Switching Commodity Plays (NTO, AMNZF.PK)

I'm taking advantage of the Yamana offer for Northern Orion that boosted prices by close to 10% at one point, and selling my NTO shares in order to open a position in a very different kind of commodity investment.

Northern Orion (NTO) has been good to me -- I bought shares a couple years ago at around $2.20, and sold them yesterday morning at $5.90. I do think that their reserves are worth more than that, but they will be also very expensive to produce and/or take a long time top come to market, so I'll take the short term payout here and not hold on to Yamana shares.

Instead, I've decided to open a position in an investment bank that largely focuses on commodities -- a relatively new firm, now called Ambrian Capital, that's listed in the UK (AMBR in London, AMNZF on the pink sheets). I first heard about this when I saw it teased as the "best investment of 2007" by a newsletter publisher in my work over at stockgumshoe.com, but of course that recommendation and some other heavy buying (by Rick Rule and others, particularly US investors) made the price spike up significantly in April. It has since fallen back to more reasonable levels, so I've picked up some shares here at an average cost of about US$1.36.

Ambrian is an investment bank, asset manager, and adviser that focuses primarily on resource industries -- including underwriting and advising of commodity companies and trading of actual commodities, among them metals, energy and carbon credits.

They also own large or controlling interest in several mining and energy companies, including Jubilee Platinum, Centamin Egypt, Uruguay Mineral Exploration, Inc, and Anglesey Mining among many others.

At today's price in London they're trading at a PE on last year's earnings of just about 8 (8.6 pence in earnings, 67p share price.) -- that's substantially below most investment banks, and I assume it reflects some general pessimism that we're at the peak of the commodities cycle. I don't personally believe that, but even if we are, for these prices I'm willing to take a small chance that this is the peak earnings in the near term. Their yield is about 2.5% and growing, not bad for a very new operation.

But I think what I find most compelling about this investment, aside from what looks to me like clear progress in building an effective and focused investment bank in this sector, with rapid earnings growth, is the valuation of the shares if you consider their outside holdings.

Their principal investments group, which invests the firm's own money, holds investments worth roughly 50 million pounds (including those mining companies noted above). It's certainly true that those investments could all fall precipitously if commodities collapse, and about 10% of that money is in unlisted companies so it's even more illiquid than the rest, but the current market cap of Ambrian Capital is only about 72 million pounds. That means, if you want to do the math, that the value of the bank itself today, aside from its outside investments, is 22 million pounds.

If you then take out the realized gains from the income numbers as a "what if" exercise (the income for last year was roughly 60% realized gains/40% investment banking), you get income on investment banking of about 8 million pounds from a valuation of 22 million pounds. So that means if we ignore their assets, and they sold them off today for roughly book value (which may not be possible), as I read the numbers you'd then be dealing with a fast-growing investment bank trading at a PE of under 3.

[belated note: sorry folks, just realized my error here. I still like the valuation, but it's not a 3 PE unless you screw up the exercise, as I did. This fails to assign the majority of the administrative expenses to the investment bank. Admin expenses for the group were about 8 million pounds, and investment banking operating profit was about 8 million pounds -- so I think we need to assign probably at least 75% of the admin costs to the bank, since merchant banking is much more people-intensive than investment management. Ambrian doesn't break them out, since they have no good way to do so as all overhead is shared across the group. I still like the shares as much, since the whole is more important than the parts at this point and I expect dramatic earnings growth to continue, but my error in the exercise made the valuation look sillier than it is -- sorry!]

The group's general intention appears to be to realize gains on many of their portfolio companies or to use them to seed investment funds for various sectors (they currently manage one investment fund, Golden Prospect Precious Metals), and they recognize the need to diversify as much as they can given the volatile nature of commodities. They're also planning to start a small private equity fund that they hope will both make profitable investments and help steer firms to the investment bank for advising and IPO underwriting in the future.

Like many folks, Ambrian is also looking to the East -- they recently sold a small stake in the bank (about 9%) to Sun Hung Kai of Hong Kong, and they intend for this to be a pathway into the Chinese markets, both to advise Far Eastern commodities companies, and to help invest the cash that is pouring through many of those markets.

So ... although this is certainly a risky investment and a tiny company, I like the risk-reward profile, and I think that this is the best play I can make on commodities right now -- if the commodity markets remain at all robust, Ambrian should be well positioned to continue rapid earnings growth, and they are not nearly as leveraged to any one commodity or one project as most other investments I would consider.

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner

Northern Orion to get free Copper ... someday (NTO)

Another solid earnings update was released by Northern Orion Resources, Inc. (NTO) yesterday, along with a little bit of an update on their future prospects.

NTO is a Canadian junior mining company with essentially two properties -- a 12.5% stake in the maturing Alumbrera gold and copper mine in Argentina, and 100% ownership in the yet-to-be-built Agua Rica mine a few miles away.

And as you might expect, given the tremendous metals prices we've seen this year, they are raking in the cash on their Alumbrera holdings -- bringing them .22 a share in earnings this quarter on average copper prices of $4.44 a pound and gold prices of $608 per ounce.

No surprise there -- and these high metals prices couldn't come at a better time, as they're building the cash pile that they'll need to start up a new mine at Agua Rica.

They also updated us on the life of Alumbrera, which keeps getting extended as they find more good stuff under the surface -- they're now estimating that the mine should keep producing for at least ten more years.

And somewhere in that ten year period is when it's going to get very interesting for Agua Rica. The siting, equipping, hiring and geological assessment of a mine takes a godawful long time and a lot of money -- as in many years and many billions. I heard rumors years ago that they were hoping to just move all the heavy processing plant and equipment stuff over from Alumbrera when that mine played out, but with Alumbrera having at least another decade of life and copper in a big demand cycle right now I think we can safely assume that rumor has been laid to rest. They're going to want to get Agua Rica up and producing as soon as they can, so costs maybe significantly higher than if they waited until 2016.

So first they have to nail down the financing, since their $170 million or so in cash isn't going to put much of a dent in the $2 billion or so in capital costs to get Agua Rica running. And the first step in financing is the release of a thorough feasibility study of the site -- actually, technically an update to an older study from the mid-1990s.

We had been told to expect the feasibility study by "mid year", the latest in a long run of incremental news about Agua Rica work over the past few years, so investors were a little anxious to see it -- but the preliminary information that they provided in their earnings release continued to be extremely positive about the potential for this new mine:

- 23-year life of mine

- Cash cost of $0.09 per pound of copper net of by-products (based on $435/oz gold and $7.00/lb molybdenum)

- Cash cost of negative $1.05 per pound of copper net of by-products (based on current prices of $635/oz gold and $26/lb molybdenum)

That last one is what should really get your attention -- and what I hope will get the attention of NTO's bankers and allow for some very friendly financing terms. If prices stay up in the current realm for gold and molybdenum, then Northern Orion will actually be paid a surplus of $1.05 a pound to mine the copper (and even if prices revert to where they were a year ago, NTO will still have by far the lowest cost copper mine that I'm aware of).

You see, Northern Orion is really a copper miner -- they essentially treat everything else as a nice byproduct, so they use the gold they pull out of Alumbrera to help offset the cost of the mine, and to lower their production cost for copper.

So the prospects continue to be great -- assuming that the political risk in Argentina remains limited (and since Alumbrera just paid a nice royalty on their record earnings, I assume the government's pretty happy with them), and assuming that copper remains at least above a dollar a pound (one quarter of its current level), Alumbrera will continue to spit out millions of dollars in free cash and the development of Agua Rica should proceed on the current optimistic track.

No guarantees -- except for the fact that there will probably continue to be delays, but I'm continuing to hold these shares and I think we have the potential for a continued dramatic climb over the coming year or so as the feasibility study adds a little more detail to the expected output of the mine and as firm financing (hopefully) comes on line at a reasonable price.

NTO reports that they expect mine construction to take about three years from the completion of permitting, so the old expected start date that I had of 2009 now appears very optimistic, but they are completing the social and environmental impact work and the technical analysis of the feasibility studies now (at least the fieldwork for the feasibility study is complete), so I guess patience is the watchword.

I hate to bet on metals and basic materials after the run they've had in the last year, but with NTO's enviable position as a low cost copper producer and a continuing demand for copper as the world industrializes, I think the downside is pretty limited.

In case you want a little more background, you can see that I thought pretty much the same thing, though the numbers weren't so dramatic, when I first bought these NTO shares in May of last year.

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner

Annual Checkup -- NTO

Northern Orion (NTO -- click to register for free RT streaming quote) is a Canadian junior mining company that's getting less junior every day. I bought NTO back in May at $2.14, after having previously bought and sold it at a small profit in 2004. Seeing gold and copper prices -- really, all metal prices -- exploding lately has made me really regret selling AAUK when I did early in 2005, but at least I've got some very significant leverage to gold and copper prices with Northern Orion. None of my argument for buying NTO has changed since I picked up my shares, but the company has picked up another 100 million dollars (US) in market capitalization thanks primarily to the skyrocketing price of Gold. NTO is a risky company, since their holdings consist entirely of shares in three mines -- pieces of a mine in Cuba and the aging Alumbrera mine in Argentina, and 100% of the very promising but still a few years from production Agua Rica mine, fairly nearby Alumbrera. I haven't heard any new news since their last earnings report, but they ought to be reporting their 2005 numbers in the next couple weeks and hopefully we'll hear more then about finalizing the plans for financing and beginning construction at Agua Rica. I have seen my shares nearly double on the strength of very strong gold prices, which will mean that NTO gets better royalties from Alumbrera and will have more potential profit from Agua Rica, but they could easily retreat if gold does. I plan to hold this one as a speculative investment in a cash-rich company that has their hooks in a potentially spectacularly profitable copper (and gold) mine ... and the fact that it's a nice gold-related hedge for my portfolio is nice, too. The boom (bubble, maybe?) in gold makes me a little nervous, as does political risk in Argentina, but not enough to sell -- just enough to prevent me from buying more at these prices.

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner

Socially Responsible?

I don't generally believe that "socially responsible" investing is a particularly good way to go about getting good returns on your money, though it definitely works for some of the big managers in this area.

And there are several "sin" companies that I find interesting -- mostly in the gambling and alcohol sectors. I don't own any of them at this point, but it's certainly possible that I will in the future.

I have been interested, however, to find myself staying away from three companies recently that otherwise might be a bit interesting to me because I'm not comfortable for some reason with being invested in their businesses.

I have never held Altria, but this summer and fall it started to look appealing as an undervalued company with continuing dramatic international growth. Still, I never took it seriously because I can't see myself buying shares in and getting involved in a tobacco company due to a personal distaste for the cigarette business.

And recently, I started looking at Reed Elsevier (RUK). I'm an academic, and Elsevier is the dominant "brand" in academic publishing and most profitable scholarly publisher in the world, as well as owner of the strongest brand in legal research in LexisNexis and one of the bigger textbook companies in Harcourt. Still, I've been holding back even though I think the company will show a big return over the long haul -- I think Elsevier is a bad influence on scholarly communication and I'm a little wary of investing.

Along the same lines though to a much lesser degree, I've been holding off on investing in Microsoft (MSFT) . I don't think they're evil as some do, but I hate being a customer of theirs and I don't much like most of their products, ubiquitous though they are. I may still get over this personal dislike, but it is holding me back at the moment.

I don't avoid all companies that might be bad for the environment, or in an unpleasant business, or otherwise wouldn't pass "socially responsible" screens. I have owned plenty of oil companies in the past, for example, like Statoil (STO) and Petrobras (PBRA) and Suncor (SU), all of which are pretty rough on the environment to some degree ... and I currently own copper and gold miner Northern Orion (NTO), and there aren't many businesses that are as rough on the earth as mining. Even beyond that, my single most successful investing focus over the years has been on the oil tanker business, I made great returns on Torm (TRMD), Frontline (FRO), OMI (OMM), and Overseas Shipholding (OSG) in 2003 and 2004 (and, ironically, cashed in those returns last winter to buy a new car). I see Americans avoiding companies like those to be somewhat like a meat-eater decrying the death of animals from hunting or the livestock business -- kind of silly and a little bit hypocritical.

But my personal feelings about a company definitely are a part of my investing process. I don't screen my mutual funds in various retirement accounts to make sure that they don't invest in any company I dislike or disapprove of, but for the companies that I spend a lot of time researching and am interested in owning, a personal interest in the company and lack of distaste for them is important to me on some level.

This is really just to say, and perhaps it's obvious, that investing is personal for me. I invest in individual companies because I like being an owner of interesting companies with good stories and great potential, and it becomes much less fun and interesting if I don't like the companies. There are thousands of potential investment vehicles out there, I prefer to focus on the ones that I find interesting and appealing enough to make it worth my time and attention as well as my money.

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner

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

Keep up with One Guy's Investments, Free Subscription
Enter your email address:

Delivered by FeedBurner