CENTRAL ASIA METALS - Low Cost Copper Producer in a Bull Market
Central Asia Metals - LON:CAML
I discovered Central Asia Metals Plc while searching for a low cost non-precious metal producer that would deliver safe long term gains. My main points of interest were high dividend yield, insulation from market fluctuation and steady share price growth.
The Company
CAML was incorporated as a private company in 2005. In 2007 the company acquired a 60% interest in a then-dormant Kounrad mine in Kazakhstan. The company went public in 2010 through a £35 million IPO.
Since the IPO, CAML has built and improved an SX-EW plant at Kounrad. The plant has allowed CAML to be amongst the lowest cost copper producers in the world - but more on this later. Production from Kounrad has steadily grown since it came online in 2012 and in that time has supplied a market in surplus. Copper was traded at record lows of $2 per pound and CAML still made over 60 cents profit per pound. The recently improved Kounrad operation will produce for up to a further fifteen years but with a decline in productivity setting in after five.
The Board have been active beyond the Kounrad project. CAML has acquired interests in an exploration site in Shuak, Kazakhstan and a copper tailings project but in Copper Bay, Chile. Both projects are long term and far from production.
CAML's share price has more than doubled since it launched for 100p in 2012. For investors who bought and kept shares since the IPO, CAML has also returned the acquisition price in dividends over five years. Context is important: CAML has managed this as an infant company against a backdrop of difficult market conditions.
Market Factors impacting CAML
Copper in a Global Economy
As Figure 1 suggests, the gap between global production and consumption of refined copper has narrowed in recent years. In fact, according to the ICSG (International Copper Study Group) there was a minor surplus of production in October and December 2016. The chart shows this has been a downward force on copper price (based on London Metal Exchange average Oct-Sep copper cash price).
Copper and Crude Oil
Recently, as Figure 2 shows, copper (in red) has rebounded since late 2016. In part due to a weaker dollar. In no small part due to recent strikes at mega-mines: Escondida, Chile and Grasberg, Indonesia but more on this later. What is interesting to note is the strong correlation between copper and oil price (in blue). More seasoned investors than the author postulate that copper leads a trend that oil often follows - though this an oversimplification. What is known though, is energy costs make up a significant cost of both copper extraction and smelting. The fall in global copper production would have had a significant impact on oil demand which, along with other factors, has helped to drive oil down to record lows. Lower energy prices such as oil will of course lead to improved production costs. It is also important to note that Kazakhstan's two major exports are in fact copper and oil.
Copper Supply Hiccups
The BHP Billiton and Freeport-McMoRan operated mines in Chile and Indonesia respectively, which together account for 8-9% of global copper production, have been hit by labour action since early February. The Freeport strike seems to have mostly ended although there does remain a determined contingent of activists holding out while the company and the Indonesian government attempt to thrash out a new deal for the mine. The 43-day strike through February and March in Chile is reported to have cost BHP Billiton $1 billion in lost revenue with the company only ending force majeure policies at the beginning of June.
Add to this Cyclone Debbie in April causing weeks of disruption in Australia's coking coal region, affecting producers including Glencore, Yancoal and BHP. Force majeure incidents such as this or flooding and landslides experienced by Volcan in Peru are becoming more frequent - though this may be because news affecting global markets continues to grow in frequency and depth. Semantics aside, what can be ascertained is global copper supply has been adversely affected leading to higher price for the red metal.
LME copper inventories have been high for some time, there has been concern the return to full production of the two striking mines in Indonesia and Chile would lead to a supply gut and fall in copper value - this scenario has not yet materialised. Some claims have been made that demand from China will improve in the near future, although at this stage this seems more speculation and hunch rather than factual deduction.
We do know copper inventories are finally falling. This combined with other factors has helped copper prices higher and likely stay higher for some time to come.
Currencies
Three currencies relate to copper and CAML: the US dollar against which copper is priced, the Kazak tenge against which CAML production is costed and sterling, the currency CAML reports revenues in. Figure 3 shows USD:KZT in blue and GBP:KZT in red.
The Kazakh Central Bank (KCB) devalued the tenge in February 2014, many commodity exporting EMs (Emerging Markets) were already going down a similar path. The devaluation was a response to the economic effect of falling commodity prices. The giant 20% devaluation is a measure of just how exposed the Kazakh economy was to only a nascent oil price decline - oil makes up nearly 60% of exports while ferrous metals account for 19% of exports.
The ensuing collapse of the oil price caused much damange to the Kazakh economy, with the KCB finally floating the tenge in August 2015 at 185 KZT to USD. It lost 23% of its value on first day with losses continuing until the year end by which point the tenge was trading at 385 to the dollar – the currency lost more than half its pre-flotation value in less than 20 weeks. Since then though, it has stablised. The recent strengthening in the tenge can be down to improving oil prices. Oil inventories still being high and OPEC’s production at its halfway mark, oil is still on shaky ground, the same ground as the tenge.
Given the choice, CAML would prefer KZT (currency it pays costs) to be weaker against USD (currency copper is priced in) which in turn is stronger against GBP (currency company stock is listed). Two years since a tenge devaluation and one year since sterling fell dramatically in the aftermath of Brexit, this is exactly the scenario the board is presented with.
CAML Corporate Strategy
The Board has now returned and surpassed the full 100p October 2010 IPO share value (£35 million) in dividends and is set to continue the strong dividend policy delivering a yield of 5.75%. There are no plans for future public offerings as the Board intends to self-finance new projects in Chile and Kazakhstan (never say never), welcome news to existing shareholders and an important point to note for prospective investors.
In fact the Board is keen for investors to know more about all aspects of CAML operations. The company issues in depth financial and operational reports with plenty of detail for those who know what to look for. CAML is covered by several analysts, most recently "QuotedData" issued a detailed report on CAML operations which can be found here. Of course there is a level scepticism attached to reports that are generated at the behest of a Plc for that same Plc, the author would still encourage readers to have at least a skim of the QuotedData report before drawing conclusions. The CAML Board has the feel of a collective that has confidence in its operations and wants to be as open as possible with its shareholders.
The Board prides the company on being a cost efficient producer and has been quick to emphasise Central Asian Mineral's position is in the lowest cost quartile of global producers in all its publications. The early strategy has been to pursue low cost SX-EW production, through Kounrad and the shelved-for-the-moment tailings project in Copper Bay, Chile. This has allowed CAML to generate revenues and margins high enough to deliver strong dividends despite low copper prices. With no debt and plenty of cash at the bank, CAML's next step is exploring the Shuak site - due to begin in the coming weeks.
Group Portfolio
Kounrad, Kazakhstan
Kounrad is the site of an exhausted and abandoned former Soviet copper mine. The mines house huge dumps of waste from which copper is extracted using the SX-EW process. Understanding Kounrad requires gaining some understanding of the SX-EW process.
Solvent Extraction and Electrowinning (SX-EW) technology has been developed and used for over forty years. It now makes up about 20% of global copper production. In a nutshell, low grade copper bearing minerals are stripped of copper properties, processed and produced as copper plates. The process does not require mining - waste dumps from former mines provide high yielding minerals - often in abundance. Absence of mining means SX-EW copper production is significantly more cost effective than traditional mining. Kounrad's production process is broken down as follows:
- Leaching: sulphuric acid is "irrigated" over dumps at a controlled rate. This leads to copper ions dissolving from dumps resulting in a copper laden solution, referred to as Pregnant Leach Solution (PLS) is collected.
- Solvent extraction: in the SX stage, PLS is directed into holding pods where an organic substance is added to extract copper ions from solution. Like magnets, the copper is attracted to the organic substance until it floats to the top.
- Stripping: the now copper laden organic substance is treated with an acid which strips the copper and creates a copper sulphate solution.
- Electrowinning: in the EW stage, electricity is used to reduce copper from the sulphate solution and plate into copper cathodes.
CAML completed the construction of SX-EW plant on the doorstep of Kounrad in 2012 at a cost of $51 million. Recent improvements have increased its productive life span to 15 years. Proximity of resource and processing area - as well as weak KZT - has brought cash cost down to $0.43 per pound (2015: $0.58).
Copper Bay, Chile:
CAML owns a 75% stake in Copper Bay Ltd which has the rights to process copper tailings at Chanaral Bay in the Atacama region of Chile. The area was mined for copper between 1938 and 1975 from El Salvador (previously Porterillos) mines. Tailings were disposed through Rio Salado into Chenaral Bay. Modern techniques allow for copper extraction from tailings. A Pre-Feasiblity Study (PFS) has been conducted and made the following conclusions:
- 9 year project: 2 year construction, 7 years production
- Estimate 5 million tonnes of 0.24% copper grade material annually
- Recvoeries estimated at 72%
- 7080 tonnes of cathode
- 1560 tonnes of 20% concentrate
- Annual Production 8640 tonnes
- C1 cash cost $1.37
- $34.1m profit if copper at $3 per pound.
The project has been shelved for the moment, to be called upon when both strategic position and copper price allow for greater returns.
Shuak, Kazakhstan:
Shuak is an exploration site in Akmola Oblast, northern Kazakhstan. In November 2016, CAML acquired an 80% interest in Shuak BV which holds the rights to the site. As part of the Shuak BV deal, CAML has to spend $2 million on exploration within five years - it is planning to spend $1.3 million in 2017 on trenching and drilling. Exploration is due to commence in the coming weeks.
Group Operations
The cash trading price of LME copper had fallen nearly 40% since CAML began production in 2012 until late 2016. The fall in the commodity is not ideal for CAML profits but neither is it catastrophic, lest we forget the board's mantra of "lowest cost percentile producer".
The rebound since November 2016 has seen the metal trade consistently over $5500 per tonne, recently threatening to reach $6000. However, this recent upturn will not manifest itself until CAML interim report in September covering January to June 2017.
Figure 5 shows fully absorbed costs increased into 2014, countering improved efficiencies in cash costs that year. Since then however, both absorbed and cash costs have continued on a downward trend. Some of the revenues lost from low copper prices have been partially offset by production savings.
CAML Financials
CAML reported a net profit of $26.1 million (2015: $22.2m) on revenue of 69.27 million (2015: $67.3 million. Comprehensive income improved from -$55.13 million to $27 million. Operating margin and ROCE ratios trimmed from 51.2 and 38.3 in 2015 to 49.44 and 36.1 respectively. Year on year in 2016, dividend yield increased from 5.6% to 5.75% and PE ratio from 11 to 11.4
CAML's financial position has not changed substantially since 2015. On 31 December 2016 the company had net current assets of $38.23 million and non-current of $83.19 million leaving it with net equity of $121.42 million. CAML's financial position stood slightly higher at $138.48 million.
On the horizon
As previously pointed out, copper has fallen substantially since CAML commenced operations in 2012. In that time time, the company has done better than survive. Half way through 2017 the ferrous metal is 20% higher than at the end of 2016 and on what looks to be a continuing upward trajectory. Anticipated increased production capacity at the Kounrad mine from Q2 2017 will supply a market heading towards a supply deficit.
Final Thoughts
I started off by looking for a low cost non-precious metal producer that could give me safe long term gains. CAML ticks most of those boxes:
- low cost production, able to withstand market downturns
- the company has no debt, is in a strong cash position and has no foreseeable need to issue new shares
- CAML has history of paying high yield dividends - c6% and shown commitment to increase dividend payout in proportion with EBITDA
- CAML has been profitable during low copper prices, outlook of higher prices in short to medium term would boost Revenue and EBITDA
- Kounrad produced record 14,000 tonnes of copper cathode in 2016. Infrastructure improvements will keep production levels at that level for up to five years before significant decline sets in
- On the flip side, should copper prices fall or the KZT suddenly strengthen (both scenarios are unlikely in short to medium term), CAML's value should not suffer significantly (as already demonstrated) and expectation is the Board would still deliver a significant dividend
Interestingly, while copper prices have been on the up, CAML's share price has remained stagnant and recently event dropped 5% - perhaps a side effect of low volume and nervous trading in the aftermath of recent UK general election.
Increased commodity price, improved and increased production, favourable exchange rates, two viable future projects in the pipework - it seems like the perfect storm scenario for CAML. However, the earliest indication of whether the company has managed to harness the storm will likely not arrive until the interim the report in September.
Quoted Data has valued the stock at 265.5p. At c210p currently, that would suggest the stock is trading at nearly a 20% discount. While the valuation may give some idea as to what price to purchase at, what is more relevant to me in my search is CAML is a consistent payer of high yield dividends (yep, took that right out of the Quoted Data report!). At the recent 210p stock price, CAML's 2016 dividend of 15p stood at 8.5% The expectation is is the Board will share the benefit of higher copper prices by deliver a higher gross dividend in 2017.
All in all, it looks like a good price to buy for those looking for a long time earner and steady share price growth.
