Aggressive Treatment for Dr. Copper

By David Dittman • October 19, 2012

What to Buy: Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF)

Why Now: Figures released by the National Bureau of Statistics this week show that China grew by 7.4 percent in the third quarter, slowing from 7.6 percent in the second quarter. The third-quarter 2012 rate is the slowest pace of Chinese gross domestic product (GDP) growth since the first quarter of 2009.

But it was in line with expectations. And on a quarter-over-quarter annualized basis–the way it’s measured in the US and Europe–growth actually accelerated to 9.1 percent in the third quarter from 8.2 percent in the second.

Other statistics suggest the Chinese economy is stabilizing, and even show signs the Middle Kingdom is its inevitable transition from investment-led to consumer-led growth. Retail sales rose 14.2 percent year over year, the best showing since March 2012 and better than a 13.2 percent consensus forecast.

A two-and-a-half-year effort by Chinese leaders to arrest the country’s real estate market seems to be succeeding, as an analysis of average home prices in 70 cities by the Wall Street Journal blog China Real Time Report revealed a 1.2 percent year-over-year decline in September.

This effort is in fact the primary cause of China’s slowdown. And new residential floor space under construction declined by 28 percent year over year in September, reversing what looked like a resumption of growth in August, when data revealed a 15.6 percent year-over-year increase.

But China Real Time also reports, via a Credit Suisse Group AG (Switzerland: CSGN, NYSE: CS) property analyst, “that monthly data is volatile” and “that the downturn in the numbers was at odds with what their research team had been hearing on the ground.”

According to Credit Suisse note to clients, “A very large national construction company chief executive told us in September that he saw housing new starts accelerating, especially in the South China region.

The National Bureau of Statistics also reported that during the first three quarters of 2012 per-capita disposable income of urban households grew by 13 percent, which along with the effects of policymakers’ successful attempts to rein in housing affordability problems are being solved.

Value-added industrial production was up 9.2 percent in September from a year earlier, accelerating from an 8.9 percent increase in August and beating a consensus expectation for a 9 percent rise.

Fixed-asset investment in non-rural areas–a closely watched indicator of construction activity and demand for machine equipment–was up 20.5 percent in the first nine months compared with the same period a year earlier. That was up from 20.2 percent in the first eight months of the year and also beat a consensus forecast of 20.2 percent rise.

It’s been pretty dark data for some months now out of China, now the world’s second-largest economy and its most-watched growth engine. But consumption is clearly rising, and construction and industrial activity appear to be at least establishing a foundation for new growth.

And that means now is a good time to check out opportunities in copper.

Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF) is a small-cap producer of the red metal, with two high-quality operating mines in Australia and several exploration and development opportunities on the horizon. It’s backed by one of the world’s biggest conglomerates and has very little debt.

It’s trading at just over six times earnings, and its price-to-book ratio is just 0.31. And, most germane to our purposes, it’s yielding 9.4 percent as of Friday’s close of trading on the Australian Securities Exchange in Sydney. Wait for a pullback to AUD0.50 before stepping in to buy Aditya Birla Minerals.

The Story

As we wrote in the October 2012 In Focus feature for Australian Edge, copper is ubiquitous. More than 15 million metric tons of the red metal are used every year, in almost every home, in almost every vehicle, in parts and appliances as well as infrastructure projects and communications devices. It can be shaped and molded, rolled into thin sheets or drawn into wire. It conducts electricity and heat, and it doesn’t rust.

Malleability, strength and resistance to corrosion make it useful in a broad range of building, construction and electrical applications. Wiring and plumbing are the largest markets. In air conditioning and refrigeration, copper acts as a heat exchanger. It’s also an important material architecturally and used in such applications as roofing sheet.

Over the past century demand for copper has increased with the industrialization of developing economies. As the number of people living in cities continues to grow, there will be increased demand for copper used in housing, infrastructure and consumer goods. It is one of the key elements of the modern world.

But copper consumption in that most critical growth engine China will contract in 2012 for the first time since 2008. Demand is weakening, and inventories are climbing. Consumption will drop about 8.5 percent to 5.6 million metric tons in 2012.

The three-month rolling forward contract on the London Metal Exchange slid 21.9 percent from a peak of USD9840 in mid-July, weeks into what most Australian companies define as fiscal 2012, to close at USD7685 on Jun. 29, 2012. It traded as low as USD6735 in early October 2011.

During calendar 2012 copper’s been as high as USD8740, on Feb. 9, and as low as USD7295, on Jun. 8.

Copper rose 6.8 percent in the third quarter as central banks in the US, China, Japan and Europe expanded stimulus to try to revive economic growth. Producers’ share prices, however, have priced in lackluster fiscal 2012 results driven by the big slide before that.

But the widely respected metals and mining research firm Simon Hunt Strategic Services, which compiles analysis for users and fabricators, also forecast usage by copper’s biggest consumer, China, to grow by 5.6 percent to 5.9 million metric tons in 2013.

That means now is a great time to snap a high-yielding, beaten-down copper producer.

David: Before we move on to Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF) I’d like to pat us on the back for the decision last month to let one of our winners, CSR Ltd (ASX: CSR, OTC: CSRLF), continue to run.

The company makes stuff for residential and commercial construction–windows, roofing, insulation, things of that nature–and it also has a significant aluminum investment. Construction in Australia is still in a rough patch, but the price of aluminum has bounced a bit.

We’re definitely enjoying the effects, as the stock closed at AUD1.80 on the Australian Securities Exchange (ASX) on Friday, or about USD1.86 based on the prevailing exchange rate. And that’s actually off about AUD0.03 from Thursday’s ASX close.

We’re sitting on a 48.81 percent gain for this one.

Roger: I say we continue to let it run. But I also say we reiterate our advice to those who happened to purchase the stock on our initial recommendation to book a partial gain.

David: Exactly. And we’ll continue to keep a close eye on this one.

I imagine you have some things to say about some of our other Open Positions. Our coal picks from the last two months look to be working out rather well so far, yes?

Roger: Well, I think it is fair disclosure to say that all of our Big Yield Hunting picks are economically sensitive, at least to some extent. And that hasn’t been a bad thing since mid-summer.

In fact I think the real surprise going forward could be that these low interest rates we’ve seen the past three-plus years finally start to fire things up a bit, just like they did in 1992, the last time the Fed eased aggressively following a deflationary event.

There really wasn’t much hard news here the past month, though there will be as earnings come out over the next few weeks. BreitBurn Energy Partners LP (NSDQ: BBEP) did affirm its earlier guidance, which is bullish for dividend safety.

And a couple analysts picked up QR Energy LP (NYSE: QRE) with “buy” ratings. But there wasn’t much to shift my assessment of value. And there won’t be until we see earnings, which I guess we’ll talk about next month.

David: Data Group Inc (TSX: DGI, OTC: DGIPF) took another dive, falling from CAD4.09 on Sept. 20, the date of our last issue, to CAD3.54 on Oct. 9. But it’s also bounced again and is trading at CAD3.70 as of this writing. No “new” news, though this week the board approved and management declared another dividend of CAD0.542 per share.

I don’t get it.

Roger: It looks a lot like nerves before they do announce numbers. Frankly the size of the yield does send a chill up my spine. But I’m willing to stay on there so long as the numbers support the dividend. And for that information we just have to wait.

David: One move I’d love to have back is our close-out call on Arrium Ltd (ASX: ARI, OTC: ARRMF, ADR: OSTLY). The former OneSteel, which now fashions itself an iron ore producer, bounced from AUD0.57 the day we issued our “sell” advice to back near AUD0.80 on the ASX after the company received and rejected a takeover offer from a consortium including Noble Group Ltd (Singapore: NOBL, OTC: NOBGF, ADR: NOBGY), POSCO (Korea: 005490, NYSE: PKX), the National Pension Service of Korea, Korea Investment Corp and Korea Finance Corp.

This group offered AUD0.75 a share, or a 37.6 percent premium to Arrium’s close the day before the solicitation. Looks like we pulled the cord a little early on that one.

Roger: To our credit we did advise Big Yield Hunters to sell half their positions back in the spring, when the stock hit AUD1.36 on the ASX.

Don’t’ beat yourself up. We get it right from time to time.

David: We’ve done a lot of cleaning up in the Open Positions space, and I’m pretty comfortable with where we are…

Roger: Yeah, I’m comfortable holding all of our positions for another month.

Again, earnings are going to be very important to look at. They always are for riskier fare. And until we do get hard numbers investors should be ready for volatility.

In fact it could well accelerate as we wait for numbers. But then that’s the nature of these trades, which after all are high-risk, high-return. We just have to be ready to pull the plug if things do come apart at one of these companies.

But there’s no reason to expect anything but good news when they do report.

David: Sounds good.

So let’s talk about Dr. Copper and what is perhaps the most aggressive play on the red metal in the Australian Edge coverage universe.

Roger: Aditya Birla Minerals. Hmmm. The dividend yield at a share price of AUD0.50 is in double digits, exactly 10 percent, in fact, based on the payment declared May 30, 2012, and paid on Jun. 26, which was AUD0.05.

David: Yes, the dividend history is rather spare and a little sporadic. The company paid AUD0.10 per share in May 2008, “omitted” its dividend in 2009 and 2010 and then paid AUD0.09 in June 2011.

As you note, the board approved and management declared a AUD0.05 dividend on May 30. It was paid Jun. 26, 2012, to shareholders of record on Jun. 12. The company’s next dividend is likely to be declared in May 2013.

Roger: It appears the company pays an annual dividend, but policy remains “to seek to maximize cash returns to Shareholders whilst having regard to ensuring a sound financial structure for the Company and providing for value accretive development and exploration activities and targeted growth opportunities.”

David: That’s why I’d like to issue the tortured disclaimer now: Aditya Birla is a particularly aggressive play on copper’s rebound, for big yield speculators who know that although a dividend is probable–like 51/49 probable–it’s not a guarantee. A lot will depend on how the next several months shake out.

I will say, however, that I’m confident in the direction things are going.

Risk appetite toward industrial commodities has been improving on the back of the US Federal Reserve’s now open-ended commitment to quantitative easing as well as the European Central Bank’s plan to tackle the crisis in the euro zone and infrastructure spending announcements from China.

And over the first half of 2012 mine output growth of 2.4 percent year over year was outpaced by a surge in apparent consumption, which rose 7.3 percent according to the International Copper Study Group.

Copper has been able to hold up relatively well due to positive fundamentals on the supply side, even though the global macro picture was getting progressively bleaker the first six months of the year.

Roger: I also see that Chile’s output–which is about 26 percent of global consumption–has plateaued since 2004 because of declining ore grades. Costs are rising at the big mines in that South American country, as their having to dig deeper. And a weakening US dollar will also support higher copper prices.

So I think you’ve assessed the situation well. And so what about Aditya Birla?

David: The company controls two high-quality copper mines, Mt. Gordon in Queensland, approximately 120 kilometers north of Mt Isa, and Nifty in the Great Sandy Desert Region of the East Pilbara in Western Australia. Mt. Gordon has capacity of 1.2 million metric tons per annum, Nifty 2.3 million.

It’s part of the USD40 billion India-based conglomerate Aditya Birla Group and is backed by Hindalco Industries Ltd (India: HNDL, OTC: HINDG), one of the world’s largest aluminum manufacturing companies.

Roger: Just taking a look at numbers here.

Revenue for fiscal 2012 was up 7 percent to AUD498.6 million, though net profit after tax (NPAT) was off 54 percent. Fourth-quarter copper production and sales, however, each rose 29 percent

David: Aditya Birla mined and processed 2.81 million metric tons of ore, up from 2.19 million in fiscal 2011. Production was 59,707 metric tons, up slightly from 59,661 in fiscal 2011. Cash costs for the period were AUD2.45 per pound; for the first quarter of fiscal 2013 management reported a figure of AUD2.60 per pound.

Production guidance for fiscal 2013 is 70,000 to 80,000 metric tons, a nice increase over fiscal 2012.

Roger: The cost numbers look a little high compared to global metrics. But I guess that’s because it operates primarily in Australia.

David: Right again, sir. Rising labor costs in the Land Down Under are crimping resource producers of all stripes. I think that’s one of the reasons the stock is so beaten down compared to other similar issues.

Roger: The company actually has no debt, at least as of the end of fiscal 2012, and more than AUD100 million in cash on its books. It’s also a strong positive that it has the backing of a big conglomerate.

David: The cash costs are high and rising, and the dividend history is tough to pin down. This combination is what makes it a particularly aggressive play.

As of this writing the stock is trading at just 6.25 times earnings and 0.31 times book value. It’s rallied since mid-August, pushing from AUD0.04 on Aug. 15 to a close of AUD0.53 on Oct. 19 in Sydney.

I think it best to wait for a pullback to AUD0.50 or below to establish a position in Aditya Birla Minerals, which, again, is a speculative play for very aggressive investors. The symbol for buying on the Australian Securities Exchange–our preferred venue, if your broker can access it for you–is ABY. The US over-the-counter (OTC) symbol is ABWAF.

  • December 16, 2010: Capital Product Partners LP (NSDQ: CPLP)–Buy < USD9
  • April 21, 2011: Superior Plus Corp (TSX: SPB, OTC: SUUIF)–Buy < 7
  • July 22, 2011: France Telecom (France: FTE, NYSE: FTE)–Hold
  • November 18, 2011: BreitBurn Energy Partners LP (NSDQ: BBEP)–Buy < USD20
  • April 20, 2012: QR Energy LP (NYSE: QRE)–Buy < USD21
  • May 17, 2012: Tabcorp Holdings Ltd (ASX: TAH, OTC: TABCF, ADR: TACBY)–Buy < USD3.15
  • June 22, 2012: Data Group Inc (TSX: DGI, OTC: DGPIF)–Buy < 5
  • July 20, 2012: CSR Ltd (ASX: CSR, OTC: CSRLF)–Buy < USD1.35, SELL half of position
  • August 24, 2012: Natural Resource Partners LP (NYSE: NRP)–Buy < USD22
  • September 21, 2012: Rhino Resource Partners LP (NYSE: RNO)–Buy < USD16
  • October 19, 2012: Aditya Birla Minerals Ltd (ASX: ABY, OTC: ABWAF)–Buy < USD0.50
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