Minefield: Going to ground

Recent trends in nickel, gas and graphite stand to impact these companies.

As with every edition of Minefield, this article is not providing investment advice. For all of Eureka Report’s stock recommendations, click here and then click on each of the three tabs: ASX Large Caps, ASX Mid Caps, and ASX Small Caps.

Commodity prices are one way of gauging the likely future direction of resource stocks, while another is to see what’s happening at ground level. Two recent deals involving “ground” are indications that the mining trend is up.

The first deal was a move by lithium project developer Pilbara Mines to buy an exploration project that abuts its Pilgangoora project in WA’s Pilbara, a move which is all about acquiring access to additional land and to lock out a potential rival.

Independence Group has just done something similar by launching a takeover bid for Windward Resources, which controls land close to its almost complete Nova nickel and copper mine in the south of WA.

The deals are for different commodities, but there is a common driver: land access at a time when values are reasonable and the future for mineral prices looks better than at any time in the past few years.

Of the two deals the one that seems to offer the greatest potential is that by Independence, a company which has the appeal of a diversified asset base. This is an important consideration for investors interested in the mining sector but uncertain where to start.

GREEN LIGHT - Independence Group (IGO)

Once seen as a pure nickel play thanks to its roots in the Kambalda nickel belt of WA, Independence has blossomed into a true diversified resource stock, adding copper, zinc, cobalt, silver and gold to its portfolio.

The combination, which is dominated by nickel and gold, is a useful hedge, with gold doing well in uncertain times while nickel and copper benefit from rising industrial production.

Like all mining stocks Independence was sold down sharply during the latest commodity slump, with its shares falling to a five-year low of $1.98 in mid-January before staging a solid recovery thanks to its gold assets that include a 30 per cent stake in the rich Tropicana mine in WA. After hitting the bottom Independence shares have risen to around $3.89.

While gold has worked for Independence it has more recently been the turn of nickel to generate interest, with the 100 per cent-owned Nova mine due to start production in the next few weeks. It will join the smaller but high-grade Long mine as a source of the company’s nickel.

In the background are the other assets which round out the company’s production profile, including the wholly-owned Jaguar copper and zinc mine, and an extensive exploration division that is focused on the Fraser Range, host of the Tropicana and Nova ore-bodies.

There is another reason for keeping an eye on Independence and that’s because of the role played by one man, Mark Creasy.

While not on the board of the company, Creasy is the power behind the throne thanks to his 17 per cent stake in the stock and his unparalleled record as a prospector able to discover ore-bodies and then create value out of the discovery. This started with the Bronzewing, which he sold for $115 million in 1991, and has since been followed by his pioneering role in the Fraser Range, which has become Australia’s hottest exploration address.

The latest deal by Independence, its 19c-a-share offer for Windward, is all about pulling another Creasy creation under its corporate wing thanks to Windward having the third-biggest land position in the Fraser Range with tenements that are close to the Nova nickel mine.

Like Creasy himself, Independence is a company with fingers in many pies. That means it is well positioned to rise with a commodity-price recovery, or to ride out a storm if tough times return.

GREEN LIGHT - Karoon Gas (KAR)

Once a high flyer with a share price approaching $7 in 2013, Karoon crashed with the rest of the oil sector when Saudi Arabia opened the flood gates to try and kill the US shale-oil industry, only to discover that the oil-price slump almost killed its own economy.

Whether oil is in the early stages of a sustainable revival is a hot debating topic in the commodity sector today, though it seems that the management team at Karoon reckons that is precisely what’s happening and why a potential “company-making” deal has been initiated in Brazil.

While it already has assets in Brazil, the proposal being considered by Karoon is the acquisition of existing oilfields operated by the scandal-wracked national oil company of that country, Petrobras.

No price has been put on the possible acquisition of a 100 per cent interest in the producing Bauna oilfield and a 50 per cent stake in the Tartaruga Verde development project. Both are located in the offshore Santos Basin close to Karoon’s existing Echidna and Kangaroo projects.

Petrobas put the two assets on the market 12 months ago, with Karoon last week winning the right to negotiate a price during what is expected to be an exclusive six-week opportunity to agree on a price.

Reports so far indicate that the Brazilian fields will cost more than $US1 billion. According to Deutsche Bank, the well-regarded oil industry consultancy Wood Mackenzie values the assets at $US1.6 billion. But that value assumes an oil price of $US74 a barrel, well above its latest $US52/bbl.

With around $480 million of cash in the bank, largely as a result of selling a gasfield off the WA coast just before the oil price tumbled, Karoon will need a helping hand to secure the Brazilian assets. That could come from its shareholders, banks or a joint venture partner – with Woodside Petroleum suggested as a possibility.

On the market, Karoon shares have been moving higher, in line with the oil price. After hitting a low of $1.14 in January the stock is currently around a six-month high of $1.62, which values it at $400 million, or $US300 million – less than a third of what it might have to pay for the new Brazilian assets.

Deutsche Bank likes the proposed deal and reckons Karoon has a 12-month price target of $2.30, while Macquarie Bank reckons $2.90 is the target – views that are very much oil-price dependent.

RED LIGHT - Syrah Resources (SYR)

Once a darling of speculative traders with an interest in graphite, one of the emerging winners from a future world filled with electric cars powered by long-life batteries, Syrah has hit a rocky patch that is not yet fully understood by outsiders.

The key asset of the company is the Balama project in the East African country of Mozambique, centre of the global rush to develop new sources of graphite to break a Chinese stranglehold on the material.

As a project Balama is world class, though there is some concern over Syrah’s plans to produce 350,000 tonnes of graphite a year. That target represents close to one-third of current global consumption of a carbon-rich material which is effectively ultra-high-grade coal.

Syrah is not alone in what has become a stampede to snatch a slice of the graphite market, which will undoubtedly grow as demand for electric-storage batteries grows. The critical question is whether too much graphite could hit the market too soon, crushing the price and profitability of all producers.

Concern about over-production has been evident for some time in the graphite industry and Syrah has not been immune, with its share price retreating sharply since it hit an all-time high of $6.72 in June. It reached $4.34 earlier this month, when a management change shook the stock.

With no prior notice the chief executive of Syrah, Tolga Kumova, announced last Wednesday his immediate resignation, but with plans to remain a consultant to the company.

Kumova’s exit sent a shockwave through Syrah, with the share price plunging to $3.32, a price which represented a 50 per cent fall in three months. It has since recovered to around $3.75, a level which values the company at $975 million.

The challenges ahead for Syrah are to find a new chief executive, finish building Balama, deliver finished product to its customers, and to push ahead with value-adding projects it has proposed such as the production of spherical graphite. It must do all that ahead of its competitors in what looks likely to become a crowded market.

Deutsche Bank likes the Syrah story, telling clients on Monday that it was a buy with a 12-month price target of $7.30. Morgan Stanley sees things differently, telling clients that the exit of Kumova “raises questions”, leading to an underweight recommendation and price target of $3.75.