TNM Roundtable: Industry leaders debate strategy

Industry experts weighed in on how companies could best deploy cash at The Northern Miner’s roundtable discussion in Toronto in early April. The roundtable — sponsored by PwC and moderated by Northern Miner editor-in-chief John Cumming and publisher Anthony Vaccaro — augments the Miner’s independent research on this topic that will be released on May 9 at the Canadian Mining Symposium in London, organized by The Northern Miner and the Prospectors & Developers Association of Canada.

Andrew Kaip, managing director at BMO Capital Markets, kicked off the roundtable discussion noting companies have focused on cash since metal prices fell in 2013, following high prices and a decade of expansion, where “cost got out of control.”

Since precious metal companies felt the commodity price crunch first, they were the first to show signs of recovery after restructuring. For an instance, Barrick Gold (TSX: ABX; NYSE: ABX) posted “exceptional free cash flow” in the third quarter of 2015, and started its run to become re-rated.

Broadly speaking, majors in 2016 strengthened their balance sheets, leading to excess cash generation and the question on how best to deploy cash, Kaip said.

He argued, as an equity analyst, that companies need to consider juggling their shareholders’ demands with the longevity of running their business.

Cormark analyst Stefan Ioannou, who covers base metal companies, agreed. He pointed out that in the last cycle during the “euphoria of higher metal prices,” many good projects were built or financed. Unfortunately, when some of those projects came online, metal prices had collapsed, and some companies “found themselves in trouble immediately.” One such company was Hudbay Minerals (TSX: HBM; NYSE: HBM), with its Constancia copper mine in Peru.

Although base metal prices are recovering, Ioannou noted, “the market learned a pretty harsh lesson last time that you’ve really got to be careful on timing.”

Denison Mines (TSX: DML; NYSE-MKT: DNN) CEO David Cates says as a developer, Denison will always spend money. The biggest hurdle is “finding ways to raise money that aren’t excessively dilutive.”

While the uranium-focused firm has relied on flow-through financings, it raised $43.5 million in February by monetizing a toll-milling stream. Cates revealed that while he may not do anything with the cash now, “it means that I can choose to do what I need to do when the market tells me I should do it for my uranium asset.”

According to The Northern Miner’s research, TSX-listed mining companies with market caps under $3 billionin 2015 completed 75 equity financings totalling $1.6 billion. A majority — roughly $700 million — of those proceeds went towards development, followed by $600 million on debt reduction and $300 million on exploration. Performance ranking of these companies, based on percentage gains and equity valuations, showed the companies that invested in development performed slightly better, followed by companies that invested in debt reduction, and then exploration, Vaccaro shared.

Annie Zhang, co-manager of TD precious metals, resource and energy funds, says the improved company performance could have been due to different reasons. For example, companies that raised money for developmental purposes and delivered development on schedule in 2016 could have had their shares re-rated.

Free cash flow is one of the metrics that Zhang looks at “very closely,” as companies with free cash flow have a better chance of withstanding the cyclicality of the industry.

That said, she noted that the best way to deploy cash depends on “the stage that the company is at” and the “cycle the sector is in.”

Stephen Mullowney, a partner with PwC Canada’s corporate finance in the mining department, said that in the last few months “there’s been a lot of refinancing in the high yield market,” where companies, focusing on liquidity, are pushing out or laddering debt maturities. “The market can get a much better sense of the companies’ ability to repay those coming maturities as they become due.” He believes this trend will continue.

Given that it’s easier to raise money when markets are healthy, companies should build a “liquidity buffer” so they can be prepared for future downcycles, Mullowney added.

Harte Gold (TSX: HRT) CEO Stephen G. Roman concurs that companies should raise funds when they can, especially now when capital is coming back to the sector with the uptick in commodity prices. “Now is the time to really make some hay,” he said.

Roman revealed he relied on friends, family and flow-through to raise money for Harte’s Sugar Zone property in Ontario during the last downcycle until it got too dilutive. “We said: ‘Why don’t we just put this into production and generate some cash flow?’ It will allow us to  finance our own exploration.”

Harte began processing a 70,000-tonne bulk sample through a toll-milling deal with Barrick. This attracted Appian Natural Resources Fund — Harte’s first large institutional holder — to participate in a $25-million financing last December.

The debt-free junior is using funds to accelerate exploration and development of the Sugar Zone property. Roman expects the deposit will be in commercial production within a year. “Now it was sort of an overnight success that took six years,” he says.

Dustin Angelo, CEO of Anaconda Mining (TSX: ANX), said that since Anaconda is a  junior producer — making $4 million a year in cash flow after corporate expenses — it can’t afford to keep more than $1 million in its treasury. “We have to put it back in the ground … to grow and try to get that return that people are looking for. And we need to show longevity, and the only way you can do that is if you spend money.”

Canadian Zinc (TSX: CZN) executive John Kearney jokingly admitted that excess cash is not a concept he’s familiar with, as it doesn’t apply to his exploration company. “We never have excess cash. We’re constantly looking for cash. We’ve been trying to raise equity all the time to keep the project going.”

While the junior has been advancing its Prairie Creek zinc project in the Northwest Territories, the progress hasn’t been reflected in its share price. Because of this, it has been forced to issue shares at “lower and lower prices.”

That said, Kearney argued that cash-rich majors should invest more on exploration, particularly given that “exploration worldwide for base metals is way down.”

“There’s no such thing as excess cash if you’re not making free cash flow, period,” Eastmain Resources’ (TSX: ER) chief financial officer Joe Fazzini added. Before worrying about excess cash, you either have to “repay your debt, clean up your balance sheet or invest in your own projects.”

Fazzini, who joined Eastmain in 2016 after a proxy battle triggered a management and board overhaul, said the junior raised $20 million in flow-through last year. It will use the proceeds to drill and advance its three gold projects in Quebec.

Outlook on M&A

Majors in the uranium sector are not spending on building their pipeline or project development because of the persisting low uranium prices, Denison’s Cates said. He argues they should, so that they don’t end up buying when prices become too high.

“Meanwhile, the majors are actually buying each other,” Kearney observed. “So they look at growth and turn around and merge or acquire each other, and that works on the number system.” But from an “industry perspective,” he argued those firms should put that money into developing new projects.

Acknowledging that majors such as Agnico Eagle Mines (TSX: AEM; NYSE: AEM) and Goldcorp (TSX: G; NYSE: GG) have acquired minority stakes in juniors or bought them completely, Kearney urges that other majors should follow suit.

Goldcorp recently announced a $247-million, all-share acquisition of Chile-focused Exeter Resource (TSX: XRC; NYSE-MKT: XRA) and last year bought Kaminak Gold in the Yukon.

Zhang of TD observed that majors like BHP Billiton (NYSE: BHP; LON: BLT) and Rio Tinto (NYSE: RIO; LON: RIO) are looking for “world-class assets,” with a long-life and low-cost potential. This may explain why the money isn’t flowing downstream to juniors, particularly if they have marginal assets.

“The M&A cycle needs to pick up from the development project’s perspective, for those companies to raise money at a higher value to attempt to advance projects,” PwC’s Mullowney said.

But because of the cost overruns and punishing effects of the previous cycle, majors are more cautious about “taking on large capital commitments,” he noted.

Agnico is “taking the lead with a different approach to make investments at an earlier stage in companies,” Zhang said.

Agnico acquired 15% of GoldQuest Mining (TSXV: GQC) for $23 million this March. Last year, it bought or increased its interest in three other juniors.

By doing this, it lowers the major’s capital and project development risk, while providing the junior with much-needed cash.

Kearney cautioned this approach could lead to a “stalemate,” with a block of shares not trading.

“When the major decides to sell the block too, it just puts a complete negative pall on the company,” Roman of Harte added.

Dividend policy

Roman admits he’s a “strong believer” in dividends and thinks that large mining companies should pay higher dividends. “Why don’t they pay more money to the shareholders? Then they’ll attract more shareholders, maybe more capital. They’ll be able to spend some on developers.”

But Anaconda’s Angelo argues dividends aren’t appropriate in mining because mines are finite assets. “If you’ve got a 10- or 15-year mine life you’re basically committing yourself to a dividend forever. It’s not a piece of real estate that’s going to continue to generate cash flow in perpetuity.”

Investors are buying mining stocks as leverage to commodities and not really for a dividend, he added.

Kearney concurs a dividend policy will make sense for majors. But investors in juniors often look for “capital appreciation.”

Mid-tier companies are at an “inflection point” where they are making enough money that investors inquire about potential dividends, analyst Ioannou said.

“You’re damned if you do and damned if you don’t in that mid-tier space,” he said.

Roman reiterated that dividends should come from a “senior-level company, not mid-tier or juniors.

“And you have to have multiple projects. You’re constantly building assets, you’re selling assets and you’re developing assets.”