Freeport-McMoRan Inc. (FCX, NY, 15.06) has reached agreement with the Indonesia government on the future of its crown jewel Grasberg mine. The agreement has three main components. First, Freeport gets a long-term license (through 2041) and will remain operator. In return, Freeport has agreed to sell 51% of the mine to local interests; and to build a smelter in the country. The devil, however, is in the still-unknown details.
This is a bad deal for Freeport, particularly given that it already had a Contract of Work which has been abrogated by the government. One can understand, however, that Freeport did not want to go to international arbitration, given the delays involved, possible mine shutdown, and the harm to its relationship with the government. Receiving legal and financial certainty is a positive.
At what price
However, three major details have yet to be resolved. First, the government has stated it wants to receive more revenue from the mine, and the tax and royalty rates are yet to be decided. Second, the price at which the majority ownership will be sold is equally unknown. Freeport has said it wants any sale to be at market rates. The right of the company to export concentrate, which has been a contentious issue, was not mentioned. This is also an important issue if Freeport is to receive full price for its output.
Moreover, Freeport has committed to spend as much as $20 billion for further development of the mine, including the smelter. That is more capex than Freeport has previously announced. It is not clear whether the 51% local partners will be responsible for their share of the capex and the smelter. Being the minority owner of the asset but apparently have control of the mine and its operations is clearly an arrangement open to conflict.
Lower debt and better political profile are positives
Certainly, if Freeport were to sell at a good price and receive proceeds at the time of the sale, it would enable the company to pay down its debt significantly to very comfortable levels. The share of the mine to be sold is perhaps worth $5 billion. That would be a positive, as would, frankly, reducing its exposure to the country. Freeport has already improved its political profile by exiting the Congo.
There is another important wrinkle. Freeport has already agreed to sell 40% of its output to Rio Tinto (above certain levels until 2021, then 40% in absolute terms). This reduces Freeport's economic interest to under 20%. Currently, the mine, which is Freeport's lowest cost operation, represents about 25% of its total profit. The deal will reduce that and increase the company's overall cost profile.
One hopes there will be more clarity on some of the critical details soon, but for now, we would hold off buying.
Royal's "aggressive" strategy pays off
Royal Gold Inc. (RGLD, Nasdaq, 92.86) has been on a tear lately as pieces in its somewhat more aggressive position have fallen into place. A higher gold price will see it outperform its peers in the period ahead. In the latest quarter, it reported record revenue, cash flow and net income; operating cash flow was up over 50% since a year ago. Mt. Milligan, its largest single contributor, is on track, and gold grades are expected to improve in the near term, with a longer-term expansion in throughput both helping Royal.
In addition to improvements at Mt. Milligan, Royal can look ahead to three major new sources of revenue: from Rainy River at the end of this year; Cortez Crossroads next; and the Penasquito expansion the year after. Each of these represents between 5-8% of Net Asset Value, so are significant.
Improved balance sheet
Even taking into account the copper contribution from Mt. Milligan—the pure gold royalty was renegotiated to allow Centerra to take over the mine from failing Thompson Creek—Royal will still generate about 85% of its revenue from precious metals. The improved performance allowed Royal Gold to pay down nearly $100 million of its debt, improving its balance sheet which had been another source of some concern. This allowed for an expansion of its credit facility, with $850 million in available liquidity. The dividend was increased by 5%.
We have said for some time that Royal likely had more leverage than Franco or Wheaton, if things fell into place. This remains true going forward, though at today price, following a rally from $76 in early July, and a 50% move from March, we would hold off additional buying.
Almaden Minerals Ltd. (AAU, NY, 1.21) continues to have success in its drilling on its Tuligtic project in Mexico, both additional drilling on the existing main Ixtaca zone, and on new targets. Recent drilling has expanded the main zone to depth, while it has recently discovered high-grade mineralization on a previously undrilled area of the North Zone. Significantly, the new discovery is within the pit of the pre-feasibility study.
A full feasibility study is expected early next year, and we expect that will be the trigger for companies potentially interested in acquiring the project to step forward. The company recently raised $17 million, sufficient to take it through any production decision and to put it in a good position in any negotiations that may take place.
Almaden remains significantly undervalued its attractive gold/silver project in a good jurisdiction. Accumulate Almaden.
Moving forward on two fronts, but slowly
Miranda Gold Corp. (MAD, Toronto, 0.07 x 0.08) is moving ahead of two fronts. First, it has filed a pre-feasibility study on the Lucky Shot project, in the Willow Mining District in Alaska. Miranda optioned the project to Gold Torrent, which is developing the mine, potentially with no financial contribution from Miranda (Miranda pays a percentage of capital costs over $10 million). Miranda will receive a share of the proceeds, up to 30% after capex has been repaid, and it also has, separately, a 3.35% royalty. The mine is forecast to start production at the end of 2018. Though modest, it will put Miranda in the enviable position of an exploration company whose costs are covered by revenue.
New projects in Colombia
It is also making progress in Colombia, acquiring its fourth large project in that country. It is actively working on a second major joint venture, in addition to the venture with IAMGOLD on the prospective Antares project. Though the country remains highly prospective and under-explored, permitting and property titling remain a struggle.
The company recently added a new director, John Anderson, of Purplefish Capital, who has been involved in various mining ventures over the years. After raising C$2.6 million a year ago, Miranda has a little over $1.5 million in the bank. That means another financing is likely before Lucky Shot is in production, unless the stock price moves up to allow some warrants to be exercised. Nonetheless, Miranda is a buy at this level.
Slow and steady
Alterra Power Corp. (AXY, Toronto, 5.33) continues to make progress towards building a large alternative energy company. Generation was up 8% in the last quarter with the addition of a new hydro project. It has three projects currently in development, and a large pipeline of projects, particularly U.S. wind. It could potentially as much as double its capacity by 2020.
The U.S. is currently attractive because of wind tax credits and infrastructure funds, which allow for cheaper financing of new projects. An oversupply of turbines—partly because of the tax credits (who would have thought?)—mean low capex costs when Alterra gets to build these projects.
The company has again to reduced debt. It is undervalued on an asset basis and trades at a prospective single-digit cash flow multiple, as it moves to consistent positive income. As this occurs, we expect the dividend to grow. For long-term investors, Alterra is a buy.
Adrian Day, London-born and a graduate of the London School of Economics, heads the money management firm Adrian Day Asset Management, where he manages discretionary accounts in both global and resource areas. Day is also sub-adviser to the EuroPacific Gold Fund (EPGFX). His latest book is "Investing in Resources: How to Profit from the Outsized Potential and Avoid the Risks."
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1) Adrian Day: I, or members of my immediate household or family, own shares of the following companies mentioned in this article: Royal Gold. I personally am, or members of my immediate household or family are, paid by the following companies mentioned in this article: None. My company has a financial relationship with the following companies mentioned in this article: None. Funds controlled by Adrian Day Asset Management hold shares of the following companies mentioned in this article: Freeport McMoRan, Royal Gold, Almaden, Miranda, Alterra Power. I determined which companies would be included in this article based on my research and understanding of the sector.
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