article 3 months old

Of Nickel, Minara and Rio Tinto

Commodities | Mar 02 2007

By Greg Peel

The nickel price has risen 36% from US$14.95/lb on January 3 to around US$20.30/lb currently. Merrill Lynch notes the key driver, outside of solid demand, has been a fall in LME stocks from 6,570t to 3,282t over the period.

While analysts have been in general agreement that nickel will remain tight in the short term, and consequently prices should be strong, there are mixed views on what happens after that. UBS, Merrill Lynch and Macquarie, for example, are all looking for prices to weaken later in 2007. Credit Suisse does not totally disagree, but suggests late 2007 will see another push of base metal prices. GSJB Were is just plain bullish, as is Citigroup.

How the nickel price plays out is of material consequence to Minara Resources (MRE). Minara has just completed a great year, and without much to spend money on has rewarded its white-knuckled shareholders handsomely. Many an analyst fell of his/her chair when Minara announced a 45c dividend when consensus was for 26c. Except perhaps Citigroup, who had called a benevolent handout back in January.

Macquarie notes that Minara’s “margin leverage to a volatile nickel price is huge” given it is a medium cost producer and it is totally unhedged.

Analyst recommendations for Minara are thus based entirely on their views on the nickel price. From the five in the FNArena database covering Minara this year, we derive a 2/1/2 B/H/S ratio. The two Buys are Weres and Citi, with Weres posting both a short term and long term positive rating.

UBS is sitting at Neutral based on its up-then-down nickel price forecast.

Macquarie and Merrils are the doomsayers. Merrills doesn’t provide a target on a Sell rating but Macquarie now has a mere $4.80 against yesterday’s close of $6.73. And that was an increase from $3.70 previously. This target weighs down the average in the FNArena database, which stands at $5.97. As Weres doesn’t ever provide targets, there are only three to average, so Macquarie’s low marker is influential. Citi’s high marker is only $7.00, which does not suggest a lot of upside.

Merrill Lynch’s main concern over the nickel price is possible stainless steel destocking. 67% of the world’s nickel is used in stainless steel production. The analysts note US stocks have risen to levels not seen since late 2005, when a major destock was triggered and the nickel price fell from US$8/lb to US$5.50/lb. (How low those prices look now).

UBS raises a concern that the higher the nickel price reaches, the more substitution becomes an issue.
Both Merrills and Macquarie note the simple fact that the Minara price has run hard, and that the stock is fully priced even with a positive view on nickel. (This view would also appear to be played out by Citi, despite its Buy rating. The analysts lifted the target yesterday from $6.14 to $7.00, but as noted that’s not a lot of upside.)

JP Morgan (which does not cover Minara) has long held the view that a lot of pure-play miners are riding high on market valuations based on “current” spot prices being maintained forever (a recurring theme from Merrills as well). Of course, “current” spot prices have, for the most part, just kept moving up, but JPM constantly warns that share prices of the juniors are overvalued.

JPM has been forced – like everyone else – to constantly lift their spot price assumptions, but have always stayed well below the actual market. This is a case of traditional analyst conservatism in the face of extremely volatile commodities. The analysts note today that of all the base metals, nickel is trading at the greatest premium to their assumption. Thus nickel has the most “upside risk”.

This could become a material factor for the big diversifieds, the analysts suggest. BHP Billiton (BHP) acquired a lot of nickel production when it bought WMC a while ago. Rio Tinto (RIO), on the other hand, has no nickel.

The current nickel spot price is double that of JP Morgan’s FY08 price forecast. If all commodities hold their spot prices from here (a possibility which JPM constantly dismisses but often sounds unsure) to FY08 then the analysts’ valuation for BHP would be 42% higher, and 62% of that would come from nickel.

The same exercise for Rio would only render a 5% increase in valuation.

So from little Minara to the Big Australian (with Pommy connections) the future price of nickel will have a major influence. As to what it will be, well, has anyone got a nickel?

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