BMO looks for leverage to soaring zinc price BMO looks for leverage to soaring zinc price
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2014-07-17
With several major zinc mines slated to close in the next few years, zinc prices have responded accordingly — climbing 12% year to date and 24% over the last 12 months.
So where does zinc go from here? In a note today, BMO Capital Markets calculates the metal's upside and downside potential and concludes that while any upside left for zinc prices is limited, so are the downside risks.
BMO estimates that the closure of large mines, including Century in Australia and Lisheen in Ireland next year, will remove about 800,000 tonnes per year from the 13-million-tonne-per-year zinc market by 2018.
However, the investment bank says that those favourable fundamentals are already baked into the zinc price.
Still, BMO expects bullish market sentiment regarding zinc to keep the price near its current level of US$1.04 per lb. (The current price, BMO notes, is well ahead of the 90th percentile of the cash cost curve, meaning that most zinc producers should be cash flow positive right now.)
Despite the looming closures, BMO doesn’t foresee a large supply-demand gap materializing for zinc, which is primarily used to make galvanized steel. The bank sees a relatively tight market for zinc that is balanced this year and will grow to a modest surplus next year (138,000 tonnes, or 1% of the global market). Restarts and expansions of both primary zinc mines and byproduct operations are expected to make up for lost production from shuttered mines.
There is some downside risk for zinc – primarily from expansion of Chinese supply.
“As China accounts for around 30% of mined zinc supply and 40% of smelting output, its ability to ramp up production quickly could reverse the positive outlook for market fundamentals,” reads the report by BMO mining analyst Aleksandra Bukacheva and research associates Luigi Di Pede and Milovan Pejic.
In a conservative base case scenario, BMO expects Chinese zinc mine supply to grow at a compound annual growth rate (CAGR) of 1.5% through 2018.
But given that Chinese zinc production ballooned from 2009-12 with a surprisingly strong CAGR of 15%, it’s possible the country could again quickly ramp up production and tamp down zinc prices.
“At stronger zinc prices, BMO Research understands that there is potential for 1.2 million tonnes per year of incremental zinc mine capacity (8-8.5% of the global market) to start up quickly,” reads the note.
BMO forecasts that zinc will average US98¢ a lb. this year, increasing gradually to US$1.10 per lb. in 2018.
Zinc names
Assuming that zinc prices remain strong, there are few companies that offer investors meaningful leverage to the price of zinc, BMO notes.
However, the bank has initiated coverage on two companies whose share prices could see a boost with higher zinc prices: Nyrstar(OTC: NYRSY; BRUSSELS: NYR) and Boliden (OTC: BDNNF; STOCKHOLM: BOL). Both are vertically integrated companies with both zinc mines and smelting facilities.
Nyrstar’s “main attraction” is leverage to zinc prices. Zinc represents more than 75% of the company’s revenues and BMO notes that a 10% increase in the zinc price above US$1 per lb. would mean a more than 80% jump to Nyrstar’s expected earnings per share and net present value in 2015.
As for Boliden, BMO forecasts that the company will more than triple its earnings by 2017, thanks to a combination of rising copper and zinc production, an expansion in smelting capacity and cost cutting efforts.
BMO has an outperform rating on Boliden and a target price of SEK135, while it has a market perform rating on Nyrstar with a target price of EUR 3.50. The companies recently traded at SEK111.6 and EUR 2.56, respectively.
On the strength of zinc prices, Canaccord Genuity mining analyst Rahul Paul recently raised his 12-month target for Nevsun Resources (TSX: NSU) to $5 from $4.50. Nevsun recently traded at $3.38.
Canaccord recently revised its long-term metal prices (looking out to 2019 and beyond) with gold, silver and copper all being revised slightly lower (between 0.6-1.2%), and zinc gaining by 7.9% to US$1.01 per lb.
Nevsun’s Bisha mine in Eritrea contains copper, gold, silver and zinc, and is expected to start producing zinc in 2016. Bisha is a volcanogenic massive sulphide deposit with a gold-enriched oxide layer lying overtop a copper-enriched supergene horizon that covers the primary high-grade zinc deposit.
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