Management Teams In Precious Metals Companies Are Making Adjustments In Where To Reinvest Cahs Flow Due To Long-Term and Multinational Nature Of The Space, Says Managing Director At Deutsche Bank Securities
April 19, 2012 - The Wall Street Transcript has just published Metals and Mining Report offering a timely review of the sector. This Special Report contains expert industry commentary through in-depth interviews with public company CEOs, Equity Analysts and Money Managers. Please find an excerpt below.
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Jorge M. Beristain, Managing Director at Deutsche Bank Securities Inc., is the Head of Americas metals and mining equity research, which unifies regional coverage of mining and metals stocks under one team. Team coverage includes precious and base metals, iron ore, steel and coal equities. His team ranked number three in the 2011 U.S. Institutional Investor survey for the metals and mining category. He previously served as Deutsche Bank's Head of Latin American Equity Research. Mr. Beristain has ranked in Latin American Institutional Investor's survey as the number two Analyst in the metals and mining industry, and over the years has ranked highly in multiple industries including pulp and paper (number two) and conglomerates (number four). Mr. Beristain is a CFA and holds Securities Principal and Supervisory Analyst licenses.
TWST: Aside from the forecast for rising prices, would you tell us a little bit more about your optimism as you look at the stocks in the precious metal space?
Mr. Beristain: Undeniably, the prime mover for these stocks is the metal's price, so it's difficult for the equities to work if the underlying metal is going sideways to down. But I think that we've also come through a very harsh period. It depends which end of the spectrum you're talking about, but for example the smaller-cap silver sector has, in some cases, issued their equity base five or 10 times over in the past decade. I think that the period of "serial equity issuance" is coming to a close, because there's less and less investor tolerance for companies continuing to write blank checks or using equity to pay for capex or to fund deals in this space. Conversely, we're also seeing that debt is very cheap right now and can be obtained for long durations. I think that there's more pressure on corporates to look across the street to the debt market and start to think of using debt capital as opposed to issuing equity. I also think that some of the company-specific drivers are an awakening within some of the management teams to start to return some of that cash to shareholders. I guess the way I would summarize it fundamentally is, as long as they're earning high returns on capital employed, on investments, generally speaking investors are OK with a lower dividend or even foregoing a dividend, because the first and best use of cash from a corporate is to reinvest in its business to grow it. However, given the long-term capital nature and the multinational nature of the mining industry, especially operating in countries with heightened political risk, rising taxation and rising currencies, it's not a sure thing to continue recycling the money into the business. I think that's where management teams have come a bit of a realization, to just fine-tune the formula between how much cash flow are they reinvesting in the business and how much they can actually throw off to shareholders in a sustainable dividend stream.
TWST: How does your view of the base industrial metals differ from the optimism about the precious metals?
Mr. Beristain: We've been living through a seven- or eight-year bull market at this point in commodities, largely driven by the infrastructure expansion in China. Base metals have ridden that wave and have had their day in the sun for a quite some time. We've seen companies such as Cliffs Natural Resources (CLF), which has been the second top performer within the S&P over the past decade, after Apple (AAPL). We maintain a "buy" on Cliffs, but for company-specific reasons. There has already been investor recognition of that sector. With Cliffs, there is an element of underlying leverage to China's growth. The company has also obviously done some bold diversifications and expansions into seaborne iron ore, coal and other things. I think it's a story that, in the industrial metal sector, investors make the connection: China growth is good for these equities. However, even a U.S. or a European economic recovery will be good for Cliffs and for Freeport-McMoRan (FCX) in the copper sector. In the gold or silver sector, it's more difficult to make that commodity or economic leverage case. Aside from sovereign risk flare-ups or world catastrophes, or contagions which flare up every once in a blue moon, why do you want to own these equities? The answer to that should be simple: they're doing a good job taking the marginal dollar, reinvesting it for an excess return on capital, and as a shareholder you are going to benefit from the company's rising earnings and dividends the investments will throw off.Strong companies like Freeport-McMoRan have also become pretty "well held" stocks within the portfolios of U.S. and global investors.
TWST: As you talk to investors, do you feel like folks are starting to recognize that? Do you see some sort of inflection point coming where they will?
Mr. Beristain: I noted in the fourth quarter that the precious metals equities actually were holding up fairly well in the context of the pullback that gold and silver experienced in the September-October time frame. For a short period, they were almost disconnecting from their underlying metal and implicitly rerating. The market was for a short period seeing through the near-term volatility of a pullback in the metals' price and bidding up their future earnings. Unfortunately, once we got through fourth-quarter earnings, for a lot of the gold investors were sandbagged by write-downs - Kinross (KGC), obviously, was the notable one, but Newmont (NEM) did a write-down as well. Guidance from the major gold producers was also pared, whether it was slightly nudging up their unit-cost projections or slightly pulling down their volume projections. Against that backdrop, in the past six weeks or so, gold prices again have kind of rolled over, from a peak of $1,800 an ounce in the first quarter to closer to $1,650. As I said, it's difficult for these equities to work when the underlying metal is not going in the right direction. So just as the bad news of the fourth-quarter results was getting digested and the sector started to get on a positive run, the metals' price itself is not going in their favor. Sometimes you almost have to ask yourself, under what combination or circumstances do these equities work? When the precious metals were doing well in the spring of last year, these equities weren't performing as strongly as they should have. Conversely, when the metal has fallen recently, they seem to be falling worse. It's difficult to pinpoint if we're at the bottom, but it certainly feels to me that the level of investor apathy now in the sector is starting to be too much. I think that the gold sector and the silver sector worked quite well in 2010 as an outperforming sector, but really in 2011, courtesy of the world's volatility, erratic metals prices and some specific corporate actions and/or changes in guidance, it struggled somewhat.The sector hasn't really regained its footing this year. In fact, it's off quite sharply. But I think precious metals equities should be doing better than they are right now, because they are for all intents and purposes trading as cheaply now as industrial metals equities. The difference is, in a precious metals equity, you have more proportionate resource optionality - the ability to discover significant new resources through exploration. But additionally, you have the change, as I said earlier, in dividend policies, and some contemplation of how to better run the companies in response to investor concerns. It's not quite yet been reflected in the equity prices.
TWST: So where are you pointing investors now? What are some of your favorite stories?
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