Natural resources equity roundtable: Part 2

 Robert Lyon, senior vice-president and portfolio manager at AGF Investments Inc., also a growth-at-a-reasonable-price manager. His responsibilities include AGF Canadian Resources Class, AGF Precious Metals, AGF Global Resources Class and AGF Global Resources.

 Norman MacDonald, vice-president and portfolio manager at Invesco Canada Ltd., a value manager. His Canadian mandates include Trimark Resources and Trimark Energy Class.

This week's three-part series by Morningstar columnist and roundtable moderator Sonita Horvitch began on Monday and concludes on Friday.

Q: What about the Canadian oil sands?

Vali: Back in 2004, 2005 and 2006, there was a lot of hope about the Canadian oil-sands production profile. In 2007 and 2008, we realized that the capital cost associated with developing the resource had screamed higher and made it uneconomic to develop in many cases. The equity market started to reduce its assessment of the future value on some of that resource. At the same time, the U.S. shale resource was coming into focus. It was growing and could be developed economically. Companies that had U.S. shale resources started to be re-rated by the market and companies with Canadian oil-sands holdings started to be de-rated.

MacDonald: The Canadian oil sands have been the fantasy of free cash flow that has never transpired.

Robert Lyon

Lyon: Five years ago, if an investor wanted to own growing oil production in a low-risk political jurisdiction, the Canadian oil sands were the only game in town. With the U.S. oil plays, there is strong competition for those investment dollars. This has taken some of the shine off the oil sands.

Q: Can we briefly talk about the large number of energy assets for sale in Western Canada?

MacDonald: In 2013, some $2.6 billion in asset sales cleared. But there's much more for sale. It's a buyers' market, if you want to assemble a concentrated asset base in some of the unconventional basins in Canada.

Vali: Another facet of Canadian versus U.S. energy producers is that many of the Canadian companies are smaller and have not had the same access to capital as their U.S. counterparts. The U.S. companies have had an investor base that is more than willing to fund these companies' growth. Part of the reasons for asset sales by Canadian companies is to help them fund some of their other projects and reduce their leverage.

Lyon: That access to capital cannot be overemphasized. This is a highly capital-intensive business. Driving these asset sales, in part, are companies trying to concentrate on one or two of their key resources, because it's that resource concentration that the equity market is favouring.

MacDonald: In summary, don't count Canada out. Look for energy companies that continue to focus and streamline their asset base and also look for opportunities in unconventional plays. Some Canadian names are so cheap that they could be takeover targets.

Lyon: An improvement in the infrastructure for Canadian producers and/or an improvement in the oil-sands economics could bring the foreign investor back into Canadian energy stocks. As Norm has said, there are opportunities in Canada. Liquefied-natural-gas projects are a clear example. The basin that is likely to provide most of the gas for this is Western Canada's Montney. So, Montney producers such as Canada's Painted Pony Petroleum Ltd. PPY and ARC Resources Ltd. ARX will benefit. I own Painted Pony.

Vali: I have a small position in Painted Pony's stock and a significant holding in ARC.

Norman MacDonald

Q: Time to talk about the materials sector, which has been a laggard.

MacDonald: Bullion was one of the weakest performing commodities in 2013, down about 26%. Gold bullion is out of favour with many investors. Canadian gold stocks were down about 42% in 2013. Trimark Resources has a reasonable exposure to gold stocks. I use US$1,200 per ounce to value the companies, because that is the new marginal cost of production. I focus on the quality of assets and of management.

Lyon: Marginal cost of production roughly sets a long-term price for commodities. Commodity prices across the board are now generally in equilibrium between supply and demand and their prices are range-bound. On bullion, most of the prior price premium, reflecting a range of investor concerns, has been taken out. This reduces the downside risk for the commodity. For gold-stock investors, there is a need to focus on those producers that can survive or potentially thrive in a US$1,200-per-ounce environment.

MacDonald: An example is Torex Gold Resources Inc. TXG, which is one my favourite names. The company came in to talk to me four years ago. At the time, it thought there might be four million ounces on its property and the price of gold was US$100 per ounce less than it is today. At that time, Torex's market cap was about $400 million. Fast forward to today, management's estimate for the property is 10 million ounces and the price of gold is US$100 per ounce higher than it was then, yet the market cap does not reflect this. It's a good-quality, low-cost deposit in Mexico.

Lyon: It's a fairly high-grade ore. I own it in AGF Precious Metals.

Vali: In 2013, not only did the gold price drop, but a lot of the companies also disappointed in terms of their ability to execute. We saw that, for example, in Barrick Gold Corp. ABX. To the extent that this is behind us now, perhaps we have seen the bottom in some of the gold stocks.

MacDonald: Poor management has hampered this industry.

Lyon: Investors have forced change on the gold industry, including on Barrick, to try and make these companies an investible asset class again.

Q: Base metals?

Norman MacDonald and Scott Vali

Vali: We're fond of copper. The market believes that we're going into oversupply in the next couple of years. But looking longer-term, we still need a higher price to encourage future production. As we look into 2016, 2017, that surplus is expected to diminish. There is a need to start building those mines now to fill that gap.

Lyon: I own Freeport-McMoRan Copper & Gold Inc. FCX in AGF Global Resources.

Vali: I also own the stock.

MacDonald: I own Turquoise Hill Resources Ltd. TRQ.

Lyon: I also own First Quantum Minerals Ltd. FM.

MacDonald: I also own this stock.

Vali: So do I.

Q: Interesting, all three of you have a holding in First Quantum.

MacDonald: It has a good growth profile in Africa and Panama. First Quantum bought Canadian rival Inmet Mining Corp last April, mainly for its Cobre Panama project. First Quantum has underperformed a little in 2013 because of the delay on the final capital-expenditure budget for Cobre Panama. The market doesn't like uncertainty. At the multiple that you're buying First Quantum today, there's not much growth baked into the share price. First Quantum's management team is best in class in the mining industry. It takes a long-term view from a net-asset-value perspective.

		First Quantum Minerals Ltd.	Turquoise Hill Resources Ltd.	Freeport-McMoRan Copper & Gold Inc.¹
	Jan.13 close	$18.66	$3.61	$35.63
	52-week high/low	$21.95-$14.22	$9.40-$3.20	$38.09-$26.37
	Market cap	$11.0 billion	$3.6 billion	$36.9 billion
	Total % return 1Y*	-11.6	-61.1	8.2
	Total % return 3Y*	-8.4	-47.7	-11.7
	Total % return 5Y*	33.0	-1.2	26.8
	¹ Figures are in U.S. dollars *As of Jan. 13, 2014 Source: Morningstar

Lyon: The ink is barely dry on its Inmet transaction. It's premature to pass judgment on it, when 80% of the rationale for the transaction was a project that is still being built. First Quantum's management team is rightly regarded as one of the premier copper-mine builders in the world.

Vali: Correct. Another base-metal commodity that is looking interesting is zinc. The challenge with it is that there are not a lot of companies that provide a pure play on zinc. One company that is growing its zinc production is Lundin Mining Corp. LUN, a holding in Signature Global Resource.

Lyon: I own Lundin and a few names that have some zinc exposure such as Hudbay Minerals Inc. HBM and Teck Resources Ltd. TCK.B. Teck is the largest zinc player in the world, although its financial leverage to zinc has gone down as it has expanded into copper and into metallurgical coal.

Photos: paullawrencephotography.com