Northern Orion Resources (NTO)



Bought May 20, 2005 at $2.14

Northern Orion is usually considered to be a "Canadian junior," which is how you'll hear folks refer to small mining companies north of the border. They are a $500 million (US) market cap mining company focused on copper, and they rely heavily on two projects: a 12.5% ownership interest in a very successful but aging copper mine called Alumbrera in Argentina, and a 100% interest in Agua Rica, a similar mine, also in Argentina, that is not yet in production.

I thought this was a good one to address today, since the London bombings are making people think about the safety of their investments and one of the things that people tend to flock to is gold and other commodities. While I just sold AAUK yesterday, which is a broad-based commodity concern that I didn't fully understand, NTO is a much smaller, more focused concern that I think I do understand and that I think has potential for dramatic growth in the long term. And the Northern Orion story is an interesting one that is tied both to growth of the global economy AND the defensive interest in gold.

Why gold for a company that is unabashedly focused on copper? Because the two metals are often found in quantity in the same places, and in the case of both Alumbrera and the future Agua Rica gold is and will be a valuable by-product of copper production which helps to offset the cost of mining and make these two mines some of the lowest cost producers of copper out there.

Increasing demand for copper is the global growth story -- copper demand is very tightly tied to construction and development, since it is the material of choice for both wiring and plumbing. China is what everyone thinks about, and they currently use about a tenth of the amount of copper per person that the industrialized nations use. Since the world copper supply is currently barely adequate to meet demand, any increase in demand from China or elsewhere as the world continue to industrialize will dramatically increase the demand for copper. With the lowest cost mines in their portfolio, NTO is leveraged nicely to that increased demand and can survive quite nicely even if demand slacks off for a long time.

For some of the details, if you're interested: NTO's share of Alumbrera production is expected to be about 50 million pounds of copper and 75,000 ounces of gold next year, and that amount is likely to tail off over the next several years. Agua Rica is planned to be a self-financed mine, using primarily bank debt, and production is expected to begin in 2009. With an assumed slight discount to current gold and molybdenum (another byproduct expected from the mine) prices at production, the cost of the copper is projected to be .23/pound, making Agua Rica one of the lowest cost copper mines in the world at a time when copper prices are well over a dollar a pound and, in my opinion, likely to increase over the long term.

Why did I buy?

In the world of small mining companies, Northern Orion seems to be a pretty safe bet. They have excellent cash flow from Alumbrera, more than a quarter of their market cap in cash, and they are in a good position to develop the Agua Rica mine smartly and independently to build a cash cow that should last for at least 30 years at current estimates. While they will become leveraged with bank debt, they are not yet there. They are profitable and, I think, undervalued, and they have not been forced to sell out the potential of Agua Rica in order to develop it -- they are starting the development phase of Agua Rica on very good footing.

When or why would I sell?

This is a fairly small position for me, and I don't foresee selling for the next ten years. I'm interested in seeing how Agua Rica develops, and I see much more potential to the upside than the down. With the recent assessments of the site just released a week ago, all looks very good and, even in the worst possible scenario Northern Orion could sell out their Agua Rica interest today and, even with conservative discounting of net present value, probably get enough cash that they'd be trading at close to cash value at this price. I'm waiting it out, even if copper drops under a dollar for a few years.

There are certainly some risks, the primary ones being that not everyone agrees that the copper supply-demand picture will remain favorable for producers, and that it is possible that the current copper demand will spur enough additional exploration and production activity (such as the recent mines being assayed in Mongolia) that the supply will spike in the next decade. I'm not worried about that, primarily because I think the demand for infrastructure in the developing world will continue to grow unabated in the long term.

Some good resources for information on Northern Orion:

Investor news page with their new estimates for the Agua Rica site is available here.

Link to a good pdf presentation done at the end of June is available here, with lots of detail on the movement from Alumbrera to Agua Rica.

Northern Orion's filings with the SEC are available at Edgar (the filings are a little different, since it's a Canadian company).

Interesting postings on copper from a blog on metal markets here.

Technorati tags: northern orion, nto, gold, copper

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Changes to portfolio

I haven't gotten around to writing up these two companies, but I just sold them ... will explain more in detail later.

Sold CNET on June 30, 2005 for $11.98

I had bought CNET at 9.20 on March 30 and 10.14 on April 28. I sold all my holdings in this one at 11.98 on June 30.
Why did I sell? Because I had been becoming uncertain about why I had bought. I'm a CNET user, but I bought it after reading up on some articles in Motley Fool and elsewhere and convincing myself that they had uniquely valuable web real estate (download.com, cnet.com, mysimon, etc.) which pulled in unusually high advertising revenues per user. This was and is true, but as I continued researching it after buying my two positions, I became more and more concerned about competition from Google and Yahoo (and others, I'm sure). CNET was a very early mover at supplying premium online content supported by advertising, but the more I read the less certain I was that they would be able to maintain their competitive advantage, and the premium price of the shares was making me a little nervous. I still think that the online delivery of premium (and bandwidth-intensive) content is a good business, but I no longer want to focus my money on CNET as an investment in this area. I'm keeping my investment in Akamai (AKAM) and would like to add to it, I see them as a better investment in the future of rich commercial internet content, since they enable reliable and fast delivery of content for any provider who wants to pay for that insurance (and their acquisition of their major competitor, Speedera, means they've got more growth potential and pricing power going forward).

When buyout rumors surfaced in the NY Post and quickly spread online last week, the stock shot up 10%. This was a good opportunity for me to sell out of a position that I had lost faith in and that I thought was becoming overvalued, so I sold. It might have been a mistake to sell, it's certainly possible that the analysts foreseeing a $14 takeover price for CNET by one of the big boys will be correct. I'll take my small profit for a couple months work and cheer it on from the sidelines.

Sold AAUK on July 7, 2005 for 23.44

I had bought Anglo American UK on January 7 for 22.50, so this is pretty much a wash. AAUK had held the position in my portfolio of being a commodity (precious metals/ore/diamonds/coal) play, and I decided this summer that this wasn't necessarily something I needed to have exposure to in an individual stock. I like a couple things about AAUK, including the fact that I still think they're generally undervalued because they don't get enough credit for their interest in DeBeers, but there are two basic things that made me sell: 1, I didn't think I wanted to buy a company just as a hedge without really understanding their business well or their prospects, which is what I had done when I bought AAUK; and 2, I had other areas I wanted to invest in and this was the only other holding (besides CNET) that was on my "think about selling" list.

Bought IFN on July 7, 2005 for $30.15
Bought EWY on July 7, 2005 for $31.90

These are two of a feather as far as my strategy goes, but are very different animals. IFN is the closed-end actively managed India Fund, while EWY is an ETF for the South Korean Index. I bought both to expand my international diversification in the two countries that I see as growing parts of the world economy with relatively low risk -- India because political risk is limited as their increasingly business-friendly government is stable and democratic, and South Korea because market risk is somewhat limited by the fact that South Korea is the bargain basement of the world's emerging markets, with growing and dominant companies that I believe are extremely undervalued. Will provide more of my thoughts on these purchases as I have time.

Technorati tags: anglo american, aauk, Akamai, AKAM, cnet, india, south korea

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MEMC Electronic Materials (WFR)



Bought June 10, 2005 at $16.25

[note: see my other writeup on a semiconductor industry company, Formfactor, here]

MEMC Electronic Materials (WFR) has been a hot property lately – a week or two ago they were even yelling about it on CNBC. What put this bland little company on the hot seat this summer?

One word: polysilicon.

Polysilicon is what semiconductors are made out of, eventually. You see, MEMC is a supplier to the semiconductor industry, they make the actual highly polished, ultrathin wafers of precisely tuned silicon that Intel and the gang use to punch out the little tiny doohickeys that power and control our computers, phones, cars, and smart toasters.

Still awake? Well, it turns out that polysilicon has had a wild ride as a commodity during the past six months or so. At one point this Spring, spot prices jumped 25% in just a few days. And this isn’t one of those “China commodity” plays like steel or oil – no one in Shanghai is using polysilicon to build malls or factories, and it’s not being manipulated by the NYMEX crude oil futures traders.

There are a couple reasons for this increase in the price of polysilicon – first, semiconductor manufacturers are actually starting to make things again, recovering from the huge inventory surpluses that smushed their stock prices last fall.

And second, it turns out that the folks who make photovoltaic cells and similar equipment for solar power systems rely on polysilicon, too … so an industry that has been boom or bust on the volume of semiconductor manufacturing for years is now forced to serve two growing industries, with solar power growing very quickly thanks to some big subsidies from places like Germany, New Jersey and California.

The increased polysilicon demand is very real, for more information on what it is and why it's critical to this industry, read the briefing from SEMI (Semiconductor Industry Association) here, and a good article explaining the recent market trends and shortage from EE Times here

So why does that matter for MEMC Electronics?

Well, unlike the other major manufacturers of wafers, MEMC is almost completely vertically integrated. That’s right, they make their own polysilicon at a factory in Pasadena, Texas. And polysilicon has not gotten more expensive to make, according to the company, it’s just in higher demand. MEMC needs almost all of the polysilicon it makes, it seems, so it’s not as though they’re going to ride this boom in the spot market to boost their sales. They’re still focused on designing, manufacturing and selling wafers. So how do they get value out of this vertical integration thing?

One (more) word: margins.

The other wafer manufacturers in the world have to buy their polysilicon from someone else, so unless they wisely hedged against the rising price by buying their supply well in advance (remember Southwest doing that to great acclaim last year with jet fuel?), they’re going to have to raise their prices or suck up losses. MEMC can either raise their prices, too, and reap the benefits of higher margins, or they can cut prices and try to pick up some more customers – either way, that sounds like good news.

Now this might be overplayed – MEMC has already advanced significantly, up close to 50% in the last six months. But the trailing PE is under 13, and the analysts who follow the company guess that the coming year’s earnings will put the PE at about 11. None of the other major wafer manufacturers trade on the US markets, so it’s hard to compare, but next to any other company that relies on overall increased demand for chips this PE has to be at the bottom of the list.

Why did I buy it?

I believe in the silicon economy. I think that the increasing prevalence of semiconductor chips in consumer products is a continuing trend, which will mean greater overall demand for semiconductors. That greater demand means that the few manufacturers who supply them with high quality silicon wafers will have some pricing power and should see continued good business. I see this industry as a long term good bet, but I wasn't comfortable betting on a specific chipmaker. I think the semiconductor services and supply companies show more promise for those of us who can't predict who will design the best new chip (or in the case of Intel and AMD, win the next lawsuit). Applied Materials seems overpriced to me even at this point, and I generally prefer to invest in smaller companies that are either undiscovered or underappreciated or that have potential for more significant growth. The other stock I particularly like in this area is FormFactor (FORM), which supplies high-tech and patented testing devices for semi manufacturing.

WFR is cheap, and very competitive within its industry, which means the downside should be somewhat limited even if the industry goes through more turmoil (though I hope the turmoil has worked itself out of the system over the past couple of years).

There are good writeups in Smartmoney from last fall and in the most recent print issue (July? Not available online yet). This is a "cheap growth" story, in my opinion.

Why would I sell?

My primary concern with MEMC is that other competitors in Asia might succeed in building lower cost platforms and increasing their polysilicon supply to the point that MEMC's edge in their integrated business plan is moot. I don't expect that to happen, but the major competitors at the top of the list of wafer suppliers are building capacity for more polysilicon and new chips. I expect the demand to continue to keep up with and at times outpace supply, especially with the move to the larger, 300 mm wafer as the standard for the industry that is now underway.

It is likely that I would sell if MEMC becomes overvalued, just because the history of the industry makes one extra interested in taking profits, but I don't see that happening. I foresee continued solid performance, strong growth from this point in line with increased wafer demand -- but not a meteoric rise, or, one hopes, a meteoric fall.

The only reason I might sell at a loss or breakeven in the next three years is if a price war develops in the wafer market and MEMC's competitors are able to overcome MEMC's advantage in lower polysilicon prices -- but with price increases looking more likely this summer, I'm not very worried. Even with a price war, if MEMC's positioning looks solid I would consider buying more if it appears that they can maintain better margins than their competitors going forward.

Technorati tags: wfr, memc, , semiconductor

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