Road to Recovery

R O A D T O R E C O V E R Y

Metals & Mining

S e p t e m b e r

2 0 0 8

Corporate Directory

Institutional Sales:

Research:

Paul Carter

Ian Christie

Executive Director

Director, Research

Direct Line: +61 8 9224 6864 Email: [email protected]

Chris Wippl

Troy Irvin

Senior Institutional Dealer Direct Line: +61 8 9224 6875 Email: [email protected]
Associate Director, Resources Direct Line: +61 8 9224 6871 Email: [email protected]

Ben Willoughby

Tim Serjeant

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Analyst

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Registered Office

Kevin Johnson

Level 30
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Allendale Square 77 St Georges Terrace Perth WA 6000

Glen Colgan

Executive Director
Telephone: +61 8 9224 6888 Facsimile: +61 8 9224 6860
Website: www.argonautlimited.com

Geoff Barnesby-Johnson

Senior Dealer

Corporate Contacts

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Charles Fear

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James McGlew

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Edward G. Rigg

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Andrew Venn

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Michael Mulroney

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Ben Kay

Rob Hamilton

Argonaut is natural resources focused investment house that understands resources at a financial and technical level. Our expertise in natural resources has given us the ability to identify opportunities in the oil and gas and mining industries as well as the companies that service them.

Argonaut Securities Research

i

Road to Recovery

Contents

This research piece is divided into three sections: Section 1: Key issues facing the Mining industry Section 2: An overview of selected commodities, including Copper, Nickel, Zinc, Iron Ore and Gold Section 3: Individual reports on 16 companies

ROAD TO RECOVERY .......................................................................................... 1
Summary of Recommendations ....................................................................... 2 Sector Overview ............................................................................................ 3 Comparative Metrics....................................................................................... 4
SECTION 1 - OVERVIEW................................................................................... 11
Future Drivers ............................................................................................. 12 Other Issues ............................................................................................... 15 Implications ................................................................................................ 18
SECTION 2 – COMMODITIES ............................................................................ 19
Copper ....................................................................................................... 20 Nickel......................................................................................................... 24 Zinc ........................................................................................................... 27 Iron Ore ..................................................................................................... 30 Gold........................................................................................................... 33
SECTION 3 - STOCKS........................................................................................ 37
Aditya Birla ................................................................................................. 38 Albidon....................................................................................................... 42 Atlas Iron.................................................................................................... 46 Avoca Resources.......................................................................................... 50 CBH Resources ............................................................................................ 54 Dominion.................................................................................................... 58 Independence Group.................................................................................... 62 Jabiru Metals............................................................................................... 66 Kagara ....................................................................................................... 70 Mincor........................................................................................................ 74 Mirabela Nickel ............................................................................................ 78 Mount Gibson Iron ....................................................................................... 82 Panoramic................................................................................................... 86 Perilya........................................................................................................ 90 Troy Resources............................................................................................ 94 Western Areas............................................................................................. 98 GENERAL DISCLOSURE AND DISCLAIMER......................................................102

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iii

Research

Summary

4 September 2008

Commodity prices and stocks have taken a battering over the last few months as global growth concerns come strongly to the fore. In Argonaut’s view fundamentals have taken a back seat to sentiment and this book endeavours to set that right. The timing is certainly appropriate.

As the major western economies slow sharply with the contraction in credit, all eyes turn to China. Can the populous country remain immune to the demand shocks elsewhere and take up the slack? The answer to the first part of the question is obviously “no” – after all, China’s formidable growth has been spurred largely by exports. The so-called decoupling does not make much sense.

However, the answer to the second part of the question is more than likely “yes”. China’s momentum is astounding, and even accounting for the inevitable slowdown, its growing dominance in the consumption of resources will ensure that any slack is readily absorbed. Remember that China is not just a short-term wonder – its growth has averaged 9.7% p.a. since 1980, with only two years out of 27 exhibiting growth rates of less than 5%.

The bottom line is that even under the assumption of lower growth rates in China, the increase in demand for resources would still be significant in terms of global production. (And we haven’t started talking about India yet.)

The supply side is not a simple matter either. Labour issues, a shortage of equipment and services, and (more recently) less forthcoming capital markets have emerged as serious constraints. These issues, together with declining grades and higher energy prices, have had a major impact on production costs.

Commodity prices that would have provided fat margins only a couple of years ago now barely cover the marginal costs of new production. Add to that the fact that capital costs for new developments regularly blow out, and it shouldn’t come as a surprise that new supply is rarely delivered as expected.

The world has changed markedly over the last year and companies are no longer able to rely on the rising tide of commodity prices. Stock selection is more critical than ever. Low cost producers are back in favour, while developers need to offer solid projects backed up by financing, infrastructure and reasonable timing. Explorers are off the boil, primarily because in the current environment, cash is king.

Argonaut’s views on individual commodities are largely related to the supply side. As a result copper is expected to remain reasonably firm in the short term, while nickel and zinc are underpinned at current levels with prices near the marginal cost of new production. With major supply increases on the way, the big gains in iron ore have already been won, while gold gains support from ongoing financial and economic uncertainties.

Argonaut’s key selections feature proven management offering significant cash flow generation from low cost quality assets with growth upside:

uuu

Jabiru Metals (JML) – High grade Jaguar operation running at nameplate capacity, expect lowest quartile cash costs, bringing the Stockman project in Victoria on line down the track

Mount Gibson Iron (MGX) – Clean and simple iron ore exposure, one of few cashing in on the buoyant iron ore pricing environment, exploration at Koolan Island to provide strong organic growth

Panoramic (PAN) – Tangible production growth profile, extensional drilling to increase mine life at both projects, a steal at current prices

1

Summary of Recommendations

Table 1: Stock Recommendations (Key picks highlighted)

Market Cap.
Enterprise Value
Share Price
Company

Nickel

Code

Valuation

Rec

Comments

Rare new high margin nickel sulphide mine

Ramp up risks in Zambia

Albidon

ALB

IGO MCR MBN PAN WSA
289 326
336 182
$1.75 $2.79 $1.61 $4.39 $1.86 $8.69
$3.20 $3.67 $2.80 $8.48 $4.71 $6.66
HOLD BUY BUY BUY BUY SELL
Mine life upside within the 2.5km long Munali Intrusion Track record of consistent production, high grades and low costs Own 30% of the multi million oz remote Tropicana gold project Share price has fallen harder and faster than nickel producing peers Inexpensive on all valuation metrics
Independence Group

Mincor

320

210

Long term production target of 20 years at 20ktpa nickel in ore Well-positioned to grow the nickel inventory and mine life Low cost open pit nickel production in Brazil from mid 2009 Resource target size exceeds 1 million tonnes contained metal Corporate appeal is significant

Mirabela

570

524

Inexpensive on all valuation metrics

Panoramic

357

256

Tangible production growth profile

Extensional drilling to increase mine life at both projects Ramping up to a production target of 35ktpa contained nickel Exploration highlights overshadow hard production data Trading at a lofty EV compared to nickel sulphide mining peers

Western Areas

1,457

1,553

Zinc/Copper

Trades on cheap earnings multiples, but has a history of disappointing

Additional mine life at Mt Gordon is crucial

Aditya Birla

CBH Resources Jabiru Metals Kagara
ABY CBH JML KZL PEM
492 79
486 158 187 770 29
$1.57 $0.09 $0.35 $3.17 $0.43
$2.04 $0.08 $0.75 $2.98 $0.57
HOLD SELL BUY
Remain cautious of high cost producers in the current environment Low grade / high cost resource base Falling zinc prices have made life tough Embarked on an operational resizing at the Endeavour mine High grade Jaguar operation running at nameplate capacity Expect lowest quartile cash costs <US$0.20/lb payable zinc Bringing the Stockman project in Victoria on line down the track Producing from a number of small, but high grade deposits Tight balance sheet
175 686 85
HOLD HOLD
Growth prospects heavily tilted towards the struggling zinc price Lower zinc price and higher costs are squeezing margins Tenuous hold on Broken Hill following operational resizing plan Focused on cash conservation
Perilya

Gold

Ramping up production at the Higginsville gold mine Quality team developing a high grade underground ore body Significant mine life upside with $11m exploration budget A model of consistency

Avoca

AVO

DOM TRY
370 245 128
450 190 66
$1.66 $2.39 $1.83
$2.03 $3.05 $2.69
BUY BUY BUY

Dominion

Unheralded high grade, low cost producer with a strong balance sheet

Continues to deliver as peers increasingly struggle Management team has earned its stripes in Brazil Healthy balance sheet with ~$60m cash and no debt Near-term iron ore opportunity
Troy

Iron Ore

Clean and simple strategy with a busy six months ahead Reliant on third party access and public infrastructure Production beyond 3Mtpa is contingent on additional port/rail access Uncomplicated story One of few cashing in on the buoyant iron ore pricing environment Exploration at Koolan Island to provide strong organic growth

Atlas Iron

AGO

MGX

611

468

$2.10

$2.12
$2.30 $3.12
HOLD

BUY

Mount Gibson

1,705

1,814

Figures in A$m unless stated otherwise

2

Sector Overview

Table 2: Argonaut’s Sector Views

Key Points

Argonaut Forecasts

Base Metals

uuu

Mine production below capacity continues to keep a lid on inventories

4.00 3.50 3.00 2.50 2.00 1.50

Production issues, associated with labour and power, are an ongoing concern

The power industry accounts for half of the demand from China (unlike the US where it comes primarily from the building industry)

Copper Nickel Zinc

u

Price forecasts reflect short term supply issues and ongoing demand from China which offsets the slowdown elsewhere

2009F

2010F

2011F

2012F

11.00 10.00
9.00 8.00 7.00 6.00 5.00

uuuu

The rapid rise in nickel inventories reflects a drop in stainless steel production in the 2^ndhalf of 2007

New nickel supply is also on its way, although most additions are from far less reliable laterite greenfields

High nickel prices have also encouraged production of nickel pig iron (but quality and costs are questionable)

Prices should be underpinned by an improvement in the stainless steel cycle, a slower than anticipated supply response, and less emphasis on nickel pig iron

2009F

2010F

2011F

2012F

1.30 1.20 1.10 1.00 0.90 0.80 0.70 0.60 0.50

uuu

Demand growth for zinc is expected to remain robust, although the recent fall in the zinc price reflects the widely held view of strong growth in new supply

Argonaut suggests some caution is warranted with regard to new supply – even existing mines are battling at current zinc prices

Prices should stabilise, with production holes in years to come underpinning the long term price

2009F

2010F

2011F

2012F

Bulks

210 190 170 150 130 110
90

uu

Enormous infrastructure requirements in China have driven, and will continue to drive, the demand for steel

Aggressive expansion plans from the majors ensure that significant new supply of iron ore is on its way over the next few years

Iron Ore

u

The big price gains have already been won and Argonaut expects the abnormal margins in the sector to be eroded by lower prices in the medium term as the new supply comes on stream

70 50

2009F

2010F

Lump

2011F

2012F

Fines

Precious Metals

u

Investment has been the main driver for gold in recent times on the back of US$ weakness, economic and financial uncertainty and inflation threats

920 900 880 860 840 820 800 780 760 740

uuu

Forecasting its price is difficult with demand dependent on fickle investors and price elastic jewellery demand

Gold

It’s further complicated as, although mine supply is falling, above-ground stocks can easily add to supply

However, gold should be supported by increased jewellery demand, its role as an investment alternative, and by a weak supply response

2009F

2010F

2011F

2012F

3

Metrics Summary (continued)

Figure 1: Market Capitalisation

2,000 1,800 1,600 1,400 1,200 1,000
800 600 400 200
0
MGX WSA KZL AGO MBN ABY AVO PAN IGO MCR ALB DOM JML TRY PEM CBH

Figure 2: Price/Net Asset Value (P/NAV)

1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0

Premium

Discount

WSA CBH KZL AGO AVO DOM ABY IGO PEM TRY MGX MCR ALB MBN JML PAN

6

Metrics Summary (continued)

Figure 3: Price/Earnings (P/E)

56

38

20.0 15.0 10.0
5.0 0.0
AGO WSA AVO IGO TRY KZL JML MCR DOM ABY MGX PAN ALB MBN CBH PEM

FY09

FY10

Figure 4: Price/Operating Cash Flow (P/CF)

42

27

12.0 10.0
8.0 6.0 4.0 2.0 0.0
AGO WSA IGO TRY AVO PEM KZL MBN MGX JML DOM ABY PAN MCR ALB CBH

FY09 FY10

7

Comparatives

Typically, higher EV to reserve / resource multiples reflect higher grades. However, note that this is simplistic and ignores other stock specific variables including costs, sovereign risk, mineralogy, deposit depth and management.

Nickel

Figure 5: EV/Reserve ($/t)

Figure 6: EV/Resource ($/t)

6,000 5,000 4,000 3,000 2,000 1,000
6% 5% 4% 3% 2% 1% 0%

18,000 15,000 12,000
9,000 6,000 3,000
0
4% 3% 2% 1% 0%

0

WSA IGO ALB

PAN MCR MBN

%Ni

WSA IGO MCR ALB PAN MBN
$/t %Ni

$/t

Notes: WSA has a perceived strong growth profile; IGO also has a 30% share in the 4Moz Tropicana JV (gold); ALB has execution risk associated with the first new nickel mine in Zambia; MBN is a disseminated nickel sulphide deposit (lower grade but significantly larger size).

Zinc

Figure 7: EV/Reserve ($/t)

Figure 8: EV/Resource ($/t)