Iron ore sector investment trends, appetite and opportunities

Iron Ore Sector – Investment Trends, Appetite & Opportunities

SIMON PRICE | 20 MARCH 2013

STRICTLY CONFIDENTIAL | 2

TABLE OF CONTENTS

SECTION I WHAT’S GOING ON IN THE MARKET? 3

SECTION II WHAT’S GOING ON IN M&A? 15

SECTION III HOW’S A PROJECT GETTING FINANCED? 25


Section I THE MARKET

THE MARKET

M&A ACTIVITIES

FINANCING ACTIVITIES


A"er 5 years of misery, a bull market may be emerging for equi7es... US markets are above their post GFC highs and Australian markets are geBng there… the ASX accumula7on index (includes dividends) is reaching 2007 levels…

ARE WE SEEING THE MOVE FROM BEAR TO BULL MKT?

Source: Bloomberg as at 18/03/13.

40

50

60

70

80

90

100

110

120

2007 2008 2009 2010 2011 2012

ASX 200 Index ASX All Ordinaries Index ASX 200 Accumula7on Index

40

50

60

70

80

90

100

110

120

2007 2008 2009 2010 2011 2012

Dow Jones Industrial Average Index S&P 500 Index

Aust capital markets: ASX200 and ASX All Ords (rebased to Aug 07) US capital markets: Dow Jones and S&P 500 (rebased to Aug 07)


Australia looks middle of the road compared to Europe, Japan and China…

RECOVERY IS NOT A GLOBAL THEME … YET


Major stock exchange indices (rebased to Aug 07)

20

40

60

80

100

120

140

160

2007 2008 2009 2010 2011 2012

HK Hang Seng FTSE 100 Nikkei 225 Euro Stoxx 50

SSE Composite ASX All Ords S&P 500

← ASX All Ords


A"er the crash, the ini7al recovery and a (very protracted) period of consolida7on, the final stage – the rally into a bull market – is what investors are now hoping for...

LOOKING FOR THE LAST (BULL MARKET) PHASE OF THE MARKET CYCLE


ASX200 Index

3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

7,000

2007 2008 2009 2010 2011 2012 2013

3. ConsolidaMon -‐ market trades sideways for 3 years from 4800 in Oct 09 to

~5000 now

1. Market crashes – post GFC severe at -‐56% over 17

months

2. Market bounces off the bo]om -‐ +53% over 8 months

4. Finally the bull market -‐ rally

commences in 2013 ??


The distribu7on of recent returns in ASX stocks does not reflect a broad based up-‐cycle – we have seen strong moves from retail, steel, financial and media stocks (some off a low base), plus the high yielding banks, Telstra and large retailers, but small cap and small resources sectors have declined…

PERFORMANCE IS PATCHY AND NOT BROAD BASED (YET)

30

40

50

60

70

80

90

100

110

120

2008 2009 2010 2011 2012 2013

ASX200 Index ASX Small Cap Index


Small cap resources halved over 24 mths…

Top 10 vs Bo]om 10 movers in ASX200 – past 6 months (%) ASX200 vs. Small Cap Resources and Small Cap Indices (rebased to Jan 08)

127%

100%

80%

68%

68%

65%

53%

50%

49%

49%

(34%)

(34%)

(35%)

(37%)

(38%)

(43%)

(45%)

(47%)

(50%)

(51%)

Magellan Financial

BlueScope Steel

Seven West Media

JB Hi-Fi

Myer

Arrium

Seek

Super Retail Group

Horizon Oil

Perpetual

Lynas Corp

Mount Gibson

Perseus Mining

Silver Lake

St Barbara

Billabong

Troy Resources

Alacer Gold

Maverick Drilling & Exploration

Discovery Metals


5.9

5.4

4.4

5.1 5.0

3.9 4.2

6.1

5.5

4.5

5.3 5.1

4.0 4.3

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 YTD

ASX200 Index ASX All Ordinaries Index

In the past two years the ASX has been characterised by very low levels of liquidity… this is star7ng to change… in par7cular in February there were 7 trading days when turnover exceeded $5bn… but decline remains in small caps…

LIQUIDITY IS STARTING TO TURN


268 255

166

260 251

146 144

0

50

100

150

200

250

300

350

2007 2008 2009 2010 2011 2012 2013 YTD

ASX Small Cap Resources Index

↓ 34% since 2007 for ASX200 and ASX All Ords indices

↓ 46% since 2007 for Small Cap Resources Index

Average daily turnover ASX200 vs. ASX All Ords (A$bn) Average daily turnover ASX Small Cap Resources (A$m)


A"er huge growth in gold as a financial investment both directly and via ETFs, appe7te has diminished as the global economy recovers, although some ques7on whether currency devalua7ons and the West’s sovereign debt stress will support it going forward…

GOLD LOSING ITS SHINE


20

30

40

50

60

70

80

90

2007 2008 2009 2010 2011 2012

Total Known ETF Holdings of Gold

0

400

800

1,200

1,600

2,000

0.0

4.0

8.0

12.0

16.0

20.0

2007 2008 2009 2010 2011 2012 US Total Public Debt Outstanding Gold Price

0

0.2

0.4

0.6

0.8

1

1.2

0

300

600

900

1,200

1,500

1,800

2007 2008 2009 2010 2011 2012

Gold Price USD per AUD

Total known ETF holdings of gold (Moz) US govt. debt (US$trillion) Gold price(US$/oz) Gold price (US$/oz) USD per AUD

Blip on the way? Or first signs of a shij out of ETFs?


A"er reaching high rates of household equity ownership (in part due to compulsory super), Australians le" the market in droves due to post GFC losses and percep7on of bejer risk adjusted returns in cash. Interest rate cuts are s7mula7ng some reversal of this…

HOUSEHOLD SELLING OF EQUITIES BOTTOMING

Source: Goldman Sachs A"ernoon Market Report (5/3/13).


Cash is star7ng to return to US equi7es funds … a"er a long and constant weekly oumlows. However limited signs of “rota7on” out of bonds and into equi7es…

MONEY STARTING TO FLOW BACK INTO EQUITY FUNDS


-‐15

-‐10

-‐5

0

5

10

15

-‐15

-‐10

-‐5

0

5

10

15

ICI total equity esMmated weekly net new cash flow (US$bn) ICI total bond esMmated weekly net new cash flow (US$bn)

< <


40

80

120

160

200

240

2007 2008 2009 2010 2011 2012 2013

ASX300 Resources Index

RBA Commodity Price Index (in A$ terms)

As a broad observa7on mining equi7es have underperformed the underlying commodi7es although when viewed in AUD, the strong dollar translate to a less drama7c difference…

MINING EQUITIES UNDERPERFORMING COMMODITY PRICES

Notes: 1. All indexes are presented on monthly intervals. Source: Bloomberg as at 18/03/13, Reserve Bank of Australia (RBA).

40

80

120

160

200

240

2007 2008 2009 2010 2011 2012 2013

HSBC Global Mining Index

RBA Commodity Price Index (in US$ terms)

HSBC Global Mining Index vs. RBA Commodity Price Index in US$ terms (Rebased to Jan 2007)

ASX300 Resources Index vs. RBA Commodity Price Index in A$ terms (Rebased to Jan 2007)


62% Fe fines spot price1

Mid cap iron ore peers index2

Similar theme applies to the Australian iron ore sector… (chart excludes majors as they are diversified)

THE SAME TREND CAN BE SEEN IN IRON ORE

Notes: 1. China import iron ore Fines 62% Fe spot (CFR Tianjin port) – denominated in US$/dmt. 2. Mid cap iron ore peers consists of Aquila Resources, Atlas Iron, Gindalbie Metals, Grange Resources and Mount Gibson Iron. Source: Bloomberg as at 18/03/13.

20

40

60

80

100

120

140

Jan-‐12 Mar-‐12 May-‐12 Jul-‐12 Sep-‐12 Nov-‐12 Jan-‐13 Mar-‐13

Index (rebased to 100)


KEY THEMES AND CONCLUSIONS

Source: Australian Financial Review.

Global EquiMes Resource EquiMes

Global economic outlook is improving even though sovereign debt issues remain

Key Australian and US markets have (more or less) recovered GFC losses and we are soon entering a bull market phase

Major Equity markets slightly ahead (US, UK, HK)… Australian equity recovery in its infancy… economic laggards yet to recover

Interest rate cuts in Australia have sparked a return to (some) equi7es as investors look for yield but yet to see a broad based return of investors

Liquidity low but may have bojomed

Small caps looking very cheap and out of favour

Resources have underperformed significantly and may be next in line for a rally

Clear underperforming sector of the past 12 months having been the outperformer through the bear market. Reasons include:

– Investor risk appe7te remains low and cash is looking for yield… mining tradi7onally low yield

– Major M&A failures

– Concern over low returns on capital / poor value outcomes from major investments

– Rising costs, taxes and currencies

– Management change

– Increased ajrac7veness of other sectors

Commodity prices are a reason in specific cases (e.g. gold) however overall equi7es have lagged commodi7es

Small cap and early stage very unloved right now


Section II M&A ACTIVITIES

THE MARKET

M&A ACTIVITIES



0

50

100

150

200

250

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

0

200

400

600

800

1,000

1,200

Deal value (US$bn) Deal volume (#)

Deal value (US$bn) Deal volume (#)

M&A in 2012 declined… In general, ac7vity was low compared to the pre-‐GFC period…

METALS & MINING M&A IN 2012

Source: 2013 mergers, acquisi7ons and capital raising in mining and metals – Ernst & Young.


2,132

1,971

1,655

335

318

308

588

China

Japan

South Korea

India

Taiwan

South Africa

Other

Australia s7ll remains the top des7na7on for iron ore M&A deals in 2012 in terms of deal value, and China the main buyer…

IRON ORE M&A IN 2012 – BY COUNTRY

Source: 2013 mergers, acquisi7ons and capital raising in mining and metals – Ernst & Young.

4,182

1,500

405

308

239

193

191

Australia

Sierra Leone

China

Republic of Congo

Liberia

Canada

India

Value of deals targeMng iron ore by desMnaMon (US$m) Value of deals targeMng iron ore by acquirer (US$m)


While sen7ment in iron ore was low several notable transac7ons s7ll took place…

IRON ORE M&A IN 2012 – ACTIVITIES

Date completed

Target Acquirer Deal

Company Company Country Up or

downstream? Acquisi7on level (asset/corporate)

Stake acquired (%)

Deal value (A$m)

Selected Australian iron ore transacMons

18 Dec 12 Nullagine JV project

(Fortescue) BC Iron Australia Upstream Asset 25% 190

31 May 12 Balla Balla project

(Atlas) Forge and Todd Capital

Australia Upstream Asset 100% 40

Mar / Apr 12

Roy Hill project (Hancock prospec7ng)

POSCO, Marubeni and STX Corp

Korea and Japan

Downstream Asset 25% 3,200

Roy Hill project (POSCO)

China Steel Corp Taiwan Downstream Asset 2.5% 305

15 Mar 12 African Iron Exxaro South Africa Upstream Corporate 100% 308

Selected internaMonal iron ore transacMons

[pending] Amapa project

(Anglo American and Cliffs) Zamin Ferrous Brazil Upstream Asset 100% [pending]

3 Apr 12 Tonkolili project (African Minerals)

Shandong Iron & Steel

China Downstream Asset 25% 1,463

Source: Mergermarket as at 18/03/13 and company announcements.


80

100

120

140

160

180

200

Jan-‐10 Jan-‐11 Jan-‐12 Jan-‐13

Iron ore spot price has recovered from the lows of US$90/t in 3Q 2012, and is star7ng to trend back down. Its tradi7onal correla7on with the AUD has also become tested in recent years, puBng pressure on Australian suppliers and developers…

IRON ORE SPOT PRICE

Notes: 1. China import Iron Ore Fines 62% Fe Spot (CFR Tianjin port) USD/dry metric tonne. Source: Bloomberg as at 18/03/13.

62% Fe fines (US$/t)1

0.6

0.7

0.8

0.9

1

1.1

1.2

40

80

120

160

200

Jan-‐10 Jul-‐10 Jan-‐11 Jul-‐11 Jan-‐12 Jul-‐12 Jan-‐13

62% Fe Fines CFR China USD per AUD

62% Fe fines (US$/t)1 USD per AUD


Notes: 1. This index takes the average of Hebei/Tangshan and Shandong/Laiwu iron ore price in China (in USD), normalising the grade to 62%. The average domes7c grade of the two is 65% before normalising.

The index then subtracts the import price from the Steel Index. Source: Bloomberg as at 18/03/13.

A major recent influence on the seaborne price is the Chinese domes7c iron ore price – when it is cheaper than imported ore (as happened in January) it signals a falling seaborne price…

CHINA IRON ORE ARBITRAGE INDEX

DomesMc Price < Import Price

DomesMc Price > Import Price

China Iron Ore Arbitrage Index (US$/t)1

-‐20

-‐10

0

10

20

30

40

Nov-‐08 Apr-‐09 Sep-‐09 Feb-‐10 Jul-‐10 Dec-‐10 May-‐11 Oct-‐11 Mar-‐12 Aug-‐12 Jan-‐13


Another support for the iron ore price (and M&A ac7vity) is the con7nued growth in costs…

RISING COSTS OF PRODUCTION

Notes: 1. In 2011-‐dollar terms. 2. In 2020-‐dollar terms. Source: Mineral Council of Australia (MCA).

96

150

100

195

0

20

40

60

80

100

120

140

160

180

200

2007 2011/2012 Rest of the world Australia

Capital expenditure (US$/tonne of capacity)1

20

(5)

(48) (50)

(40)

(30)

(20)

(10)

0

10

20

30

Established Pilbara Emerging Pilbara Non-‐Pilbara

Delivered cost advantage over Brazil (US¢ per dmtu, China CIF)2


IS IT CHEAPER TO BUY OR BUILD? Simple comparison between trading values and capital costs suggests exis7ng producers are rated at values below what it will cost to build greenfield projects in Australia…

49 49

131 139

145

271

30

60

90

120

150

180

210

240

Mt Gibson Grange Atlas Iron BC Iron Fortescue (envisaged 155Mtpa) Fortescue (FY13E produc7on)

145

188

200

30

60

90

120

150

180

210

240

MCA -‐ Rest of the world MCA -‐ Australia Major project finance basket (average)²

EV/FY13E producMon (A$/t annual producMon) Capex/esMmated producMon (A$/t annual producMon)

Notes: 1. Mean excludes Fortescue’s trading mul7ple on FY13E produc7on. 2. “Major project finance basket” includes Mbalam, Southdown, API, Marampa and Roy Hill. Source: Bloomberg as at 18/03/13, Mineral Council of Australia (MCA) and company announcements.

Mean (excl. outlier)1: A$103/t

Mean: A$177/t


The big ques7on: what will be the long term price for seaborne iron ore?

LONG-TERM PRICE OUTLOOK

Source: Australian Financial Review.

Consensus view The counter view?

China’s growth may slow but there is enough urbanisa7on and ongoing construc7on that new iron ore projects will need to be developed for another ~5 years un7l supply catches up

Chinese domes7c produc7on costs set a floor around $100-‐120/t CFR

Rising costs will con7nue to underpin the price... – new supply has a habit of running late... – ... but in 7me significant new supply will

dampen the price in the long term

Fall below US$60/t before sejling at an average around US$80/t in the long run

“ …it could go to 50-‐something… you need it to go low enough to convince Chinese producers to abandon produc<on”

“…consump<on of steel had peaked at 700 million tonnes… investments in rail and motor vehicles would not offset fixed asset investment in highways and property…”

“How could they jus<fy a big boom in steel demand?”

Andy Xie, former chief strategist, Morgan Stanley Asia and renowned China commentator


Some predic7ons for 2013?

IRON ORE M&A – TRENDS AND OUTLOOK

2012 observaMons

Subdued M&A climate – largely brought about by global macroeconomic uncertain7es and massive vola7lity in the iron ore price

Chinese steel mills, Japanese and Korean trading houses s7ll appears to be ac7ve acquirers by taking minority stakes in projects opportunis7cally (i.e. in projects that need financing etc.)

Companies shi"ed gear to “op7misa7on” mode – non-‐core asset dives7tures and cost cuBng are a common theme as companies pushed to op7mise balance sheet

2013 outlook

Divestments by the majors as they focus on costs, core business and divest explora7on stage / long term / higher cost assets

Asian steel mills and trading houses remain acquisi7ve to secure iron ore supply – but will “pick the eyes” out of what's available

Capital intensity remains an issue. Unlikely to see major port and infrastructure developments other than those already commijed to or already in the funding process

Lack of funding from capital markets and depressed valua7ons will mean it remains a buyers market

Area to watch: assets in produc7on or ready to construct with below average capital intensity


Section III FINANCING ACTIVITIES

THE MARKET

M&A ACTIVITIES



16

21

30

35 39

54

59

50

88

35

28 28

0

10

20

30

40

50

60

70

80

90

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Equity issuances (A$bn)

All (A$B) Hybrids Secondary offers

2012 sees one of the lowest Australian equity issuance over the past decade... driven by low liquidity and reduc7on in investor appe7te for equi7es. 2012 marked the 10-‐year low for equity issuance, and the high for hybrids (appe7te for yield)…

AUSTRALIAN EQUITY ISSUANCE AT 10 YEAR LOW

Source: Bloomberg and Dealogic as at 18/03/13.


The deals we saw were generally small and done in tough condi7ons. BCI placement being the excep7on done at a premium, to fund an accre7ve M&A deal. Note all but one for advanced projects…

EQUITY RAISING 2012 – IRON ORE

Date announced Company Amount Raised (A

$m) Type

Premium / Discount to last close

Purpose

10 Dec 12 BC Iron 57 Placement and SPP 3.7% premium Acquisi7on of addi7onal 25% interest in the Nullagine JV

30 Nov 12 Gindalbie Metals 62 Placement 13.6% discount To fund commissioning at Karara if required

4 Oct 12 Northern Iron 55 En7tlement Offer 46.4% discount Strengthen working capital posi7on

2 Aug 12 Iron Road 40 En7tlement Offer 8.1% discount Fund DFS for Central Eye Project

9 Jul 12 Centaurus Metals 26 Placement -‐ Progress development at Jambreiro

12 Jun 12 Sundance Resources 40 Placement 8.0% discount Development at Mbalam Project

Source: Mergermarket as at 18/03/13 and company announcements.


Despite the gloom in equity, raising US Dollar high yield debt (ie non-‐investment grade) is cheaper in absolute terms than pre GFC! Although in spread terms, not quite as cheap...

US DEBT MARKETS – NEVER BETTER


0

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011 2013

0

5

10

15

20

25

1999 2001 2003 2005 2007 2009 2011 2013

Cheaper in absolute terms than the last ~ 10 years

Median: 8.9%

Median: 5.5%

Not as cheap on spread basis

Credit Suisse High Yield (CS HY) Index (%) High yield spread – CS HY Index vs. 10-‐yr US treasuries (%)


Australian miners are accessing the US high yield markets with increasing frequency, and raising significantly more than what we have seen in the equity market…

US DEBT MARKETS ARE OPEN FOR AUS MINERS

Source: Company announcements.

Borrowing in US high yield markets is as cheap now as it ever has been for Australian miners

This suits Australian miners, who have US$ revenues so tradi7onally borrow in US$ debt, and so issuers are tapping the market in increasing numbers

Rates can be fixed at historical lows, leverage is o"en generous and covenants/condi7ons generally “light”

This suits:

– Producers looking to refinance, fund acquisi7ons,

– Brownfields development

– In strong and low risk cases, greenfields development

Date announced Company Amount Raised (US

$m)

Selected ASX-‐listed companies

14 Mar 2013 St Barbara 250

22 Oct 2012 Ausdrill 300

18 Oct 2012 Atlas Iron 275

15 Oct 2012 Linc Energy 265

18 Sep 2012 Fortescue 5,000

31 Mar 2011 Mirabela Nickel 375

1 Feb 2011 Atlan7c 335

Selected TSX-‐listed companies (with Aust operaMons)

27 Sep 2012 First Quantum Minerals 350


FMG and Atlas are examples of recent iron ore miners who have tapped the Term Loan B market…

RECENT IRON ORE DEALS – TERM LOAN B

Sector FMG AGO

Loan Type Term Loan B Term Loan B

Lead Arranger(s) Credit Suisse & JP Morgan Credit Suisse

Amount US$5.0bn US$275m

Security Yes Yes

Covenants Covenant Light Covenant Light

Margins LIBOR (1.00% floor) + 425 bps LIBOR (1.25% floor) + 750 bps

Tenor / Amor7sa7on 5 years, minor amor7sa7on 5 years, minor amor7sa7on

Announced Date 18 September 2012 18 October 2012

Source: Company announcements.


Investors today are more interested in cost cuBng and dividends than growth and capex…

IRON ORE – INVESTOR THEMES AND PERCEPTIONS

Investor concerns about the broader resource sector

apply to iron ore…

Resource stocks are down because investors are currently concerned about: – High capex / low cashflow and dividend yields / too heavy a focus on growth – Commodity price outlooks – Management and regulatory change – Cost growth and ability to achieve cost cuBng targets

…Low capex and exisMng producMon are key preferred

a]ributes

Greater interest in producing assets that are trading at recent lows or conserva7vely valued

Development stories, projects that need finance and explora7on plays are all being marked down

Iron ore is generally capital intensive and so these concerns dampen interest in the junior scene

In the short term the prevailing view is that the iron ore price has peaked and is due for a correc7on – Iron ore producers are bejer posi7oned in this regard than some other

commodi7es (e.g. gold)

Some explora7on successes (e.g. Sirius) support the view that the market is s7ll open for the strongest and best opportuni7es


Iron ore was a market-‐favoured commodity for the past 5 years with some large transac7ons taking place. Now investors are more discerning but appe7te remains…

RAISING FUNDS FOR IRON ORE PROJECTS TODAY

ExploraMon stage Equity markets Tough but possible for the best quality opportuni7es “Out of favour” sector

Feasibility stage Equity markets Strategic investors

Subject to quantum equity markets will support studies for quality orebodies

Need to believe project is high quality / low cost Strategic investors from Asia for the bigger projects − Chinese SOE appe7te has diminished in this space − India, HK, Korea

Greenfield ConstrucMon / Project

Finance

Equity markets Debt markets Strategic investors

Equity markets scep7cal of high capital intensity / massive scale projects – mega raisings not happening

Debt capital markets currently ac7ve and open Western bank project finance a bit harder, Chinese

development banks ac7ve Strategic investors ac7ve but discerning

Brownfield / AcquisiMon of exisMng

producMon

Equity markets Debt markets Strategic investors

Sweet spot right now but focussed on value, cost, management

Debt capital markets currently ac7ve and open Strategic investors ac7ve Equity market available provided quantum not

excessive


QUESTIONS & ANSWERS

QuesMons?

AZURE CAPITAL PO Box Z5340 Perth Western Australia 6831

Level 34 Exchange Plaza 2 The Esplanade Perth Western Australia 6000 Phone: +61 8 6263 0888

Fax: +61 8 6263 0878 www.azurecapital.com.au

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Iron ore sector investment trends, appetite and opportunities

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Transcript of Iron ore sector investment trends, appetite and opportunities