Mining for Profit

Investment opportunities in distressed mining stocks

SAM OUBADIA, MANAGING DIRECTOR, WINDERMERE CAPITAL

Left behind?
While equity markets have recovered sharply since March of this year, there is an asset class that may have been left behind in the recent rally. Commodity prices have seen huge gains over the last six months, but not all mining stocks have benefited from the recovery in metals prices.

A good proxy for the performance of mining stocks is Canada’s S&P/TSX Venture Composite Index, also know as the CDNX. More than half of the world’s mining companies are listed on the Toronto Stock Exchange, and three quarters of these trade on the CDNX, making it about 60% pure mining stocks (see Fig.1).

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There is a large group of distressed mining companies that have been so shaken by the economic crises that they require either some form of financial support, or additional managerial expertise to steer them through these troubled times. While some of these companies are publicly listed, in many cases there is limited activity in their shares, leaving daily trading volumes at very low levels. This makes it difficult even for most institutional investors to gain exposure to this asset class. Perhaps the more important question is, why would investors want the exposure?

To answer that question, it is first necessary to understand how these companies became distressed in the first place. While there are a variety of reasons, the root of the problems inevitably stems not necessarily from poor business practices but from the 2008 credit crisis. Some mining companies in need of refinancing in 2008 suddenly found themselves in a very difficult situation – refinancing had become tough, and in cases impossible, even for the best names. Metals prices such as nickel and zinc plunged, hammering revenues. In some case, the operating costs of extracting and processing ore even meant some companies were better off by shuttering their production. In many cases, companies did not have the cash flow to service their debt.

The banks and financial institutions that had traditionally financed these mining companies were already dealing with their ownproblems and were in no mood to continue to lend money to these businesses. While the credit markets have improved in recent months, many companies still face difficulties in finding access to capital. The problem with banks and other financial institutions is that they are using conventional methods to assess the health of these companies. This prevents them from seeing that the issues these mining companies face may be short-term in nature, and that in some cases the problems can be resolved with some slightly more innovative financing arrangements. To look at these companies in this manner may be short-sighted and prevents the banks from seeing the true potential of the business, or at least, the potential of the business’s underlying assets. For example, we are aware of one company which saw production in its key mine levelling off and realized that it would soon be in decline. The company wanted to begin mining at another site near-by. However, with lending restricted by the credit crunch and the worth of mining stocks and commodities decimated, the company found its existing operations were insufficient to obtain the additional credit needed to begin operations at the new site.

In many cases, it is not only financial expertise that is required. The technical and operational skills involved in running a mining company are also necessary. Companies may have run into difficulties due to the shortcomings of their management. In these cases, it is necessary to understand why the problems arose and what needs to be done (aside from additional financing) to resolve the problem in question. This usually requires the expertise of mining engineers, metallurgists and people who have a sound knowledge of metals markets. The time it takes to turn around some of these distressed companies varies. In some cases, a new financial plan can lead to a quick recovery. In other cases, a year or more may be needed.

Nevertheless, an effective plan can make the difference between taking a firm from near bankruptcy, to bringing it to a point where its operations can be running normally again. Windermere Capital, Ocean Partners, and Hawley Etal have created a fund that intends to hold a portion of its investments in a number of these so-called distressed assets. The fund, for which Newedge will be acting as prime broker, brings together three partners that have the financial, operational and technical expertise necessary to approach these types of investments. This allows the partners to identify the best candidates for inclusion in the fund, and provide the necessary support to turn these companies around.

ABOUT THE AUTHOR

Samuel Oubadia has worked as an emerging markets investment manger since 1996. He previously managed funds for ING Investment Management, and also worked at Lombard Odier Darier Hentsch. In 2009, he joined Montreal-based Windermere Capital.