Investors who want to play in the iron and copper space should look to small-cap producers for attractive valuations and lower risk, says Matt Gibson, institutional research analyst with CIBC World Markets. In this Gold Report interview, he says he believes iron has found its floor in 2012 and names iron ore and copper companies with upside potential.
The Gold Report: Matt, you cover four companies in the iron space with market caps that range from Cliffs Natural Resources Inc. (CLF:NYSE) at $4.2 billion and Labrador Iron Mines Holdings Ltd. (LIM:TSX) to Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.MKT) and New Millennium Iron Corp. (NML:TSX) with market caps around $200 million. In Q1/12, all of them were worth double what they are trading at today. Why should investors be interested in these companies?
Matt Gibson: We have started to see positive trends in the iron ore space. Chinese port inventories have started to tick down, while capacity utilization globally and in the US has started to tick up for steel companies. Iron ore prices have rebounded from lows of $86/metric ton (Mt) to the $118–120 Mt level.
TGR: Are larger companies like Cliffs being punished for their acquisitions or is the across-the-board share price decline all about low steel prices and global economic fears?
MG: I think most of it has to do with iron ore prices and sentiment regarding Chinese growth.
For Cliffs, the slow ramp-up at its Bloom Lake mine, which has led to elevated cash costs at the facility and lower margins, has not helped. Delays to the planned expansion and the downward revision of the mine plan to an ultimate capacity of 14 Mt have not helped either. Finally, higher operating costs put pressure on the company's balance sheet.
TGR: A recent CIBC World Markets' research report stated, "Despite elevated inventories of steel and iron ore, Chinese steel mills continue to maintain daily crude steel output near record levels." As you mentioned, that seems to be changing. But is it changing quickly enough?
MG: I think China's infrastructure announcement earlier in the fall helped draw down some of the inventories. Certainly, the overcapacity issue in China has a lot to do with the fragmented nature of the industry there, and that will take some time to play out. However, the Chinese government has been putting efforts into consolidating production into larger, more efficient operations.
TGR: The Chinese bought in at much higher prices on several juniors in the iron space. Do you think the Chinese regret that decision or was this always about the long term?
MG: China's real interest is not so much from an investment point of view as it was about longer-term offtake, securing supply of iron ore and being able to diversify away from reliance on the big three producers.
TGR: In September, you dropped your 2012 near-term iron ore price forecast from $143/Mt cost, insurance and freight (CIF) to $128/Mt CIF. That also caused you to lower your target prices for the four iron companies you cover. Have we reached a bottom to the price drop?
MG: Near term, I believe prices found a floor in the $110-$120/Mt level. That's pretty much where most estimate the average cost of production to be in China.
That being said, the upside or potential price increases will be limited by growth in China and economic growth in Western Europe.
TGR: Would you say your view of global economic growth is reasonably bullish?
MG: There are some positive indications and I am optimistic that 2013 will be a better year than 2012, and that will be good for the iron ore sector.
TGR: Let's move to your coverage, starting with Alderon Iron. Your 12-to-18 month target price on that company is $5.20, more than double its current share price. What about Alderon and its Kami Iron Project engenders that kind of confidence?
MG: Alderon's management team has experience developing and building these types of assets. Several people on the management team have a background with Consolidated Thompson or with the Iron Ore Company of Canada, which have operated in the Labrador Trough for a long time.
Alderon also has a strong partnership with the largest Chinese steel producer. This is a producer that has only a small fraction of its iron ore supply captive right now.
Finally, there are potential catalysts on the horizon, including the release of definitive feasibility studies, rail agreements and permitting.