With 40% of the world's population, India and China will continue to fuel demand for natural resources and offset the concern we're seeing from a U.S. slowdown. Rio Tinto's CEO in a speech this week said China is increasingly decoupled from the U.S. and the Asian powerhouse would still grow at about 10% in 2008 even if the U.S. went into recession. They expect growth in China near 10% in 2008 and sustained growth of 9%. On top of this, few are even thinking about India but it won't be long before this country of a billion people starts to have a profound impact on the consumption of raw materials.
“Whether the U.S. is heading for a recession or just a mid-cycle slowdown remains to be seen,” CIBC World Markets chief economist Jeff Rubin wrote in a report Friday. “But the more important question for crude, base metals, and other resource markets, is whether it really matters any more.”
According to reports, during the last five years American consumption of zinc and copper has dropped, while aluminum and nickel has remained flat. During that same time period, demand from China jumped 20% and, as a result, we've seen record high commodity prices. Any slowdown on the demand for raw materials from the U.S. will be more than offset by demand from China, India, Russia, Brazil and the Middle East (our New Economy).
View this as opportunity - not disparity
The last time MicroCap.com had opportunities like this was back in 2001 and 2002 when we were buying beaten down tech stocks for discounts on cash value alone. Marimba (NASDAQ: MRBA, Bullboards) was the perfect example at the time. Few would buy the stock at $1.45 even though they had $60 million in the bank (approx. $2/share) and $40 million in revenue. We believe it was 12 to 18 months later when we saw the stock bought out for approx. $8/share.
This week we sent out a research note to paid subscribers on a TSX uranium stock that hit cash value (with $30 million in the bank and no debt) yet they have millions of pounds of uranium in the ground worth well over a billion dollars. People panic and have absolutely no idea why they're holding a stock or why they're selling. One investor's misery is another investor's opportunity.
Stocks are overbought going up and oversold going down. What is happening right now is that so much doom and gloom is being created by the media, that people are losing site of where the opportunities lie (outside the United States). In 2001 it was techs, now it’s the beaten down resource stocks with exposure to energy, gold, or certain base or precious metals. In the case of First Nickel this week, it’s nickel. Speculating in this type of environment means you stick with strong balance sheets, strong management, high demand commodities, strong exploration potential and, where possible, production situations.
First Nickel (TSX: T.FNI, Bullboards; 50 cents)
https://www.firstnickel.com
52-week high: $1.90; low: 48 cents
Shares Outstanding: Approx. 140 million - current market cap $72 million
Approx. Cash: $25 million
Ore in Process: $8 million
Property, plant, and equipment: $52 million
Accounts Payable approx. $6 million
Future tax liabilities: $5 million
Net Asset Value: approx. $74 million (52 cents/share)
Revenue in last quarter $14 million (cash flow positive)
We have a nickel mine (in production and cash flow positive) with a market value equal to its book value. Nickel prices have weakened from record highs but overseas demand means they should remain strong for 2008/09. Currently nickel trades around $28,400 per tonne - approx. $14 per pound.
On Wednesday, FNI announced its new 43-101- compliant mineral resource - total of 113 million pounds of contained nickel in the indicated resource category for the Lockerby Depth zone, and represents a net increase of 68 million pounds.
In our calculation above, the "book" value of its mineral properties is $22 million (plus plant and equipment of $30 million). If FNI has 113 million pounds (at a producing mine don't forget - not in the middle of moose pasture), the gross metal value at today's prices is $1.6 billion.
So even if it took $100 million to expand the mine to greater depths, and we discounted cash flows, lowered the price of nickel, etc. etc. - this $1.6 billion worth of nickel (according to the market) is only worth $22 million (?!)
We just calculated that cash, plant, equipment, and $22 million book value for mineral property less $11 million in debt was = $74 million. The stock at 52 cents times140 million shares out = $72 million.
So the increased tonnage of nickel and the simple fact they have 113 million pounds of it ($1.6 billion worth) is (according to the market) only worth $22 million (?!)
Does this really make sense?
Even if this was a private company, we would have to have our head examined if we made the decision to sell our plant, equipment, machinery, and ore already in process and add it to our existing cash. We then pay off our bills and ask someone to give us $22 million for the $1.6 billion worth of nickel sitting on our land with existing infrastructure. That’s exactly what we're seeing with this stock trading at 52 cents a share.
Cash flow positive
During the third quarter of 2007, 36,258 tonnes of ore were delivered to the Xstrata treatment facilities.
The payable metal content in the ore is estimated to be approximately 1,021,739 pounds of nickel and 619,522 pounds of copper.
Cash cost per pound of nickel = US$8.10 (net of other metal credits)
Nickel is selling for approx. $14 per pound
Revenue of $14.1 million, or approx. $13.8 per pound produced
Operating profit $1.9 million / Earnings of $1.7 million
Cash flow approx. $2.5 million, or $2.45 per pound produced
They produced approx. 28 pounds of nickel for each tonne of ore delivered to the plant. Monthly mine production is targeted at 13,500 tonnes per month going into 2008. If they even average this during Q1/08, they should produce 1.1 million pounds and generate approx. $2.7 million in cash flow.
The resource estimate for the Lockerby depth zone released on Wednesday indicates a total of 113 million pounds of contained nickel. Even if production never changed (and revenue and costs stayed the same), the company could generate cash flow (after all costs) approaching $300 million over a 25 year mine life.
It’s very realistic that exploration will continue to increase reserves and that they will be able to increase annual production rates and subsequent cash flows. Obviously, the company is at the mercy of fluctuations in nickel prices but increased global demand from stainless steel producers would have a positive impact on bottom line profitability and cash flow.
Currently, the Lockerby mine is producing at a rate equivalent to 4.5 million pounds of nickel annually but its last stated goal was to increase output to eight to 10 million pounds. Such a scenario with current nickel prices would generate close to $20 million in annual cash flow.
China demand fundamentals
China's demand for nickel imports could still rise by 15% this year as stainless steel mills seek metal on the international spot market. In 2007, nickel hit a record $51,800 a tonne in May, but ended the year almost 50% lower at $26,200, causing big losses to many Chinese importers.
Nickel consumption in China, which accounted for about a fifth of the world's nickel demand last year, may rise 32,000 tonnes, or about 11%, to 345,000 tonnes this year as China's stainless steel production rises, said Xu Aidong, senior analyst at Antaike Information, a state research group.
Stainless steel production is expected to rise 42% to 7.6 million tonnes last year out of capacity of up to 20 million tonnes, indicating another output jump this year. In an effort to try and control prices, Chinese stainless steel mills will buy domestically produced nickel from Jinchuan Group Ltd, China's largest nickel smelter. How well this will work is still undetermined. Demand throughout the rest of Asia will continue to impact supply.
India lurking in the shadows
Asia, which includes China, South Korea, India, Thailand and Taiwan, has become the largest user segment of stainless steel (the driver of nickel demand). This region accounted for almost 43% last year and is expected to increase to 50% in 2008.
In 2004, China's stainless steel demand at 5.3mt already surpassed the aggregate demand of 5.2mt from Japan & the U.S. At just over 1kg of consumption per capita in India (two years ago) that country had the lowest stainless steel consumption of all developing nations. China by comparison (was) 4kgs, the U.S. 8.4kgs, and Japan 20kgs.
Everyone is ignoring India but without question it will become the next China (while at the same time China's demand of natural resource will outpace everyone else). In 2007, stainless steel production in India was in the range of 1.7mt. This country is probably 10 years "behind" China in terms of modern growth. The demand (and strain) that will be placed on industrial metals as this country grows will be tremendous.
India has a long way to go in development of its basic infrastructure. Only 1% of domestic stainless steel consumption goes into construction compared to 25% in China.
Potential for high growth in India:
- Higher expected growth in GDP & Industrial production
- Existing low per capita consumption
- Availability of key natural resources like manganese and chrome ore
- Low manpower cost
The same drivers as what we are seeing in China will drive stainless steel (nickel) demand in India:
a) Kitchenware - storage, washing, cooking, serving
b) Architecture, Building & Construction
c) Automotive, Railways & Transportation
Q1/08 expectation for FNI
According to First Nickel's CEO, they will make a number of announcements in Q1/08.
West Graham exploration results;
Lockerby Main zone exploration results;
Lockerby life of mine and shaft extension study;
Decision on Premier Ridge development;
Raglan Hills property exploration results;
Guidance on 2008 anticipated Lockerby production
Corporate Presentation – https://www.firstnickel.com/s/Presentations.asp
Excellent liquidity under 55 cents a share
Disclosure: Danny Deadlock owns 20,000 shares of First Nickel (TSX: T.FNI)