese groups backing other emerging iron ore players because they want to decrease their almost total reliance on the big three iron ore producers, who continue to have them over a barrel.

Production is due to start in the third quarter of 2007 via a hematite project that provides short-term cash flows, with initial production of 1.5 million tonnes a year for a few years. The numbers indicate that even if the Chinese walk away from the magnetite project for some reason, the hematite project is worth $190 million, or 44¢ a share, which is pretty much the current stock price.

Remember, my base case valuation is highly sensitive to the iron ore price. Every 10% change in the iron ore price it moves the Gindalbie valuation by 33%. I’m using base case iron ore prices in my model of rollover in 2007 and a 30% fall between 2007 and 2010, so the numbers aren't "hockey stick" like, or based on overly optimistic assumptions. I don't see the iron ore price falling 40–50% over this period, so I struggle to see the downside risk to valuation. If anything, my earnings numbers could be significantly higher as iron ore prices remain flat or slightly higher (up 18%) in coming years.

I was laughed at a few years back when I forecast Kagara Zinc would make $10 million net profit after tax (NPAT) for 2006-07. Today, analysts are looking for it to make $100 million. We think Gindalbie will earn $120 million in NPAT in 2010, so you would buying this stock on a price/earnings (P/E) multiple of 2 times (assuming no dilution) The company will be spitting out cash flow of more than $150 million a year from 2010, and that is assuming conservative iron ore prices for the next few years. With more than a billion tonnes of resources, Gindalbie has a mine life of at least 40 years.

At current prices you appear to be buying the 10 million tonnes a year magnetite project for free (Gindalbie has a half-share). Southern Cross Equities has a near term target of $1.10, and longer term you can see how this is a $4–5 stock. Anywhere below 50¢ this stock is a steal.

St Barbara (SBM)

St Barbara is another stock overlooked by other brokers. It has a market cap of $450 million and is Australia’s third-largest gold producer. It aims to ramp up production to 450,000 ounces a year from the current 165,000 ounces, and the company is fully funded after a recent placement undertaken by Souther Cross Equities.

Management is strong and conservative. Chief executive Ed Eshuys is well regarded in the mining world and has a key focus on exploration, so clearly there will be heavy drilling programs continuing for St Barbara to expand resources (7.3 million ounces) and reserves (1.1 million ounces) from current levels. Ed has surrounded himself with a strong board, led by chairman Colin Wise, a former WMC legal counsel; former North chief executive Richard Knight; and Doug Bailey, the former chief financial officer of Woodside. The quality of the board tells you there will be heavy debate at board level before any development decisions are made, and that no decisions will be taken lightly.

Clearly the potential recommencement of mining at Lenora via Gwalia Deeps and Tarmoola is the key to driving production up of 450,000 ounces in coming years. St Barbara is still looking at feasibility studies for Lenora and is expected to have some kind of news on that front in the next few months as those studies unfold.

Gold stocks are something many institutions have not had to worry about in years; so I suspect many clients have a poor understanding of them.

St Barbara could well be a 450,000-ounce leveraged Australian gold producer trading on less than five times’ 2007-08 earnings, if you look at numbers for that year and assume production of only 400,000 ounces and the gold price at a conservative $US588.

Some people will baulk at St Barbara because it has run from 5¢ to 58¢ and its main assets are those that had belonged to Sons of Gwalia. It was Sons of Gwalia’s strategy, debt and hedging that send the company broke, not the assets.

St Barbara is a buy and our near-term price target is $1, but clearly it could go significantly beyond that if gold prices remain strong.

Straits Resources (SRL)

Straits is another stock that is totally under-researched and under-appreciated by the market, with the stock fully funded. Here the sum of the parts is worth significantly more than the current stock price. Straits appears to have been penalised for its diversity of interests, with copper, gold, coal, and salt all under their umbrella.

The near-term catalyst for its market capitalisation will clearly be the partial spin-off off its Indonesian coal assets, which they have flagged. Even if you use a cash flow multiple of seven times (a discount to the Australian producers because SRL is in Indonesia) it spits out a valuation on its coal assets of about $555 million, or $3 a share. For less than $1 a share you are buying the rump of the company. SRL has said it plans to spin off 40% of the coal assets into an Asian listing, which could generate more than $220 million in cash. The upside of holding the rest of the coal assets as well remains with SRL. Recent long-term thermal coal price deals show the price of thermal coal isn’t going to drop in coming years (as some in the market believe) and the cash flow even from Straits’ remaining 60% will be large.

Straits is also bidding for the minorities in the 54%-owned subsidiary Tritton (TTT), a copper producer that has had some terrible hedging that is due to be rolled off in the next 12–18 months. Straits will be a 30,000-tonne-a-year copper producer and will enjoy huge cash flow after the hedging is removed.

Coal is clearly the near term catalyst for SRL. I am using base case $US40-a-tonne for coal, and even if that is more realistic at $US46, Straits will spit out net profit after tax of about $119 million in 2006-07 and $128 million in 2007-08, putting it on mid single-digit multiples.

The company also has a growing gold production profile thanks to Mt Muro, and also the recently approved Hillgrove deposit. We see gold production at almost 200,000 ounces in 2007-08 up from 85,000 ounces at present thanks to Hillgrove, etc. If Straits wanted to spin off its gold assets on an exchange like Canada, it could easily fetch a few hundred million dollars.

You can see how the sum of the parts in Straits Resources is worth well over $4. I think news on the partial divestment of the coal assets for a good price, which appears highly likely, will be the catalyst for locals to look at this stock. I think Straits Resources’ current market cap of $670 million looks potentially 30–40% too light '” this stock could be a $7–8 stock with strong management, a good pipeline of growth and a pretty tight register.

Minotaur Exploration (MEP); a cheap option on exploration success

I attended a lunch here this week with Derek Carter, managing director of Minotaur Exploration. Derek was previously the chief executive of Minotaur Resources (MNR), a company that was recently taken over by Oxiana (OXR). Derek and his exploration team at MNR found Prominent Hill in South Australia's Gawler Craton region, and Oxiana bought Minotaur Resources at a 42% premium to the last trade (using Oxiana scrip) solely for the purpose of controlling the Prominent Hill asset. Investors in Minotaur Resources did extremely well in a short period, due mainly to the exploration success of the group.

Minotaur Exploration (MEP) is the rump of the exploration assets and cross-shareholdings after Oxiana bought the Prominent Hill asset, but remember, Oxiana buys existing projects and that in no way means the assets left in Minotaur Exploration were not potentially interesting for investors.

Minotaur Exploration has 63 million shares on issue, and at the current share price the market capitalisation is just $40 million. However, it has cash of $13 million and cross shareholdings in other spun-off companies with a market value of $28 million. That means you are buying all the exploration assets in MEP for nothing, and in my view those exploration assets are significant. Even if you wipe 20% off the value of MEP's cross shareholdings, you're still buying the extensive exploration assets for just a few million dollars.

Interestingly, three corporates are already on the Minotaur Exploration register, with Oxiana holding 10.5%, Newmont 8.2%, and Sempra 8.0%. MEP has a joint venture with Oxiana in exploration, with Oxiana funding half of MEP's exploration.

The simple fact here is that I believe Minotaur Exploration will make a significant discovery over the next few years. It has the track record, and the technical skill, and when I can effectively buy that for nothing inside their own share price, then that is worth having a look at. Minotaur Exploration is one that should be on your radar. Sure, it's a "Cessna" right now, but it clearly has the potential to be a much large company through time.