Although the nickel price has been relatively flat so far in 2008, sentiment towards local nickel miners has been heating up following revelations that the merged Oxiana and Zinifex are ready to go shopping. Nickel is apparently at the top of their list following Zinifex's recent takeover of Allegiance Mining. So the obvious question is who could be next?
There are several potential takeover targets on the market, and in our view, Sally Malay (SMY) is just one of them. The company’s fundamentals seem strong on their own, but the potential for a predator to emerge would be a bonus.
Sally Malay operates two large nickel projects in Western Australia with the 100% owned Sally Malay project and the 75% owned Lanfranchi project. The company has come a long way in the recent year with a large increase in earnings and reserve upgrades. Initial reserves were 3.4mt at 1.56% for 53,000t nickel and current reserves stand at 2.8mt grading 1.32% for 37,000t nickel. Last financial year the company achieved record production of 11,920t nickel, 4030t copper and 430t cobalt.
The production ramp up is set to continue, with the next phase of expansion focusing on the three ore bodies (Copernicus, Deacon, and Winner) that lie within the Lanfranchi project. The largest of these is the Deacon ore body, with recent drilling showing intercepts of 3.6m at 10.4% nickel and 5m at 9.68% nickel. The current reserve at Deacon is 1.7mt at 2.54% for 43,000t nickel, but the recent drilling results suggest the resource has a potential size of 2.5mt at 3% nickel. The total resource at Lanfranchi is 125,000t of nickel with reserves of 61,300t. This does not include the Copernicus body.
By bringing these deposits online, the company is again hoping to achieve another annual production record. This year nickel production should top 15,000t, and approach 24,000t in FY09. Although the price of nickel has softened from highs in 2007, the company has hedged 28% of their production which gives them protection for a nickel price below US$25,000/t. The price is currently around US$29,000/t.
Even though there is hedging in place against lower nickel prices and a higher Australian dollar, the risks for SMY should not be ignored. Hedging does not cover all production, which means that revenue will be affected if nickel prices were to fall. The high Australian Dollar poses a problem because revenues are earned in US Dollars, the value of which has been falling. While the high Australian Dollar and weaker nickel prices serve to depress revenues, eating away profitability at the other end of the spectrum for many miners has been rising costs, especially for labour and freight.
Currently, cash costs are sitting at US$2.99/lb, which includes by-product credits from copper and cobalt. This remains comfortably below the current nickel price in imperial terms of US$13.70/lb. Input cost pressures remain on the upside, however the planned increase in production is the best way for any mining company to battle rising costs.
In its last full year result, record production numbers and strong nickel prices boosted profits significantly over 2006 levels. Revenue increased $202.2m which was up 125% from the previous year. Net profit increased 453% to $88.1m and cash flow from operations increased 210% to $159.2m. Diluted EPS was up 397% to 45.7c which puts the stock on a P/E of just over 10 at current prices. Return on equity leaped to 72% which was up 304% from the prior year. Gearing is very low at 18.1% which gives the company plenty of room to manoeuvre if they wish to expand via acquisitions. Cash plus receivables stands at a healthy $122m with the exploration budget set at $10m for next year. The company has no senior debt.
Although nickel prices are presently lower than that experienced last year, the company’s modest valuation takes this into account. Therefore we rate the stock a buy as we search for potential capital gains from any strength in the nickel price or the emergence of a predator.
SMY Price at posting:
0.0¢ Sentiment: LT Buy Disclosure: Held
