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Jul 2002 - American Model

Following the North American Model

It is a foregone conclusion that Newmont is likely to dump or sell the non-gold asset baggage either individually or as a package that it acquired along with Normandy such as Gossan Hill, the Australian Magnesium project in QLD, that cobalt operation in Africa’s Uganda etc, simply because they are non-gold. While it is deemed OK for an Australian gold company to hold non-gold assets, it is not for a North American company.

If you look at the North American shares you may notice that there are no diversified companies. There is Alcoa Aluminium, Phelps Dodge Copper, Falconbridge Nickel, and Inco Nickel, Stillwater Platinum, Apex Silver, etc. If you invest in a North American stock then you are buying pure “relatively untainted unimetal” exposure to that particular product.

Sure there are by-products but they are usually used as credits to the costs of production from a gold orebody in the case of copper or silver, or the suite of metals including pges when producing nickel, but are not orebodies in their own right. A gold company does not have a major copper mine with by-product gold, or a nickel company have a platinum mine with by-product nickel. There is no RIO or BHP or anything like that.

So why ?. I always thought it was simply a North American “thing” or a preference for simplicity, but the actual reason runs much deeper, and the answer was given in a recent presentation at a conference on the Gold Coast in Queensland, by a company called IBIS who provide management solutions and consultancy in order to attain excellence and profitability.

The company started off by firing a salvo at virtually all the boards of directors in Australia by calling them inefficient (that woke almost everyone up) and stating that shareholders in America would not stand for such poor performance. IBIS stated that the minimum requirement for a company is the achievement of a 25% annual ROSF (return on shareholder’s funds), and boards should ask their managing director’s how they are going to achieve it, and if the managing director does not know, then they do not belong there (that woke the remainder of the audience up too).

Slides were shown in which US corporations aim for 4 times the bond rate, 3 times in the UK and 2 times in Australia. In 2001 the weighted after-tax ROSF of the top 30 largest companies (above a market cap of US$80bn) was 21.7%, ranging from 56.1% for Wyeth down to -3.7% for Cisco. Ignoring market cap, the average was 70.7% for the US top 30 ranging from 1274% down to 30.8%, and again there were no mining companies in the list.

Australia by comparison only had Woodside and Telstra above 25% in 2001, Woodside being a commendable 45.8% ROSF. Australia fared better on a 5-year average basis to 2001 averaging 30.9% ranging from 56.4% to 21.2% for its top 30 listed companies (ignoring market cap), but alas no mining companies this time. On the basis of profitability in the past 5 years, the top 30 companies in Australia averaged 68% ROSF and this time one mining company was included, namely Central Norseman (now owned and operated by Croesus) at 58.1%.

The consultancy company then went on to outline the 10 key parameters of how a 25% ROSF is being achieved and the foremost key parameter was focusing on single industries, with NO DIVERSIFICATION.

Amongst the other points were : aggressively globalizing their businesses, creating virtual corporations and strategic alliances. Is it any wonder Australia’s major gold mines and mining companies are now owned by non-Australian companies. However, those takeovers, mergers and consolidations have spawned or encouraged a number of small Australian companies to also follow the North American “model” and form unimetal or uniproduct companies, aside from gold companies.

The major companies attitudes to small companies has also changed following perhaps the “strategic alliances” route in enabling them to mine operations on a lower cost structure and deliver product to the majors who can then refine that material into a higher revenue product, such as by the major platinum companies or by Westerns (WMC) taking nickel ore from Mincor, or SGW taking tantalum ore from Haddington.

This has resulted in the spread of companies shown in the table below, with further expected IPOs coming this year (2002) to add to those in the table.

Table of Unimetal or Uniproduct CompaniesGDNjuly02

Looking at non-diversification another way, it is well-known that assets outside of the company model provide little value to the company’s share price such as the coal in Gympie Gold. If anything, more than one product can cause identity confusion as in the case of Sons of Gwalia as a tantalum or gold stock. While this can be advantageous in that SGW rose on tantalum when the other gold stocks were weak, however, it then failed to respond (like other gold stocks) to the gold price, since a part of the market now view it as a tantalum stock, regardless of its underlying gold earnings.

We have also seen share prices of companies drop back when they diversify into other metals such as a gold company into base metals (even if it is an excellent opportunity), generally because the market’s perception is that base metal exploration is longer and resulting plant capex is far higher, typically a minimum of $200m, compared to a simple, significantly less costly gold plant. While the argument put forth is usually that one project can finance another to the benefit of shareholders, it would appear that on a long-term basis it is not to the benefit of shareholders.

Consequently it appears that some companies should be seriously considering in-specie distributions such as Southland Coal out of Gympie Gold, Gwalia Tantalum out of Sons of Gwalia Gold and perhaps even Queensland Coal out of MIM Copper. On the face of it, in following the North American model, such moves could prove to be in the interests of their shareholders.

Disclosure and Disclaimer : This article has been written by Keith Goode, the Managing Director of Eagle Research Advisory Pty Ltd, who has a Proper Authority with State One Equities, and with his associates, either has or expects to have interests in most of the stocks in this article, This e-mail address is being protected from spambots. You need JavaScript enabled to view it . The opinions expressed in this article should not be taken as investment advice, but are based on observations by the author. The author does not warrant the accuracy or completeness of any information and is not liable for any loss or damage suffered through any reliance on its contents.

  • Written by: Keith Goode
  • Monday, 01 July 2002