Downgrading Mincor

Tim Treadgold writes:

No small Australian mining company has been able to ride out tough times quite like Mincor, a specialist nickel producer, which is why it's hard to believe that it will not survive the current test of low metal prices.

But without a substantial and sustained recovery in the price of nickel Mincor is facing its gravest existential threat since it made headlines 15 years ago with the purchase of the Miitel, Mariners and Redross nickel mines from WMC Resources, the company which started mining nickel near Kambalda in WA in 1966.

Mincor's deal in the year 2000 was perfectly timed, a year before soaring Chinese demand for stainless steel, the primary use for nickel, pushed the metal price up sharply.

Despite operating some of the richest nickel mines in Australia Mincor has recently been flattened by the collapse in the nickel price which has fallen by close to 50 per cent over the past 12 months, from a high of $US9 a pound to $US4.67/lb.

Even a corresponding fall in the Australian dollar has failed to compensate for the lower US dollar nickel price which was a major factor in Mincor posting a hefty loss of $34.26 million in the year to June 30.

As if the loss wasn't sufficiently concerning Mincor took a step it has generally avoided in previous periods of low metal prices, dropping its final dividend to preserve cash.

Transition ahead

Mincor's long-term chief executive, David Moore, said the next 12 months would be a “transitional year” for the company.

Ever the optimist, Moore was the man who launched Mincor when he negotiated the acquisition of Miitel and the other mines from WMC before it was acquired by BHP Billiton.

The $38m price of the original deal, struck in joint venture with the engineering company, Clough, and a private mining contractor, Donegal Resources, was quickly recouped thanks to rising nickel prices.

Moore was so pleased with his acquisition of the WMC mines that he even branded Mincor “the Kambalda nickel-mining company”, a slogan which hinted at a desire to be more successful at nickel mining than WMC.

Optimism, however, can only carry a business so far, and while Mincor has successfully ridden out past downward cycles in the nickel price (and there is no metal more cyclical than nickel) this down-leg might prove to be fatal, unless conditions improve soon.

What could save the company is an industry-wide cutback in production, or a pick-up in Chinese stainless steel demand – or, preferably, both.

It is estimated that half of the world's nickel mines are losing money at the current price, a point likely to be borne out as BHP Billiton and its spin-off South32 report this week. BHP Billiton retains ownership of Nickel West, the largest part of WMC's nickel business. South32 owns the Cerro Matoso nickel mine in Colombia.

Moore acknowledges the challenge that lies ahead. “Much does depend on the nickel price,” he said last week when releasing Mincor's annual result.

“But I am confident that, as it returns to fair value, we will be lifting our production into a tailwind of rising prices, from an expanded reserves base and a re-set cost level.”

Moore has been to the edge before with Mincor and has always been able to restore the company's fortunes.

He might do it again, but it's a reasonable assumption that even an eternal optimist like Moore will have his fingers crossed.

Chris Booth writes:

With the nickel price well below analysts' forecasts, junior miners are finding the conditions difficult. Mincor Resources has felt this significantly in the past month with the share price dropping considerably since the June quarter results were released in mid-July.

We don't know how long these conditions will last for, but for Mincor, mining at these low prices is unsustainable. Mincor is one of the many producers who has or is expected to announce a cut to production to ride out what is hopefully left of the low nickel prices. This either indicates great corporate discipline or a company teetering on the edge. In Mincor's case, there may be a little bit of both.

A mixed result

Strong production results were the only positive to come from the full-year 2015 results. The figures were marred by a significant $14m write down in property plant and equipment (PPE), with the company reporting a $34.26m net loss after tax. Operational losses for the year were at $10.65m. The significant decline in second-half revenue was due to the unforeseen falling nickel price. Cash costs were also driven higher than target to $A5.93/lb for payable nickel.

Cash at the end of June 2015 is $33m with a net cash position of around $25m which is equivalent to 18c and 13c respectively. This is a reduction of ~35 per cent in cash on the June 2014 balance sheet exclusive of last year's dividend payments.

The second half of the year has been detrimental financially to Mincor and has made a significant dent in its cash reserves. For this reason and because of the uncertainty surrounding the nickel price, Mincor has announced no dividend will be paid and a significant restructure will occur.

Restructuring plans

Capital development, drilling, nearly 50 per cent of staff and 25-50 per cent of production have all been put on the chopping block. The outcome will be a lean, hopefully well-oiled machine with the aim of protecting margins to preserve cash.

The key to this restructure is a reduced December half-year forecast of 2000-3000t nickel in ore and the company withheld any outlook for the June portion. At 2000t, the level is at a rate of 50 per cent of that of the previous reporting year.

The new operational strategy put forward by managing director David Moore and his team is attempting to protect the balance sheet from substantial cash losses while positioning them for a turnaround in the nickel market. This is done by advancing the growth strategy if the mines have to stop production.

Only time will tell if the strategy is enough to get them over the line, yet Mincor will be hoping this happens relatively soon. The lack of capital development will become a bottleneck within two to three months and potential issues about ore continuity will have to be addressed. To add to the difficulties, low metal prices generally force mining companies to increase cut off grades and pick the cream out of deposits, which ultimately makes it more difficult to get into an economic position when prices turn.

It is always a last resort to drop production levels, however in 2008-09 Mincor showed that it has the skills to rebound off price downturns. Nonetheless, last time this was on the back of $US50,000/t nickel prices which contributed significantly to the balance sheet before the restructure. This time they are not so lucky.

Where to for nickel?

All market cycles are a bit different. We have just come off one of the largest and longest bull markets in recorded history, so one could assume that the bear market could perhaps be a bit longer and this is exactly what seems to be happening.

Nickel is currently trading at ~$US10,500/t ($13,230/t) and does not look to be heading up anytime soon. Most analysts had previously forecast rising prices, with a price around $US14,000 for this time of the year based on rising demand. Obviously this has not eventuated and they are now forecasting a future recovery of nickel to around $US14,000 by the end of the year. Many are quick to say metals markets commonly disappoint, which is true, but on the bright side the longer the experts are wrong the closer they are to being right.

Nearly half the world's minerals and fuels are being extracted at a loss. Theoretically when prices are heading down mines will ramp up output to offset some of their losses, thus stocks available to the market will increase causing further pressure on the spot price. High cost mines become uneconomic at this stage and must halt or reduce production. This reduction in supply may indicate the bottom of the downturn is near.

The nickel market is also much smaller and more illiquid than other base metal markets and can be influenced not only by typical supply and demand factors but also politics as in the cases of Chinese Pig Iron and Indonesia recently hoarding supply. This means the price is more volatile and as such it may be possible to see higher prices by the end of the year if one of these factors comes into play.

Unfortunately for Mincor it is in the high cost category and unless an unforeseen factor comes into play it will most likely be one of the casualties.

Is there upside for Mincor?

Metal prices and currency fluctuations are out of the control of Mincor but these factors can influence the company's future in part by adding value to its growth projects.

There is a current feasibility study underway at Durkan North which is due for completion by the end of the year. Durkan North is the largest resource by size and grade that has not been converted to reserve and hosts about 400kt at 5 per cent nickel. Ongoing studies at South Miitel, Burnett and the small high-grade Voyce project are also being looked at.

It is safe to say Mincor has no rigs spinning at the moment to conserve cash, so further resource announcements for the new Cassini project are not likely to come for some time.

With the flexibility of multiple options, if the production stops or the mine continues, Mincor's growth projects will provide options for continuity or a later restart of operations.

Summary and recommendation

Mincor has forecast reduced production to 2-3kt of nickel in ore for the six months to December with no forecast for the second half of the reporting year.

While uncertainty around metal prices and the currency continues, production levels – and thus the future value of the company – can be difficult to estimate. The following basic scenarios can be used as a guide:

The best case is that the company continues production at around 6kt nickel in ore for FY16 which would mean it may trade back up to 40-50c/sh.

If the nickel price does not lift and the company ceases production at its mines, it will most likely trade at a slight premium to the cash backing, ~13-20c/sh.

While Mincor has flexibility on its side and may crawl over the line to meet future prices head on, in our opinion a recovery in the spot nickel price in time for Mincor is unlikely and it will have to resolve to fully cut production by the end of the year.

With the share price recently taking a battering it is currently trading down at 27c. Overall the risk still outweighs the benefit and we downgrade our hold recommendation to sell with a revised discount cash flow valuation of 20c on the stock.

This does not necessarily mean the end of the Mincor story. We will have a much better idea on the success or failure of the strategy when the September quarterly is released.

Conviction about a nickel price recovery is required to continue holding Mincor. But in our view the risk of production cuts and draining the company's remaining cash through operating losses outweighs any potential upside from stronger nickel prices.

To see Mincor's forecasts and financial summary, click here.