Minefield: Mining for price growth

Aurora Oil & Gas (AUT)
Recommendation – Outperform (under review).

Apart from BHP Billiton there are few entry points for Australian investors into the US oil and gas boom based on shale and other “tight” rocks, though that is changing with the rise of companies such as Aurora Oil & Gas.

A genuine penny dreadful just four years ago when it traded at 10c, Aurora has rocketed up the ranks of ASX-listed stocks. Its current price of $3.32 gives it a top-150 spot thanks to a market value of $1.5 billion.

Despite that upward rush and a view that it might have done its best work Aurora remains a buy thanks to growing oil production, ongoing exploration success, and exposure to US dollar income in the world’s fastest recovering major economy.

A taste of Aurora’s performance was contained in last calendar year’s performance when revenue from oil sales rose by 293% to $US295 million and pre-tax profit grew by 320% to $US167 million.

A fresh look at how Aurora is performing will be available tomorrow (Thursday) with the release of its half-year production and profit performance.

Apart from being exposed to the new technologies, which have made extraction of oil and gas possible from rock systems once regarded as too tightly-packed to release trapped petroleum, the Aurora story is simplicity itself.

It is an Australian company active in a liquids-rich corner of the Texas oil patch with exposure to the right tenements, with the right partners – and all acquired at the right time with Australian dollars that bought much more than they do today.

Previous attempts by Australian companies to play in the US oil industry were largely thwarted by low oil prices, poorly-selected tenements, and currency movements which reduced the benefits of generating US dollar income because the Australian dollar was rising.

The currency factor is now working in reverse. US dollar income rises on conversion to Australian dollars just as the shale revolution picks up speed in the US.

Fortunately for Aurora it is exposed to the prolific Sugarkane field in south Texas, which is part of the Eagle Ford shale system, one of the so-called “big four” shale plays in North America.

As well as operating its own collection of producing oil wells, Aurora has a joint venture with Marathon Petroleum, one of the biggest US oil companies.

Tomorrow’s half-year results will provide a better look at how the company is performing but a significant benefit will come on the currency conversion with the Australian dollar falling sharply over the latest reporting period, from around $US1.05 at the start of 2013 to its current level of US89.7c.

Brokers who follow Aurora have a mixed view of the stock, with most recommending it as a buy, but some are concerned that the busy drilling campaign has not yet been converted into higher rates of production.

On the buy side are JP Morgan, which has a 12-month share price target for Aurora of $4.54; UBS with a target of $3.95; and Credit Suisse with a target of $4.35.

Citi and Deutsche rate Aurora as a hold, while BA Merrill Lynch reckons Aurora has done its best work for now with a 12-month price tip of $3.19, 13c less than the current price.

Tomorrow’s half-year results will show who has got it right, but for investors seeking US dollar exposure in the fast-growing US economy, Aurora is a buy.

Base Resources (BSE)
Recommendation – Outperform (under review).

Developing the Kwale titanium minerals deposit in the east African country of Kenya has proved to be more difficult than it should have been, thanks to poor early management decisions and instability caused by the 2008 global financial crisis.

One of the original owners, Canadian-based Tiomin, failed spectacularly and was forced to almost give away a project which ranks as one of the world’s best accumulations of beach sands rich in titanium and zircon.

That blemished track record will soon be consigned to history because, over the next few months, Kwale will start shipping out a cocktail of minerals from a purpose-built berth in the Kenyan port of Mombasa.

Getting Kwale to within sight of production has been a significant achievement for the current owner, ASX-listed Base Resources (BSE), which has invested $US250 million in the mine, processing facilities and port infrastructure.

Commissioning of the project, which is one of Kenya’s first big mines, is scheduled to start soon after a four-week delay with exports, expected to start early next year.

At its planned peak output rate Kwale will produce more than 300,000 tonnes of ilmenite and 80,000 tonnes of rutile, two of the primary titanium minerals, plus 40,000 tonnes of high-value zircon.

The size of the titanium mineral output can be gauged by an estimate that when running at nameplate capacity Kwale will account for around 10% of world titanium mineral output.

The mine itself is identical to “sand” mines seen on Australia’s coast, with the heavy minerals deposited as alluvial beds over time by wind and water action.

The Kenyan Government has welcomed the investment by Base in developing a business which should eventually rank as one of the country’s top five export industries – though pressure by some politicians to demand a bigger share of the mine for locals caused a scare on the stockmarket last year.

That fright was the cause of a sharp fall in the Base share price to a multi-year low of 22c in late October. Since then, as construction has progressed and titanium minerals prices stabilised, the stock has been rising steadily despite the odd hiccup.

Until the mine is fully de-risked with completion of commissioning, and there is evidence that the road transport route through the clogged streets of Mombasa to the port will not prove to be a bottleneck, some brokers remain nervous about Base.

Goldman Sachs likes the stock but has a neutral rating, with a modest 12-month share price forecast of 44c, just 10% above its recent price.

Credit Suisse is far more enthusiastic, thanks to confirmation that extra product sales have just been booked with Chinese customers, giving it an outperform recommendation and a price target of 80c, double today’s price.

Hot Chili (HCH)
Recommendation – Neutral (under review).

Copper is always the first metal to recover from a cyclical commodity downturn and if you want copper exposure there is no better country than Chile, which is why all of the world’s major miners are active there and why a small Australian company, Hot Chili, is attracting close attention.

A measure of the growing interest in the stock came last month when it successfully raised $11.7 million through a private placement to institutional investors in what is widely regarded as the worst market for small mining stocks in decades.

What professional investors with a reasonable appetite for risk like in Hot Chili is its flagship Productora copper project, which is showing potential to be a major mine, and because copper itself is the leading industrial metal.

That’s why the new shares were snapped up without Hot Chili having to offer a discount, successfully placing the extra stock at 45c, the same price as two-days before the deal was revealed.

Drilling over the past 12-months has effectively doubled the size of Productora, which is currently estimated to contain 162.5 million tonnes of material grading 0.6% copper, with useful gold and molybdenum credits.

Reduced to a contained metal estimate, that points to the discovery area holding at least 920,000 tonnes of copper, 590,000 ounces of gold and 22,000 tonnes of molybdenum.

Turning Productora into a mine will be a heavy lift for a small company, which is why Hot Chili could become a takeover target, especially if copper demand improves.

Macquarie Equities is one of the few major brokers to follow Hot Chili, rating the stock a buy and with a very optimistic 12-month price target of $1.03, well above the latest trades at 40c.

Gindalbie Metals (GBG)
Recommendation – Underperform.

Despite earning points for perseverance in developing one of Australia’s few magnetite iron ore projects, Gindalbie continues to be buffeted by uncertainty over the financial performance of its Karara mine in WA and the even more uncertain outlook for iron ore demand.

Cost blow-outs, completion delays and a cash shortage have dogged Gindalbie, forcing it to rely on the financial support of its biggest shareholder, the Chinese steelmaker Ansteel.

If the problems persist, which is possible, Ansteel could eventually become the outright owner of Karara, though a high-priced takeover bid is unlikely given the outlook for steel demand in China and the seaborne iron ore market, which appears to be moving into a sustained period of oversupply.

At its current price of 14c Gindalbie might be seen as a recovery situation, having already risen 40% from a low point of 10c reached during the big equity-market sell-off in June.

But that 14c price also represents the consensus high point of broker forecasts. In other words, Gindalbie has done its best work in getting back to 14c and that’s as far as it will go until there is proof that Karara can not only produce a magnetite concentrate for export but that it can do it profitably.

Most brokers rate the stock as neutral or sell, with one of the surprising discoveries for visitors to the Gindalbie website being a list of broker recommendations, which are mainly negative.

Only Morgan Stanley, according to Gindalbie itself, has the stock as a buy, with a target price of 19c. JP Morgan is neutral, Bell Potter says sell, as does RBC.

Until Gindalbie shakes the last of the “bugs” out of Karara it is a stock to avoid, and by the time the project performs as promised it is likely that the iron ore price will have declined, making it harder for management to demonstrate that after the extra cost of building the project it can ever trade profitably.