Mining Notes Explained
In the preceding post(dated 3/27/07), I have listed Mining Firms in the Gold, Silver, Copper, Zinc, Potash and Uranium Sectors with their gross reserves (proven, indicated and inferred) and the gross value of these reserves (assuming conservative prices for the metals), and divided the gross value of the metal reserves by the enterprise value (market capitalization plus net debt).
In theory, a lower percentage of the gross value of metal reserves by enterprise value will indicate that the firm is undervalued. But this should be taken as a starting point to research and not as a endpoint in and of itself, for the following reasons:
1) A mining firms lifting costs can vary widely, depending on the grade of ore (higher grade is cheaper to process), labor costs, energy costs and overall efficiency,
2) Future -- to be discovered -- reserves are not included,
3) Prices of the metals may vary in the future,
4) The gross valuation does not take into account hedging and/or the time value of the reserves, meaning the lifting rate of the reserves.
Nevertheless, despite the drawbacks of the gross value to enterprise value measure, it is a useful starting point as mining firms should ultimately be valued on the basis of their reserves of ores. Mining firms, unlike oil and natural gas firms, are not required by the SEC to publish a "Standardized Measure" -- the future discounted value of the cash flows from their natural resource reserves. The Standardized Measure is a vary useful measure in valuing an oil and gas firm (for a fuller explanation of the Standardized Measure see my other blog www.oilandnaturalgasreserves.blogspot.com). In the absence of a Standardized Measure, a gross valuation is a decent starting point for the investor.
Some points on the overall mining company stock universe: First, the majority, about 50% by market capitalization, of all mining companies are involved primarily in the extraction of Gold ore. Gold mining has traditionally been the most visible and prominent of the mining stock universe, and the valuations, by the gross metal reserves to enterprise value measure, are consistently in the high 25% to 40% or higher valuation range. The other categories of mining firms, silver, copper, zinc, uranium etc, have historically not been as covered, (but over the past two years have received more attention) and therefore have much different valuations on a gross ore value basis. Uranium, probably mainly because of the scarcity of publicly listed Uranium mining stocks, trade even higher than the gross value of the reserves as a general rule, (although after the significant run up in Uranium stocks during the past 3 years), while Potash mining stocks, such as Potassium Corporation of Saskatchewan, trade at below 1% to the gross value of their reserves. Copper firms typically trade at below 10% of the gross value of their reserves.
Whether this disparity of valuation reflects that the margins are much lower in potash and copper compared to gold and uranium (in my analysis the gross margins are not significantly different to account for this disparity in valuation), or that future expected price appreciation of copper and potash is much lower than gold and uranium, or that investors simply do not value potash and copper as highly as gold and uranium, (or a combination of all reasons), is a matter of debate. As a value investor, I would personally lean toward the sectors with the lowest valuations to gross ore reserves as more attractive investments for future price appreciation.
Geopolitical instability also accounts for significant variations in valuations of mining firms. As a general rule, the firms in politically stable countries -- United States, Canada, Australia -- trade at significantly higher valuations than in those countries such as Venezuela and Bolivia in which taxation and/or outright seizure of assets is a probable threat. Whether the political instability valuation is overdone and/or undone is for the diligent investor to research, although I have noted that several mining firms are VERY conscious in their plans to account for political risk -- meaning that mining firms themselves may place a high risk premium on political instability (and the diligent investor should as well).
Mining firms can also be placing into three categories in terms of size, which have different valuations. There are development stage firms, which have prospect stage mining projects, then intermediate sized firms, which have one or more producing areas, and large mining firms, which have several mining projects. As a general rule, the valuation of the large firms should be significantly higher than the exploration stage firms, as the risk in developing mines is very high. Related, as a general rule, most projects are being delayed, and cost inflation is higher than expected currently (early-mid 2007) due to manpower shortages, political uncertainties and lack of supplies. An investor who exercises caution in investing in exploration stage mining companies has good reason to do so.
A final note on sources of information -- most mining companies provide very accessible and readable investor presentations which outline their projects, risks and timeframes, which are generally found in the investor relations section of their websites -- for an investor interested in a firm, this is generally a second step (after deciding which mining firms look attractive as an investment) toward investing. Very important is the status and quality of the producing mines (if not an exploration stage company) and the quality, timeframe and reliability of the future projects.
In theory, a lower percentage of the gross value of metal reserves by enterprise value will indicate that the firm is undervalued. But this should be taken as a starting point to research and not as a endpoint in and of itself, for the following reasons:
1) A mining firms lifting costs can vary widely, depending on the grade of ore (higher grade is cheaper to process), labor costs, energy costs and overall efficiency,
2) Future -- to be discovered -- reserves are not included,
3) Prices of the metals may vary in the future,
4) The gross valuation does not take into account hedging and/or the time value of the reserves, meaning the lifting rate of the reserves.
Nevertheless, despite the drawbacks of the gross value to enterprise value measure, it is a useful starting point as mining firms should ultimately be valued on the basis of their reserves of ores. Mining firms, unlike oil and natural gas firms, are not required by the SEC to publish a "Standardized Measure" -- the future discounted value of the cash flows from their natural resource reserves. The Standardized Measure is a vary useful measure in valuing an oil and gas firm (for a fuller explanation of the Standardized Measure see my other blog www.oilandnaturalgasreserves.blogspot.com). In the absence of a Standardized Measure, a gross valuation is a decent starting point for the investor.
Some points on the overall mining company stock universe: First, the majority, about 50% by market capitalization, of all mining companies are involved primarily in the extraction of Gold ore. Gold mining has traditionally been the most visible and prominent of the mining stock universe, and the valuations, by the gross metal reserves to enterprise value measure, are consistently in the high 25% to 40% or higher valuation range. The other categories of mining firms, silver, copper, zinc, uranium etc, have historically not been as covered, (but over the past two years have received more attention) and therefore have much different valuations on a gross ore value basis. Uranium, probably mainly because of the scarcity of publicly listed Uranium mining stocks, trade even higher than the gross value of the reserves as a general rule, (although after the significant run up in Uranium stocks during the past 3 years), while Potash mining stocks, such as Potassium Corporation of Saskatchewan, trade at below 1% to the gross value of their reserves. Copper firms typically trade at below 10% of the gross value of their reserves.
Whether this disparity of valuation reflects that the margins are much lower in potash and copper compared to gold and uranium (in my analysis the gross margins are not significantly different to account for this disparity in valuation), or that future expected price appreciation of copper and potash is much lower than gold and uranium, or that investors simply do not value potash and copper as highly as gold and uranium, (or a combination of all reasons), is a matter of debate. As a value investor, I would personally lean toward the sectors with the lowest valuations to gross ore reserves as more attractive investments for future price appreciation.
Geopolitical instability also accounts for significant variations in valuations of mining firms. As a general rule, the firms in politically stable countries -- United States, Canada, Australia -- trade at significantly higher valuations than in those countries such as Venezuela and Bolivia in which taxation and/or outright seizure of assets is a probable threat. Whether the political instability valuation is overdone and/or undone is for the diligent investor to research, although I have noted that several mining firms are VERY conscious in their plans to account for political risk -- meaning that mining firms themselves may place a high risk premium on political instability (and the diligent investor should as well).
Mining firms can also be placing into three categories in terms of size, which have different valuations. There are development stage firms, which have prospect stage mining projects, then intermediate sized firms, which have one or more producing areas, and large mining firms, which have several mining projects. As a general rule, the valuation of the large firms should be significantly higher than the exploration stage firms, as the risk in developing mines is very high. Related, as a general rule, most projects are being delayed, and cost inflation is higher than expected currently (early-mid 2007) due to manpower shortages, political uncertainties and lack of supplies. An investor who exercises caution in investing in exploration stage mining companies has good reason to do so.
A final note on sources of information -- most mining companies provide very accessible and readable investor presentations which outline their projects, risks and timeframes, which are generally found in the investor relations section of their websites -- for an investor interested in a firm, this is generally a second step (after deciding which mining firms look attractive as an investment) toward investing. Very important is the status and quality of the producing mines (if not an exploration stage company) and the quality, timeframe and reliability of the future projects.
posted by Randy Kirk at 2:32 PM
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