By Mike Thiessen,
Nevsun Resources (NSU) is going through a transition and investors with patience could benefit. NSU will shift from gold production to copper production in mid-2013 which is a headwind for earnings and cash flow. That said, the copper rich ore body should lead to strong free cash flow and earnings in 2014.
Nevsun is the operator of its 60% owned Bisha Mine located in Eritrea, East Africa. The open pit mine is unique in that it will produce high grades of copper, gold and silver at different points in its life cycle. The Eritrean government purchased a 30% interest in the mine in addition to its 10% carried interest. Nevsun has a strong balance sheet and did not use debt or hedge any production contracts to finance the development of the mine. Earnings benefit since metal prices are currently at relatively high levels. The firm pays a $0.05 semi-annual dividend, a 2.4% yield. Also noteworthy, Nevsun is an industry leader in FCF yield and EBITDA margin.
The shift from gold to copper production requires a $125 million investment 80% of which has been spent. The project is within budget and expects to start on schedule. In 2012, Bisha produced 313,000 oz of gold; management issued a 2013 forecast of 80-90,000 oz of gold and 60-80 million pounds of copper. The decline in gold is the result of a mid-year shift to copper production. Management has exceeded production forecasts before, most recently in 2012.
Copper and Zinc Fundamentals
For the next three years, copper will account for a majority of production at Bisha and drive earnings and cash flows for the firm. The global supply of copper remains tight driven largely by increasing Chinese demand. In addition, demand levels could increase further if the recovery in US housing continues. Analysts have modeled copper prices in the $3.50-$4.00 range over the next few years for Nevsun, but are often using a $2.50-$2.75 estimate over the long-term. Supply disruptions and stronger demand due to a recovery in US housing and eventually in Europe could push prices higher. This would translate directly to earnings and cash flows for NSU and upside to current earnings and cash flow estimates that use the previously noted ranges.
Zinc will come into focus in 2015 for NSU when it will ramp up its production. The bull case for zinc assumes the surplus in zinc will decrease behind depleted mines over the next 2-3 years. Analysts estimate zinc production will contract by 10% through 2016 due to depletion at mines. NSU is positioned to take advantage.
There are a few risks for NSU. The first is the transition to copper and then zinc production does not go smoothly. Second, the global economy and supply/demand dynamic could get worse hurting the net asset value for NSU. Last, NSU owns and operates one mine in one African country so geopolitical risk is much higher than at a mine like Escondida, majority owned by Rio Tinto (RIO) and BHP Billiton (BHP) located in Chile and Argentina.
Look to Other Miners for Market Knowledge
Nevsun is a bit different versus other miners since it has one mine that produces three minerals but at different points in time. Comparison to gold miners such as Barrick Bold Corp (ABX) or smaller producers like Banro Corp (BAA) are no longer a good fit given the shift to copper, followed by the shift to zinc production. Freeport-McMoRan Copper & Gold Inc. (NYSE:FCX) and Southern Copper Corp (NYSE:SCCO) both are both copper producers and act as a good gauge for that market. FCX has a lower PE at 7.4, but return on assets of 10.6 versus NSU’s 44%. SCCO is in the middle of the two with a PE of 14.4 and an ROA of 23%. In terms of market cap, FCX and SCCO are much larger each valued around $ 34 billion.
Nevsun and mining companies with few assets and no acquisitions trade off of estimate net asset value (NAV) discounted for the risk level and time. Nevsun has cash and equivalents of $1.83 per share and the remainder of the valuation is the value of the assets. If prices of copper, gold, or zinc push higher or cash mining cost is lower than expected, the value of Nevsun increases. Buying the shares at this point assumes management can execute on the production shift in 2013 and increases efficiency at the mine.