I used to assume that large mining companies would not chase projects with negative returns. This is a dangerous assumption that I need to rethink. I’m starting to realize that most large miners regularly chase projects with poor return. Or, they engage in business decisions that don’t make a lot of sense. I shouldn’t rely on the due diligence of senior mining companies when trying to value the assets of a junior.
Here’s my analysis of various large mining companies and why they are crazy.
Hebei could have purchased Alderon’s stock instead of exercising its option to buy 25% of Alderon’s Kami project for C$120M. The exercise of the option implies that the Kami project is worth C$480M, while Alderon had a market cap of $140M. This is a huge arbitrage opportunity that Hebei has missed out on.
Also, Hebei could be chasing a bad project here. Altius Minerals is a founding shareholder of Alderon and it is no longer buying more shares of Alderon. This suggests to me that Altius doesn’t think that the Kami project’s economics are very good. I think that Kami will have higher costs than Bloom Lake, which is already one of the higher-cost producers in the world ($85-90/ton). Alderon was fine when iron ore prices were much higher, but right now the economics of the Kami project are questionable.
Cliffs Natural Resources
Cliffs paid a large premium to buy Consolidated Thompson and its Bloom Lake mine. It issued press releases saying that Bloom Lake’s cash costs would drop to
$35/ton $50-55/ton, which would make the mine among the lowest-cost producers in the world. Of course this never happened because Bloom Lake doesn’t have high grades to support a low-cost operation. Bloom Lake’s current costs are around $85-90/ton, more than double management’s claims.
Now Cliffs is trying to build a chromite mine in the Ring of Fire, an extremely remote part of Northern Ontario. Its own presentation to analysts suggests that the mine is uneconomic at current spot chromite prices.
On the legal front, its battle with KWG Resources is wasteful. Cliffs is KWG’s largest shareholder and is basically wasting money to fight itself. Recently, Cliffs has been trying to force KWG Resources to buy its shares. In certain situations, Canadian law theoretically allows dissenting shareholders to receive fair value for their shares if they disagree with certain corporate changes such as KWG’s reincorporation. This is totally idiotic because KWG shares are depressed and Cliffs should be buying KWG shares, not selling them. It would avoid legal fees from fighting KWG and would pick up the 30% of Big Daddy that it doesn’t own. In the past, Cliffs was willing to take over KWG for 13/19 cents per share. Now that KWG shares are at 3.5-4.5 cents/share, Cliffs wants to sell.
Yunnan Chihong bought a 50% stake in Selwyn’s Yukon project for $100M. Various feasibility studies found that a new mine would be uneconomic. Selwyn became extremely distressed and was about to enter bankruptcy protection. However, Yunnan struck a deal to buy the other 50% of the joint venture for $50M (they originally offered $40M). They used the second deal as an excuse to report a profit:
Yunnan Chihong Zn & Ge Co. reported a 84.1% gain in net profit in the first half, thanks to non-operating income from acquisition of Selwyn Chihong Mining in Canada.
Net profit at the company was 335.3 million yuan ($54.4 million) from January to June, compared to an adjusted amount of 182.1 million a year ago, it told Shanghai Stock Exchange today.
Acquisition of Selwyn Chihong “at a discount’’ generated an income of 238.5 million yuan, it said.
In reality, Yunnan Chihong lost money on the Yukon project. They should be reporting a loss, not a profit. On top of that, it seems to me that they overpaid for the other 50% because (A) the feasibility studies came in negative and (B) Selwyn was a distressed seller that was about to enter bankruptcy.
They have a dangerous level of debt. Iron ore prices are highly volatile yet Fortescue maintains a debt:equity ratio of over 2:1.
(Almost) every senior gold miner
Had they stopped building new mines and issued dividends (or bought physical gold) instead, shareholders would have made more money. Physical gold has largely outperformed gold mining stocks.
What I’m worried about
What if senior miners stopped overpaying for assets? What if they allocated capital in a rational manner? This would be a terrible outcome for many of the stocks I own.
Altius Minerals is royalty obsessed because the royalty holder benefits whenever the mine owner decides to increase production (e.g. exploration, higher capacity) even when it isn’t economic. Furthermore, most of Altius’ assets are related to Alderon (ADV.TO). If investors stay away from marginal projects with terrible management teams, then Alderon will have difficulty financing its mine. Alderon will be stuck with the mining equipment that it placed orders for. Altius’ royalty on Alderon’s Kami project and its shares of Alderon will be close to worthless.
KWG Resources and Noront Resources are other major holdings I have. If Cliffs doesn’t go ahead with its chromite project, it would be bad news for both KWG and Noront. Without Cliffs, KWG’s chromite assets would be close to worthless. Noront’s deposit would likely be uneconomic if it cannot share infrastructure costs with Cliffs.
If the music stops playing, my portfolio could be in trouble. On the other hand, now is probably not the time to panic. Juniors continue to get slaughtered this year and fear is running high. Resource-focused hedge funds like Salida Capital are liquidating due to poor performance. My interim plan is to wait for Noront and KWG to rally so that I can sell those shares and put my money into something better. I’m fine with holding Altius and it continues to be undervalued.