Investors need to be choosy...
WITHIN the universe of junior mining companies, investors need to be choosy, says Ingrid Rico, mining analyst at Toronto-based investment bank M Partners. In this interview with The Gold Report, Rico explains how analysts value miners and reveals how she will be looking at junior mining companies in 2013—with a skeptical eye, preferring those funded to complete exploration plans for the year and a management track record to deliver results.
The Gold Report: As of Sept. 30, 2012, Toronto-based M Partners had Buy recommendations on 84% of the 58 companies it covered at that time. There are many brokerages with similar percentages. Have analysts lost some credibility in the mining space over the last few years when companies have vastly underperformed the broad market despite analysts' Buy ratings and high target prices?
Ingrid Rico: The simple way to answer that question is by explaining how we as analysts do our job. We try to do our best to demonstrate that a project makes economic sense. We look at the deposit and review mine plans. We try to get a handle on the operating challenges and the capital requirements for the project. Based on that, we build a model that needs some level of execution by the management in order to be achieved.
Over the last few years, we have seen some hiccups in the execution and delivery in the space, which has made investors grow increasingly cautious on the sector. What we're seeing now is investors needing to get that confidence back. It's not to say that the companies are not a Buy and that the target is not valid because the projects make sense economically. We have also experienced a migration of funds away from the juniors and recent producers as investors looked to mitigate risk during a period of economic uncertainty. That funds flow as much as anything has hurt the share prices of companies in the sector.
TGR: Are you adjusting your models and lowering target prices to reclaim investor confidence?
Ingrid Rico: We continue to look at the inputs and make our assumptions fit the challenges. We're trying to get better at understanding the challenges—the operating challenges, the capital challenges—improving our models every time.
TGR: With ounces-in-the-ground valuations, have you had to reassess those, too, given how the market is valuing these junior mining companies?
Ingrid Rico: Yes, we have a couple of companies under coverage that are purely valued as ounces in the ground. Just a couple of years ago, our valuation metrics were essentially double what they are now.
TGR: What are the essentials of your investment thesis when it comes to junior mining companies?
Ingrid Rico: We look at the jurisdictions, the infrastructure and the prospective nature of the property. Also, grade is key to the project. Desirable high grades make a project withstand the market when it is as challenging as it has been lately. Let's not forget management either. We need to have a highly skilled and experienced group who understand the market and have proven that they can do the job.
TGR: How are you factoring financing risk into your models? What adjustments have you made there?
Ingrid Rico: It depends on the project. We see a number of projects that have economic merit, but the project financing window is fairly narrow right now. We look at the possible financing alternatives that the project has, whether that be a royalty streaming, an offtake or the conventional debt and equity ratio.
TGR: How would you describe the financing market right now for junior mining companies?
Ingrid Rico: It is quite difficult for some companies currently. It's part of the cycle. In the junior space, a lot of money came in at the high of the cycle. But some junior companies fell well short on delivering results. So now the market is saying that we need to see more consolidation.
Quite frankly, some of the juniors that didn't deliver are going to disappear. That is what the market is saying. Again, it's all part of the cycle.
TGR: How does that affect your job?
Ingrid Rico: It makes it interesting and makes me realize that there are projects out there that do stand out. There are many projects unfairly undervalued at this point because the entire sector is suffering from a cautious investor sentiment. It's interesting to get on those companies before people start jumping in, when sentiment begins to change.
TGR: What are some ways investors can determine whether or not a junior mining company is underfunded and possibly going to fold?
Ingrid Rico: For exploration companies, the key metric you can look at is burn rate. You need to have a sense of its exploration budgets, its current cash position and whether it will be able to fund the program for the year or not.
For developers, the technical report gives us guidance as to what a company needs for project funding. With the sector seeing quite a few cost overruns lately, we typically build in a contingency of 15–20%.
TGR: The old rule of thumb was that all good projects will get financed. Is that still the case?
Ingrid Rico: Yes. The good projects that stand out will get financed. It's a matter of timing, though.
TGR: How far into the future do you see a time when the markets are going to open up and start funding companies with fresh equity issues à la 2010?
Ingrid Rico: It depends on the commodity. Supplies are pretty tight right now in the copper sector, and projects are going to have to get funded soon.
TGR: Are you more concerned about smaller mining plays in Africa than you were a few months ago, given what's happening in Mali?
Ingrid Rico: It brings the valuations lower just having that socio-political risk there. But Burkina Faso has been one of the most stable jurisdictions in Africa.
TGR: What sort of year should mining investors expect?
Ingrid Rico: It seems to be shaping up as another challenging year ahead. We expect more consolidation as cash-constrained companies join well-funded partners either by choice or, in many cases, out of necessity.
Again, in the copper space, things are much tighter than people realize.
TGR: Is that an angle investors should be looking to play if they want to get into this space?
Ingrid Rico: Yes, we think so. In the junior space, it's looking at the ones that actually stand out, the ones with cash, that will be delivering, whether that be on exploration resources or on a new resource estimate. That's what mining investors should be looking at right now.
TGR: Thanks for your time, Ingrid.
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