Tony Featherstone Columnist

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines. He writes a weekly column for BRW and The Australian Financial Review, specialising in small listed companies,IPOs, entrepreneurship and innovation.

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Resources poised for a comeback

Published 30 January 2013 17:15, Updated 31 January 2013 06:25

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Resources poised for a comeback

Source: ASX

After being smashed last year, resource stocks may be the contrarian play of 2013. China’s strengthening economy, stabilising commodity prices and an easing Australian dollar later this year may spark a re-rating of mining stocks but great care is needed to avoid sector landmines.

The resource sector’s fall from grace was swift and brutal. The S&P/ASX 300 Metals and Mining index lost 9.1 per cent (including dividends) over one year, compared with an 18 per cent gain in the S&P ASX 200 Accumulation Index. Over five years, the mining index has an annualised return of minus 2 per cent. So much for the mining boom rewarding long-term investors.

It gets worse. The ASX Small Resources index has shed almost 26 per cent over one year and badly underperformed small industrial stocks. Many explorers have been pummelled amid concerns about falling commodity prices and fears that they will be unable to raise capital to develop projects.

The good news is that fears about a “hard landing” for China’s economy are receding, with its latest quarterly growth beating market expectations. The US economy is also showing surprising resilience and signs that its sluggish recovery is sustainable. Europe has stabilised, although it is still an economic basket case.

A slightly lower Australian dollar in the second half would be better news for the big mining exporters and encourage overseas investors to buy such stocks. A stronger-than-expected US economic recovery will be a catalyst for a lower Australian dollar versus the greenback.

These trends should support the resource sector in 2013. I don’t expect double-digit growth in China, sharply higher commodity prices, or a sudden resurgence in investor risk appetite. But even signs of stablising Chinese growth and commodity prices should be enough to boost parts of the resource sector.

Conservative investors should use a managed fund for mining sector exposure, or consider a low-cost exchange-traded fund that replicates key resource sector indices. The SPDR S&P/ASX 200 Resources Sector ETF or the Aii S&P/ASX 300 Metals and Mining ETF fit the bill. Those who wish to invest directly cannot bypass diversified miners BHP Billion and Rio Tinto. Both look good value.

Active investors who dabble in smaller resource stocks should focus on emerging producers rather than explorers. Of course, there are always exceptions, given almost half of all ASX-listed companies are resource-related. Look for miners in production and ramping up output to take advantage of still high commodity prices.

Take care with junior explorers. Market sentiment is against them and any stock rallies inevitably will be dampened as investors sitting on losses sell into share price strength. Beware of mining stocks operating in frontier nations, especially in Africa. Be selective with companies that need to raise large slabs of capital to build a mine or infrastructure. Many have had to issue highly dilutive equity capital raisings to entice investors into placements.

Instead, look for well-funded emerging producers with long mine lives and reasonable production costs, such that they can still make decent money if commodity prices stay flat or weaken. Reliable management is critical. Stick to gold, copper, iron ore and possibly nickel. It’s too soon to bet on a recovery in coal, uranium, rare earths or other commodities.

Sandfire Resources, Western Areas and PanAust are examples of mid-cap producers to own in this market. PanAust owns the flagship Phu Kham copper-gold operation and the Ban Houayxai gold-silver project in Laos, and has a majority interest in a promising copper project in Chile.

PanAust was hammered in late January after reporting quarterly production in line with guidance but forecasting weak earnings growth. It fell from $3.30 to $2.90 in two days, on sharply higher volume, as the sharemarket rallied.

Source: ASX

PanAust produced 63,285 tonnes of copper, 135,965 ounces of gold and 616,687 ounces of silver in 2012 and expected unaudited group earnings, before interest, tax, depreciation and amortisation (EBITDA) of $US330 million.

However, its 2013 production and financial guidance disappointed: full-year copper production of 62-65,000 tonnes of copper was less than expected and EBITDA guidance was for $US320-$US350 million. PanAust’s share price rally from $2.60 in October to $3.50 in early January was predicated on faster profit growth in 2013.

PanAust could easily fall further in the next few weeks on an over-reaction to its earnings guidance disappointment, in turn providing a buying opportunity for patient, long-term investors.

In the fourth quarter last year, brokers such as Bell Potter and Macquarie Equities Research had share price targets of about $3.70 for PanAust and it featured in several broking top-10 lists for resource stocks. Lincoln’s current PanAust valuation is $3.36.

PanAust’s main projects have long mine lives, reasonable production costs, sound prospects for higher production and are exposed to copper, one of the better commodities to back in 2013, and gold, which should do better in the second half.

Management has a good record in delivering projects on time and budget and the $1.7-billion company is well funded.

PanAust does not suit conservative investors but still looks more attractive than most loss-making exploration companies, or those nearing production and requiring huge capital raisings to build mines in an unforgiving sharemarket.

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