Value Microcaps Junior Miners

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From the Stockhouse HBM and Breakwater boards...
Art
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Here is the article in its entirety, front page of ROB on Saturday:
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TAKING STOCK
If it's all in the curves, then copper stocks are shining brighter

FABRICE TAYLOR

August 18, 2007

"We welcome this adjustment as a potential buying opportunity," HudBay Minerals' chief executive officer said this week.

The adjustment Peter Jones was referring to was the evaporation of billions of dollars worth of investments in mining company shares. Mr. Jones had just finished releasing solid financial results. HudBay, a mid-tier base metals miner, hasn't taken part in the frenzied mergers-and-acquisitions game of the past couple of years, so one might have assumed his comments were well timed.

One might further have assumed that with a fast-growing cash balance of almost $600-million and no debt, Mr. Jones would have the resources to make an acquisition that would create wealth for his shareholders. Investors might have finally have concluded that his stock, changing hands at less than seven times earnings, had appeal.

No. His stock shed 5 per cent of its value instead.

A similar reaction greeted Lundin Mining's announcement of earnings and of the closing of its deal to buy Tenke Mining. Lundin, unlike HudBay, has been marching down the acquisitions trail lately. But like Mr. Jones, the company is bullish on metal prices because of brisk growth in the world economy. Another acquisition, Rio Narcera, will close soon, and Lundin will have all the major base metals in its arsenal. Investors? They ran from the stock and its seven times price-to-earnings ratio.

These are only two companies that sketch out the disconnect between what's happening in the real world and what's happening in the financial markets. In the real world, if we can rely on the words and actions of mining company brass, voracious consumption of metals continues and won't stop for quite some time.

Investors, meanwhile, price shares as though we are at the peak of the cycle, just before earnings collapse. Who's right?

That's a hard question to answer with airtight conviction, but it's worth taking a stab at it. If the miners are right, their companies will be worth a lot more in a year or two. If bearish investors have it nailed down, those companies will be worth a lot less.

For help, we lean on UBS's base metals analysts, who took the bold step of publishing a cautious recommendation on copper yesterday.

The firm's starting point is base metal forward curves - that is, the price of the metal for future delivery as quoted by the London Metals Exchange - which the analysts have found to be a reliable indicator of share price performance. Despite the stomach-turning volatility that infected just about every market these past two or three weeks, the forward curve for copper has been remarkably steadfast.

Copper-related equities, including Lundin, HudBay, Freeport-McMoRan and others, meanwhile, are down 30 per cent since they peaked in July.

The shares are so beaten up that they're trading at a 30-per-cent discount to their "net asset value," of what they are roughly worth, assuming the forward curve and cost estimates are correct. In early 2006, the group traded at a 40-per-cent discount to this measure of intrinsic value. They went on to post spectacular gains. Earlier this year, the group traded close to net asset value on the back of merger speculation. Buying then was not a good move. The forward curve hasn't been a perfect predictor but it's not bad at all.

Could it be wrong this time? Sure. Economic growth could stall badly. Or there could be heavy speculation in the futures market, artificially lifting the price of the metal.

Anything is possible, but for the record, few economists are predicting the kinds of mauling that recession perma-bears are calling (and hoping) for. As for speculation in the futures market, the short end of the curve did sell off about 8 per cent but longer-term contracts actually rose slightly in the past month. If there was speculation, it likely would have run its course by now.

Although market indexes recovered yesterday, the action was mainly in the financial group because most investors still aren't sure that they want to risk investing in commodity plays. Meanwhile, HudBay's Mr. Jones and his peers are coining it. UBS figures that by the end of next year, cash in the bank will represent 20 per cent of the market value of the copper companies it follows, and almost 50 per cent for HudBay. That cash will be put to work buying back shares or buying other companies.

If that forward curve is any sign, investors with sea legs and conviction can buy a piece of that action at decent prices right now.

Fabrice Taylor writes research for brokerage firm Pollitt & Co.

The views expressed are his own.

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