Tantalum tantalises Gwalia

On the face of it there's nothing very exciting in the 1999/2000 results. In the year to June - sales rose 4.1% to $367.8m, while the record net operating profit after tax, and before abnormals of $58.3m was only 7% better than a year previously. The total dividend of 25 cents was the same as last year, although this time it was 37% franked, up from nil before. However the bottom line figures miss the company's marvellous growth thanks to a timely investment in mines producing a metal most people have never heard of.

Decision to merge

When Sons of Gwalia, until 1998 purely a gold miner, announced on 2 February 1998 a decision to merge with its associate, the industrial minerals producer Gwalia Consolidated, investors didn't like the news, marking Sons shares down 7.3% to $4.45. Since then the shares have gained 40.4%, while the ASX's Gold Index has moved backwards, down around 42.8%.

The best thing you can say about gold at the moment is that at least you're still in business, protected by a low Australian dollar and the easing up on central bank sales last year. In Sons of Gwalia's case, the gold division saw EBIT gain 27% to $73.7m, helped by A$302 an ounce margins, even though its costs aren't the lowest among the listed gold miners. It was the EBIT of the 'Advanced Minerals' (tantalum, silica sand, lithium and tin) that had everyone taking notice – that figure rose 31% to $34.2m. Peter and Chris Lalor need their gold mines to generate cash to sink it into tantalum.

Sons of Gwalia has two tantalum mines, at Greenbushes and Wodgina in the southwest of WA. In 1999/2000 they produced 1.11 million pounds of the stuff.

Tantalum is a very model of modern metal, being used in electronic components, most notably in mobile phones. New uses look set to grow. Metallurgists working for the likes of Boeing have also come up with aerospace applications. Sons of Gwalia is rising to the occasion, expanding capacity at its Wodgina mine and recently negotiated a take-or-pay agreement in place that will see the company doubling its sales, to 2.3 million pounds annually, by 2005.

Certain cash flows

The certainty of cash flow from this agreement is good for the company's balance sheet which looks a little burdened - $157.8m in borrowings are balanced against only $144.6m in equity. Also, the reasonably steady cash flows up until now have meant that debt is not a threat – interest cover in 2000 was a comfortable 8.9 times.

Gold may be stuck in the US$265-270 range, but so far 2000/2001 is looking reasonably good. In the September 2000 quarter 11% more gold was produced, and while cash costs were a so-so A$339 an ounce, the Australian dollar was helping out a lot, leaving a nice fat margin - over $300 - in Gwalia's coffers.

Nonetheless Gwalia is a stock for the patient. The tantalum expansion won't really start kicking in for a while yet, so profit growth for the next few years will be slow. Consequently we're sticking to our HOLD recommendation. However, any pull back towards $4.50 can be seen as a good time to buy.