Wednesday, April 25, 2007

The Publicly Held Exchange Industry -- Any Value Left?

The publicly owned exchange industry is comprised of the firms that own and operate the world's major and minor stock and commodity exchanges. The exchange industry is a relatively "new" industry, in the sense that almost all of the publicly owned exchanges went public -- that is, demutualized (meaning to transition to a for-profit corporation from not for profit) -- from 2000 onward.

Most of the largest exchanges are now, as of 2007, publicly owned including the NYSE Group, NASDAQ, the Hong Kong Exchanges Group, the Chicago Mercantile Exchange and London Stock Exchange, for example. Notable exceptions are the AMEX (which plans to demutualize in 2007), all Indian and Mainland Chinese exchanges, all Japanese exchanges, and all Latin American (exchanges except those with ties to BME).

All publicly held exchanges are valued as of 4/07 as follows:

Ticker; Company; Enterprise Value $US; P/E – trailing/projected; Earnings Increase(Y/Y); Stock Apprec (Last 2 Years); Trading Volume Annual Increases(04-06)
NYX; NYSE Euronext; $12.56Bn; 62.8x/24.7x; +402%; 203%; Approx 10%
NDAQ; Nasdaq; $3.0Bn; 43.8x/19.3x; +106%; -10%; Approx 10%
LON:LSE; London Stock Exchange; $5.1Bn; 36.3x/na; +80%; 200%; 33% (06 only)
CME; Chicago Merc Exchange; $19.53Bn; 45.2x/28.7x; +32%; 113%; 31%(06 and 3 mo 07)
BOT; CBOT Holdings; $9.63Bn; 52.3x/33.1x; 125%; 97%; 19%
NMX; NYMEX Holdings; $11.1Bn; 66.9x/34x; 118%; -5% (IPO 11/06); 40%
TSE:X; TSX Group (Toronto); $3.0Bn; 25x/na; 27%; 150%; 27% (06 and 3 mo 07)
SAfrica: JSE; Johannesburg; $891M; 42.0x/na; +107% (EBT);1,685%(public on 4/05); 25% (but -20% in 2003)
S:S68; Singapore Stock Exchange; $4.9Bn 25.2x/na; +72%; 250%(public on 12/00); Flat to Slightly Negative 04-06
HK:388; Hong Kong Exchanges; $10.8Bn; 33.7x/na; +88%; 71% (LTM); 72% in 2006
ESP:BME; BME(Spain); $4.34Bn; 55x/na; +36%; 33% (LTM); 50% in 2006
SWE:OMX; OMX(Nordic Countries); $3.1Bn; 23x/na; +68%; +70%(LTM);20%
ASX:ASX Australian Stock Exchange; $4.05Bn; 35.4x/na; +32%; +130%; 40%(2006)
NOR:OSLO; Oslo Bors; $550M; 13.5x/na; +70%; +70%; 50%
NZ:NZX; New Zealand Stock Exchange; $169M; 35.6x/na; +31%; +475% since IPO in 04; Flat volume in 07

Valuations of the Exchange Industry:

Based on a comparison of the stocks in the industry, certain facts and trends are evident. First, there are few bargains in the exchange universe, with current P/E's (at 4.24.07) of 30x or more, up to 60x, due mainly to very high stock appreciation across the board in the industry. Most of the appreciation has occurred in only the past two years and, in certain cases, only in 2007. For example, OMX Group which represents the stock exchanges for the Nordic Countries -- Stockholm, Copenhagen, Finland, Island, and the Baltic Countries -- has appreciated approximately 70% this year and mainly in March and April 07, from relatively flat performance in 2005 and 2006. Stock performance has been extremely positive even challenging commodity based stocks in total return since 2004.

The high appreciation has led to quite high valuations for certain exchanges, if to compare with valuations in other industries. For example, CME -- Chicago Mercantile Exchange -- is valued at approximately 20% more than Cameco in terms of market capitalization -- $19.5Bn vs $16.5Bn. Cameco is the world's largest miner of Uranium, providing 20% of the world's supply of Uranium, while CME is one of three US based commodity exchanges, albeit the largest, and one of several international commodity exchanges -- so faces significant competition. The comparison in terms of value from an "eyeball test" appears to favor Cameco vs CME. Additionally, major commodity exchanges are planned to open in the Middle East and Russia -- translating to potentially more competition going forward in the commodity exchange industry.

Trading Volume is The Key Driver of Income

Second, it becomes clear that the number one driver of earnings for stock based exchanges are fees on trading volume. Exchanges earn income in three main areas -- 1. transaction fees: a small fee per transaction, typically well less than 1 cent per share, but dependent on the exchange, 2. Listing fees, based on a flat fee year per company and new fees per company IPO's, and 3. Information services, outsourcing their trading technology to other exchanges and partners.

Surveying the publicly held exchange firms, fees on trading volume for almost all of the exchanges is the largest profit center, and also is the fastest growing profit center across firms in the exchange industry. For example, the Olso Stock Exchange -- a quite small regional exchange by international standards (but still with a current market capitalization of $550M!) -- earned 62.7% of total 2006 operating income in equity trading fees, and 28% from information services. For Olso, equity trading fees were up 45% in 2006 and 49% in 2005 year over year, while information services also grew at a good clip, 33% in 2006 but only 7% in 2005.

Numbers of listed firms has been relatively flat across most of the stock exchanges, with the single exception (of the firms listed above) of the London Stock Exchange, which has seen approximately a 10% annual increase in numbers of firms listed since 2002. Part of this reason may be Sarbanes Oxley in the United States, which has made cost and compliance burdensome for public firms. Nevertheless, trading fees have been a much higher driver of profits for London than exchange fees.

Note also it is possible for the exchanges to come up with new products that could potentially be popular with investors and lead to higher fees, based on revenues from these products, such as interest rate derivatives, new index funds, etc. However, in the introduciton of these products, the exchanges will compete with the major brokerages for market share.

For Some Exchanges, Higher Fees Are the Main Driver of Trading Volume Revenues

Trading volume revenues can increase either from 1) higher trading volume or 2) higher fees per share traded. For Nasdaq and NYSE Group, the volumes traded have not increased by more than 10% over the last 3 years, but income has increased well in excess of 30%. This is mainly due to higher fees, although fee information is difficult to find in the exchanges' 10-k's. Investors should be cognizant that there are already grumblings in the major brokerages that the fees are becoming too high. Citigroup, for example, has instituted a group to investigate a separate system to trade shares that does not depend on the major exchanges' systems, to combat high fees (see:

In addition, the investor should also be wary of steep rises in trading volume in international markets. For example, the Australian stock exchange has experienced trading volume increases of 50% in 2006. Perhaps this is due to increased activity by funds and hedge funds internationally. But, in comparison, the New Zealand Stock Exchange (NZX), with a somewhat similar economy and demographic situation, has seen flat to slightly declining trading volumes in 2007. The NZX's CEO's conclusion regarding flat to lower trading volume is that trading volumes will always be cyclical and this is good advice for the investor -- to be mindful of the cycle of the exchange and economy in terms of trading volume -- but on the positive side as countries experience economic growth generally over time trading volume will increase.

Does Value Exist in the Exchange Industry?

The London Stock Exchange, NASDAQ and Oslo mainly stand out as potentially undervalued. Olso is on this list due to the relatively low p/e ratio of 13x -- but the exchange appears overvalued on first glace due to its market value of $US550M, serving as the main exchange for a country of only 4 million people. NASDAQ, interestingly, owns 28.8% of the London Stock Exchange, acquired in a failed takeover attempt and this action may have made both firms relatively undervalued in comparison to the rest of the industry.

The London Stock Exchange Appears The Most Undervalued

London has very strong volume growth that appears more sustainable than other smaller international exchanges, as it is the major regional center and is well positioned against the US exchanges as the key world financial center. Europe as a whole is showing surprisingly strong economic growth, coming off a low growth base with economic reforms instituted. The CEO has publicly stated that the current market capitalization of $5.1Bn is undervalued (and therefore will not accept the $5.1Bn bid from NASDAQ, although it is possible that prestige issues may also be present in the decision not to sell to the relatively upstart NASDAQ). London's p/e is reasonable in comparison with the industry at approximately 36x 2006 earnings. The only concern is the possibility that NASDAQ will dump its approximately 30% stake causing a significant decline. Mitigating this possibility is that NASDAQ hopefully (probably) will see that London remains a good investment -- and evidence here is that NASDAQ of course attempted to buy London.

Thursday, April 12, 2007

Northgate Minerals: Undervalued

Northgate Minerals (NXG) is an intermediate sized copper and gold miner – approximately 60% copper and 40% gold in valuation by production -- and is undervalued on a reserve basis of proven and indicated ore reserves.

Ticker; Company; Primary Reserves; Sec. Reserves (2); Gross Value Reserves (1); (2)/(1)
NXG; Northgate Minerals; 1.88M Tons Copper; 8.5 M ou Gold; $15.9Bn; $622M; 3.9%
GSS; Golden Star; 4.15M ou Gold; n/a; $2.49Bn; $1.15Bn; 46%
EGO; Eldorado; 9.7M ou; Gold; n/a; $5.82Bn; $2.10Bn; 36.1%
ABX; Barrick Gold; 139 M ou Gold; 933M ou Sil & 6.2BlbsCu; $109Bn; $26Bn; 23.9%
PCU; Southern Peru; 33M Tons Copper; n/a; $198Bn; $23.2Bn; 11.7%

Assumed prices of copper: $2.50 lb, Gold: $600 ou

The number of pure play public copper miners is limited so comparisons are difficult -- Southern Peru is a large cap copper miner so is not directly applicable to NXG (note that large cap miners should trade at a premium to smaller miners). However, in general, gold companies sell at a higher EV/gross value of ore reserves. On either basis, comparison to gold or copper miners, NXG trades at a discount to reserves.

NXG has one medium sized gold and copper mine in production currently (Kemess South) – in production until 3Q09, and two medium sized mines in the works – Kemess South and Young Davidson. These mines are analyzed in more detail below.

The most important factors in the valuation of a mining company – in order of importance – are 1) geology of the mining properties, 2) the political situation of the country and local government and 3) local and transportation infrastructure.

1) Geology:

Northgate has 1 mine in production and 2 mines under development: Kemess South is in production currently and expected to end production at 3Q 09, Kemess North expected production in late-2007 and Young Davidson, which is expected to start production in 2009-10. Note that the main concerns are for the potential production of Kemess North, which is most likely not a geological problem, but a political problem (to be addressed below).

Kemess North:

There are proven and inferred resources of 4.1 million ounces of gold in only the Kemess North mine (for comparison, the largest gold miner is Barrick Gold with 140M ounces gold total). Also 1.3 billon pounds copper indicated at Kemess North (comparison: Phelps Dodge reports 46 billion ounces copper total). These numbers for Kemess North only are numbers comparable to the total reserves of an intermediate gold and copper miner.

NXG's Kemess North Mine is expected to begin production in late 2007, and will last for 11 years. Kemess North is only 7 km north of Kemess South, so the geology strikes me (a bit unscientifically though) to be similar. Apparently the grade is a bit lower but not much. Northgate refers to the North as the "Kemess expansion."

Production from Kemess North is projected at 250,000 ouces au a year, Kemess South is currently at 300,000 ou au a year, copper production from North is set at 112 M ou ag a year while South currently is set at 75 M ou ag per year. Kemess North is being delayed however currently due to potential pollution issues concerning an Indian Tribe, part of the First Nations Group. This issue is the most important issue concerning Kemess North, and is addressed in detail below.

An economic assessment by Mining Watch Canada – which mainly focuses on environmental issues in Canada, but is still provides detailed Net Present Values of mining properties – assessed the NPV of Kemess North at $C1.9Bn at conservative assumptions for prices of gold and copper:

“If one assumes Option 1 but with Gold/Copper prices of $US500/$US1.80 then after-tax earnings reach $1,911.5
million over the life of the mine with an IRR of 47.6%, far above the credit adjusted
risk free return of 5.625% and much higher that the generally-accepted
required return 10% - 15% of for projects of this nature.”

Young Davidson Mine:

Northgate has the Young-Davidson mine earmarked after 2008 (probably 2009 to 2011) -- 170,000 ou au a year albeit higher cash costs due to a lower grade of reserves. Indicated reserves at Young-Davidson have are approximately 2 M Ou Au

2) Political Situation:

As a general rule, the political situation concerning mining in Canada is favorable – however NXG has potential problems concerning an Indian Tribe – the Te Skay Tribe of the First Nations Group (the First Nations Group represents Northern Canadian Native American Tribes) – that is delaying the project due to the proposed contamination of a lake in northern British Columbia from the Kemess North project. First Nations isn't sure if it will contaminate the lake, so they have asked for and received 90 more days to see if the project will or will not be approved. Currently the trial is set for May 14th, 2007.

In the author’s view, this political problem is the most risky aspect of an investment into NXG. However I am mainly assured that the mine will be approved -- if I put a “probability” on the approval, 80% likelihood – for the following reasons.

- The mine is far removed from local cities and populations, in Northern British Columbia, as the Kemess Mine is a "major" employer providing only 450 jobs. The tax authorities and the town and of course company want the Kemess North Project, but the tribe may or may not want it, depending on how it affects the lake.

- Further, Northern British Columbia is very similar in territory and population density to Yukon Territory, which is approximately than 50% the size of Alaska but has only 29,900 people. Yukon Territory is much less densely populated than Alaska. Population density of 0.06 per km2 compared to Alaska, 1.09 people per Mile2. It is mainly empty space -- Indian "tribe" that the First Nations Represents does not live close to the project, but has ancestors who lived there, and the tribe is relatively small, approximately 350 people.

- There are no towns around Lake Duncan and if you look at a map there are a lot of Lakes the same size/larger right in the same area. It is pure wilderness around this mine for 100's -- more like about 500 miles. No roads, only can reach by plane/helicopter. One railroad there but that is almost entirely for freight (that's how NXG ships out the metals). Not a single person from the tribes lives within 50 to 100 miles of Lake Duncan -- well maybe one or two recluses who lives off hunting -- but the elders of the tribes all live in small towns and or Vancouver. Te Skay is actually originally centered as a tribe in Southern BC.

- Note that the Te Skay tribe reached a settlement with the BC government about a different project by BC Hydro which flooded the area: Payouts of about a million Canadian dollars a year and an upfront settlement.

- The final decision lies with the Premier (governor) Gordon Campbell and the government of BC -- the mine is located in northern British Columbia, but is very under populated -- there are no roads and the mine is a fly in/fly out operation.

- The First Nations appears to be mainly an economic grouping -- they operate several businesses in BC -- hotels, fishing places. Lake Duncan is not a direct economically beneficial tourist destination because no tourists go there or even get close to going there.

- Further to the above point, my impression is that First Nations views mining and other natural resource projects in BC as like Native American tribes in the US view gaming -- a way to make money. If Northgate pays them a million or so a year for Kemess North that will not affect the economics very much at all -- 4.1 million ounces of gold total and 120 million pounds of copper a year (estimates for Kemess North) are huge numbers – NPV mentioned above is $C1.9Bn.

- The Premier of BC Gordon Campbell has the final say on the Kemess North project. Campbell has run politically on an economic prosperity platform. The head of the BC Mining Council (also required signature for the project to go forward) has a background in the oil and gas industry. Both are, in my opinion, cognizant of environmental and Indian rights but place as a first priority economic growth. As Campbell likes to say “British Columbia is open for business.”

As a final note, if the Kemess North project does not go through, (I assess approximately at a 20% chance) then NXG can take the $C190M it costs to develop the mine and look elsewhere, probably Young Davidson.

3) Infrastructure:

Both Kemess projects have established infrastructure – ore is shipped by existing railways – and established transportation infrastructure for getting workers to the mine. See for more detail.

Young Davidson exists next to a traditional mining town – Matachewan in Northern Ontario with a population of les than 400 – but the town is apparently eager to see the mine developed. As far as I can tell, no railways are close to the north but roads access is available.


As there are few intermediate copper and gold miners in the investable universe, and fewer with existing and very promising properties in geopolitically stable areas of the world, Northgate Minerals is unique and represents a compelling buy at the current valuation.

Wednesday, April 11, 2007

Cost/Ton is the Appropriate Measure to Value Coal Companies

A previous post in this blog asked the question: can an investor value coal companies based on gross value of reserves? The answer give there was "maybe." A clearer answer to value a coal company is: a much more appropriate valuation is cost/ton compared to the price/ton of coal.

Cost/ton is defined as the lifting costs per ton of coal -- an investor would compare this cost with the selling price of coal (both current and future). The difference would be the margin -- a large gross margin, of course, indicative of good profitability.

Rev/Ton - Cost/Ton Dependent on Geographic Region:

Certain producing geographic areas for coal have stronger margins than others. In Central Appalachia, International Coal Group (ticker: ICO) is producing coal at a cost/ton of $42 with an additional $4 in start up costs, while Central Appalachian coal prices are at estimated $45 to $48 until 2009 (coal contracts are of 1 to 3 years in duration). This does not leave a high margin. -- However note that ICO has operations in Illinois which are at higher gross margin, leading the overall company in profitability, but the company's main area of operations is Appalachia.

Note that both the Western US and Australia are approximately twice as profitable as the Eastern US on a margin per ton basis for Peabody Energy -- the United States #1 coal producer. Peabody Energy -- with its operations in the western and eastern US, and Australia, reports the following costs per ton in its geographic areas.

Operations Rev/Ton Costs/Ton Margin %Margin
Eastern U.S. $37.96 32.24 5.72 15.1%
Western U.S. 10.66 7.47 3.19 29.9%
Australia 64.31 43.82 20.49 31.9%

In the US, it appears that those companies without exposure to the Eastern US and Appalachia have a stronger rev/ton - cost/ton margin:

Reserves (mm tons); Res Life (years); % Owned (vs leased); Reserve Value; EV/Reserve Value; Cost/Ton (total company); Rev/Coal (average co); Margin %

Peabody 9,479; 46; 42%; 214,946; 5.9%; 13.42; 22.68; 40.8%
Consol 4,546; 65; 56%; 170,721; 3.9%; 23.80; 37.55; 36.6%
Arch 3,076; 29; 13%; 52,525; 11.3%; 13.08; 17.08; 23.4%
Massey 2,260; 52; 16%; 106,501; 2.7%; 42.33; 47.12; 10.2%
Foundation 1,708; 26; 45%; 30,744; 6.9%; 14.30; 18.88; 24.3%
ICO 1,060; 72; 72%; 42,158; 2.1%; 38.00; 39.00; 2.5%
Alliance 549; 26; 5%; 20,749; 6.6%; n/a; 37.79; n/a
Alpha* 490; 19; 3%; 26,460; 6.1%; 45.96; 54.00; 14.9%
James River 225; 24; 7%; 10,393; 3.1%; $42; 46.19; 9.1%

Information on costs/ton from the respective company 2006 year end financial statements.

*Alpha Natural Resources holds approximately 35% of its resources as Metallurgical coal which is priced at $75/ton.

Potential Improvement in Rev/Ton - Cost/Ton:

The way to improve margin for a coal company is to 1) decrease operating costs, 2) open and/or find improved geological mines and/or 3) realize a higher price for coal (the price of coal is set in contracts and in the spot market).

On decreasing operating costs, (1 above) a reasonable assumption is that coal company costs will, all other things equal -- ie no drastic cost reduction programs announced -- increase in the future, due to general construction and worker price inflation as well as more and more difficult geology (in Appalachia, several sources have stated that the easy-to-mine coal has already been mined, making geological improvements in coal recovery less likely -- although note that several sources state that in Illinois and the West the easy to mine coal is still abundant).

An example of increasing cash costs per ton is Massey Energy -- which operating in the East and Midwestern US -- reported the following costs/ton for the past 3 years as of 2006:

2006 2005 2004
Produced tons sold (millions) 39.1 42.3 40.4
Produced coal revenue ($ millions) $1,902.3 $1,777.7 $1,456.7
Produced coal revenue per ton $48.71 $42.02 $36.02
Average operating cash cost per ton $42.33 $35.62 $30.50

Future Coal Prices
The question on 3) above to improve margin is: what is the future direction of coal prices? Coal appears to be on a slight uptrend, favored by continuing demand, more difficult to produce reserves on the east coast, but under pressure currently from environmental concerns. Note that the utility TXU announced that they are dropping their permit requests for 8 coal-fired electricity plants, -- moving to nuclear powered plants -- reducing the number of planned coal power plants from 11 to 3. This could potentially signal a move from other utilities away from less-clean coal.


Caution should be applied for the investor currently in Appalachian heavy coal companies. Overall, the steep upward price appreciation in the US appears to be mitigated, so dramatic improvements in profitability -- based on higher future coal prices -- does not appear to be realistic -- although this does not include other geographic regions such as Australia, China and Russia, which have their own unique pricing and operating dynamics.

Tuesday, April 3, 2007

Uranium Mining Sector Notes -- Large Cap Value in Uranium Mining

Uranium has been one of the highest appreciating sectors over the past three years and shows no signs of slowing down. There are a limited number of public Uranium miners, evidenced by the fact that the Canadian investment management firm Sprott Asset Management -- which is one of the best research firms covering the Uranium sector -- only lists 34 firms in their Uranium universe. Further, there is especially a limited number of "quality" names -- quality meaning a reasonable chance of bringing sizable uranium to market profitably in a reasonable time frame (7-8 years).

The Large Pure Play Uranium Miners:

There are only two large, pure play Uranium miners that currently produce Uranium as a large percentage of their total production: Cameco -- currently the world's largest producer, located in Canada -- and Energy Resources of Australia (ERA), which is 68% owned by Rio Tinto. There are 3 other mid-tier producers of Uranium, which produce Uranium from smaller, geographically dispersed mines: Uranium One, Denison, and Paladin. BHP is the world's third largest producer of Uranium, due to its ownership of the Olympic Dam mine, but Uranium so far only comprises a small percentage of BHP's total sales and operating income (estimated 2.5% and 3.0%, respectively in 2006)

Note that currently the world's supply of Uranium is heavily dependent on only a few mines. Nearly 100% of all new mined uranium is derived from only 10 mines worldwide, and approximately 40% of all newly mined uranium is derived from only three mines: 1. The McArthur River Mine -- owned by Cameco in Canada, at 17% of world production; 2. Olympic Dam -- now owned by BHP (Australia) at 9% of world production; 3. Ranger 3 -- owned by Energy Resources of Australia (ERA) at 12% of world production.

Cameco and ERA can be compared in valuation as follows:

Ticker; Company Name; Market Cap; P/E (Trailing), P/E (forecasted); P/S (Trailing); Reserves (Measured + Inferred); Gross Value Reserves (at $100 lb U3O8); Market Cap/Gross Value Reserves
CCJ; Cameco; $15.5Bn; 43.8x; 17.4x; 9.25x; 526.4 Mlbs*; $52.6Bn; 29.5%

ERA (ASX); Energy Resources of Australia; $Au5.5Bn; 128x; n/a; 16.9x; 524.2 Mlbs;** $52.4Bn; 9.4%

*CCJ reserves also include 2.5M ou of Gold, note an amount comparable with a junior gold miner, and also amounts of zinc, copper and nickel comparable with small junior miners of these metals
**Reserves of ERA are only two mines, Ranger and Jabiluka, and approximately 70% of total ERA reserves in the "Jabiluka" mine, which has not been approved for production as of mid-07.

CCJ and ERA's mines are currently operating in politically stable countries (although Australia's political attitude towards new uranium mines is interesting, the subject for another post -- in summary there is a lot of resistance to new uranium mines in Australia) and have proven geology and infrastructure for getting the uranium to market. Mines in Kazahkstan and African and South American countries should be reviewed carefully before investing due to political risk. The mid-tier uranium miners Uranium One, Denison, and Paladin have significant operations in Kazahkstan, African and South America -- these firms argue that these countries present low political risk (which is debatable) but Australia and Canada are almost certainly lower risk countries for mining operations.

Cameco in addition to its mining resources has three other operating segments: Fuel Services (Uranium Enrichment -- Cameco owns 3 enrichment plants: 1 pure enrichment plant, 1 uranium refinery and 1 uranium conversion plant in Canada, Canada's only enrichment capacity), Electricity (Cameco owns approximately 31% of a nuclear power plant in Canada), and Gold (owns 52% of Centerra, a public Gold Co - market cap of $C2.4Bn at 4/07, 11.5 M ou gold measured & inferred). These segments exist in addition to CCJ's uranium mining segment.

Comparisons between Cameco and ERA should take into account that Uranium Mining only accounts for 23% of Cameco's 2006 earnings before taxes. Although note that the relatively low amount is due to contracted prices of Uranium -- average realized price by Cameco in 2006 for U308 sales between $30-60, rising by quarter over the year. 2006 profitability of all 4 of CCJ's segments is as follows:

$C Uranium Mining Fuel Services Electricity Gold Mining
Revenue $803.3M $224.1M $407.6M $414M
% of total Rev 43.9% 12.2% 22.4% 22.5%

EBT $80.9M $21.6M $143.1M $91.5M
% of total EBT 23.4% 6.3% 41.4% 26.5%

BHP and Uranium -- It is Difficult to Buy BHP Only for the Uranium Exposure

Will uranium make a significant impact on BHP's bottom line going forward? BHP is a huge company, with its Base Metals Segment -- in which Uranium production is only a part (and base metals is one of seven BHP operating segments) -- contributing 34% to 2006 sales and 35% to 2006 EBIT. BHP's share of Olympic Dam is 4,000 tonnes annually and is growing, so at $100 lb Uranium, this works out to be approximately $800 to $1000M annually. BHP total revenues in 2006 were $32.2Bn and EBIT in 2006 was $15.2Bn. Assuming a 50% EBIT margin, Uranium would only contribute 2.7% to BHP's total sales and 3.3% to EBIT. In conclusion, Uranium at BHP is too small to really make an impact unless one sees extremely high prices for uranium or outstanding, 100% growth in mine production, which is not too likely to occur (and even then it is better to buy a more pure play Uranium miner).

Significance of the Low Number of Investable Uranium Companies:

Asa a final note the limited number of names can translate that if a mutual fund or other investment firm wants exposure to the Uranium sector, there are only a few stocks to invest in -- which may mean (and/or means currently) a lot of funds chasing the few quality names -- large demand, limited supply, good conditions for continued stock appreciation.

Will the Proposed Tax on Canadian Income Trusts be Approved?

The new tax on income trusts -- a tax to eliminate the Canadian Royalty Trusts' tax free status -- was proposed on Oct 31, 2006, and voting will probably come this year. The significance of the proposed tax is that, on average, the Canadian Royalty Trusts ("CanRoy's") have dropped by an average of approximately 20%-30% when the taxes were announced, and they should regain some of this lost value if the taxes do not pass -- not and there have been significant "whispers" that the taxes will not pass currently (in 3/07 and 4/07). So the question for prospective investors is: will the CanRoy taxes pass or not?

The most important issue to determine the political success of the tax (economic and corporation issues aside) is whether the Canadian parliament has enough votes for it to pass. The Lower House of Commons is apparently the branch of government in Canada that has the most influence (the Senate mainly rubber stamps the Lower House, according to the decription of Canadian politics in the wikipedia, much different system than the US).

A simple majority is needed to pass taxes.

Lower House members:
(X means on board with the tax, - means against, ?
means undecided)
Conservative Party (Tories): 125 members X
Liberal Party: 125 seats -
Bloc Quebec: 50 seats ?
New Democratic Party: 29 seats X
Independent: 2 seats ?
Vacancies: 2 (I don't really know how to interprete
"vacancies") ?
Total: 308
Seats from the official Canadian Parliament website.

The Conservative Party and the New Democratic Party have publically stated that they are for the measure, so that totals 154 votes (50% exactly). reference:

Apparently breaking party ranks and voting against the party is rare in Canada so it looks that the taxes have 50% support.

Bloc Quebec is for the measure but would like to extend the transition time to 10 years, and would also like more evidence of the need to transition. The Liberal Party has proposed a different measure, no new income trusts but income trusts allowed if they can show a positive impact on Canada -- this is the most reasonable proposal in my view, but they only have 100 votes, approximately 32%.

But in summary, the most important factor is that the Conservatives and New Democratic Party are on board and that is enough to get the measure passed. I suppose an investment advisor can say "50% is not 51%" but 50% is close enough to 50% with Bloc Quebec still up in the air and independents and vacancies that it appears the tax is likely to go through.

It seems to me, if I were to put percentages on the passing of the tax (from my judgement only, albeit analyzing the issue for a few days), it would be: 60% passed as proposed, 30% passed with some/minor modifications and 10% passing the Liberal Party's recommendation (the passing of the Liberal recommendation would be the main driver of improved investor interest).

Coal Mining Notes Explained

The previous post listed most US mining companies and their enterprise values divided by the gross value of coal reserves. The question is: can the investor use the gross value of coal reserves as a tool for identifying undervalued coal companies? The answer: "maybe." It is not as clear cut for coal companies as for oil and natural gas firms as well as metal ore mining firms to use a net present value-like valuation approach. The reason is that the profitability of the coal mining operations fluctuates even more widely than other resources firms (Metal Ore Mining Firms, oil and gas firms), and the reserves of coal mining companies typically last 30 or more years (in some cases over 70 years) so the latter years of an NPV type calculation are insignificant to the present value.

Many investment firms, in valuing the Coal firms, do not attempt a NPV-type calculation as reserves but rather used earnings valuations, (p/e, price/cash flow or price/EBITDA) and/or perhaps a few future years with an exit value.

Nevertheless is the gross valuation measure is an interesting measure and can be used in conjunction with earnings measures. Coal companies are resource companies and as such, theoretically, they should be valued on the basis of their resource reserves, dispite the unique situation of coal compared to metal ore and oil and gas.

Coal Mining Companies Gross Value of Coal Reserves to Enterprise Value

Ticker Name Reserves Coal Value Reserves Notes: Cash Costs Per Ton (05) Realized Price per Ton (05) Enterprise Value EV/Value Coal-Costs
Notes: Listed From largest company by gross amount of reserves to smallest firm
Quality of coal not indicated -- only can be inferred from the chart from mining location and price realization
Also note, date (05) and market capitalization are getting old -- from mid-06

BTU Peabody Energy
Coal Reserves (both Measured and Inferred): 9.8 billion tons
Gross Value Reserves: $24Bn
Notes: High Sulfur Majority, MidWest. Western US Maj, #1 US Coal Producer
Price Coal Realized: $18.42 (East: $35, West:$12 $17 (East: $33.4 W:$10.5)Enterprise Value: $14.7Bn
Enterprise Value/Gross Value Coal Reserves: 61.3%

CNX Consol Energy
4.5 Billon Tons
$75Bn -natural gas not included
#3 public US Coal Co, also approx 780 bcfe gas
$17.50 $35.60

ACI Arch Coal
3.1 Billion Tons
#2 public Coal Co US, Split Appalachia, West
Appalachia Price: $17.25, West Price: $12.50

MSE Massey Energy
2.26Bn Tons
W Virg, underground, #1 US producer Met Coal
WV price: range: $40- $42.00

NRP Natural Resource Partners
2Bn Tons
Appalachia, 90% CF to Dividend (5.8%)
Receives $1-2 royalty per ton

YZC Yanzhou Coal
2.0 Billion Tons
#1 Cl China, underground
Price Range Coal Realized: $16-$37

ICO International Coal Group
916M Tons
W Virg, underground
$40 $43.60

FCL Foundation Coal
1.7Bn Tons
50/50 Apltia, West
$14 $19.33

WLB Westmoreland Coal
1.17Bn Tons
Western US, #8 US coal producer
$10 $11.50

CEY.AX Centennial Coal
1.1 Billion Tons
$8.36Bn Australia-based, Largest Australian independent coal producer by reserves
$26.03 $33.60

ANR Alpha Natural Resources
490M Tons
36% rev from met coal, 90% low sulfur
$34 $42

JRCC James River Coal
242M Tons
Kentucky, underground
$42 $46

Subprime Sector Notes

I finished up some research on the subprime sector -- perhaps a bit late if the market thinks this now is a non-issue (although I beg to differ & I think I have
pulled together some new insight, if one can believe it or not :)

- Ideally to calculate the possible impact one would utilize a series of detailed projections, taking into account the total amount of subprime and alt-a loans
and possible at risk loans. The best projection and discussion I've seen on possible subprime impacts is from (from First American Real Estate Solutions, which claims to be the number 1 source on real estate in the US, used by Moody's)

- FARES projects approximately $300Bn loans at risk over the next 5 years from interest rate resets, and, as losses will represent the loss on collateral, approximately $100Bn of total losses to the financial system, spread over 5 years.

- A weakness of the study is that only the loans made in 04 and 05 are represented, most likely significantly underrepresenting 06 and years before
03. (study completed in 2/06, but I haven't found anything of good quality newer) So one should increase the total at risk amount (unscientifically) by approximately 30-60% to account for the extra years.

- Another weakness of the study is that interest rate reset is at current interest rate levels -- all bets are off if interest rates rise significantly -- but note that much higher interest rates are not extremely likely.

- Study assumes a level of 30% from the approximate $1 Trillion in loans that will reset at risk, which the author considers "conservative" -- and walks the
reader through his methodology. I would tend to agree as the average mortage and other credit card interest payments to income is currently under 18.20% (see -- which indicates the average consumer in the US is NOT hurting by any means.

- All in all what is most interesting is that the total amount is manageable, as the total housing stock value is approximately $18-20 trillon, and value of
outstanding loans are approximately $10 trillon (according to Moody's). The defaults and losses will be spread over at least 5 years, representing in total
3% of total mortgage value (number from the study, although more like 5% taking into account other years) and losses at 1% of total mortgage loan value.

- Also demographically the subprime sector tends to be inner city -- one study of subprime loans showed that 30-40% of the borrowers were African American. In
California -- one of the largest subprime markets -- subprime loans are popular in the farming central area in addition to inner city. The defaults will hit the
inner city harder and -- if I can venture out on this -- will also contribute to the increasing disparity trend in income distribution.

- The loans will likely default and be spread over several years, 5 or more, likely leading to a stangant real estate market in the areas where subprime and
alt-a loans are popular. Perhaps a "two tiered" real estate market will develop -- inner city and other lower income areas and middle to high income class

Mining Notes Explained

The previous post listed a number of public mining companies and the gross value of their ore reserves (defined as reserves of ore, both measured and inferred times the price of ore) divided by the enterprise value (defined as market capitalization - debt).

The basic idea is that mining companies should be valued based on the ore they own in the ground. There are numerous caveats to this statement, but observing the resources of a mining company is a great first step to determining the future discounted cash flow of the mining company.

Mining companies are not required to publish a Net Present Value in their financial statements, unlike Oil and Natural Gas firms in their Standardized Measure (see my other blog for more information on the Standardized Measure). A good starting point for the investor is to see if the Mining Company's value of ore is low (undervalued) in comparison to its market capitalization.

I mentioned caveats to using the gross value of ore reserves and the caveats are:
1. Gross Value does not include costs, lifting and managerial costs
2. Gross Value assumes fixed ore prices, which may or may not be accurate (I've attempted to make the price assumptions conservative)
3. Discount rate (time value) of the reserves is included
4. Future (undiscovered) ore reserves are not
5. Inferred resources are counted the same as Measured (proven) while Measured should have a higher value
6. Political risks are not included

The list is not yet exhaustive, listing every available public miner -- for example, a few large mining companies such as BHP and Rio Tinto are not listed -- but gives a good feel for the metal mining universe -- in addition I will update the list in the future (as time allows).

Note that "comps" such as in the previous post are generally difficult to find -- although very useful for the investor -- as they are time consuming to construct, and most investment banks will not find it in their advantage to compile comps of their clients -- as they recieve fees for banking services so do not benefit if the investment bank identifies the most undervalued companies in the publicly available universe.

Major Mining Companies Enterprise Value to Gross Value of Ore Rerserves

Ticker Name Primary Reserves 2nd Reserves 3rd Res 4th Res 5th Res Net Value Enterprise Value EV/Net Value Resource
Notes: - means no reserves in this catagory, * deveolpment stage company, ** inferred resources not available

NEM Newmont Mining 132 M ounces Gold 9.5m tons Cu - - - $102.9Bn $23.8Bn 23.1%

ABX Barrick Gold 139 M ou Gold 933M ou Sil 6.2BlbsCu - - $109Bn $29Bn 26.6%

AU Anglo Gold 78.9M ou Gold ** - - - - $47.3Bn $15.3Bn 32.3%

GFI Gold Fields 64.8M ou Gold - - - -
$38.9Bn $10.53Bn 27%

KCG Kinross 24.7M ou Gold 24.4M ou Silver - - -
$15.1Bn $4.07Bn 27.2%

HMY Harmony Gold 56M ou Gold - - - -
$33.6Bn $6.61Bn 19.6%

AEM Agnico-Eagle Mines - - - $4.24Bn n/a n/a

FCX Freeport McMoRan 43.9M ou Gold 40.3 Bn lbs Copper - - $147Bn $12.6Bn 8.6%

CGR Claude Resources 178K ou Gold - - - - $106.8M $88M 82%

NCMGY Newcrest Mining (Australia) 59M ou Gold 5.5M tones Copper - $6.1Bn n/a n/a

KRY* Crystallex 26M ou Gold - - - -
$15.6Bn $704M 4.5%

AZK Aurizon Mines 2.83M ou Gold - - - -
$1.7Bn $360M 21.2%

TSX: JAG Jaguar Mining 4 M ou – targ 8-10 M ou $4.8Bn (at 8 M ou) n/a n/a

GG GoldCorp 25.01M ou Gold 69.7M ou Silver 1,481 MlbsCu - - $19.3Bn $10.6Bn 55%

BGO Bema Gold 25.6M ou 83M ou Silver 1.5Mlb - - $20.0Bn $2.81Bn 14.1%

OPYGY Polyus (Russia) 101M ou Gold - - - -
$60.6Bn $8.0Bn 13.2%

GLG Glamis Gold 22.6M ou 878M ou Silver 11.9Blbzinc - - $40.3Bn $6.15Bn 15.2%

Centerra (66% in Kygryz Rep) 12.2 M ou - - - - $2.6Bn n/a n/a

CBJ Cambior 8.0M ou Gold - - - -
$4.8Bn $865M 18.0%

GSS Golden Star 3.78M ou Gold - - - - $2.27Bn $633.5M 28%

EGO Eldorado 9.7M ou Gold - - - - $5.82Bn $1.64Bn 28.1%

PD Phelps Dodge 23 M Tons Copper 2bn lbs Molyd - - - $158Bn $15.9Bn 10.00%

NXG Northgate Minerals 1.88M Tons Copper 8.5 M ou Gold - - $15.9Bn $550M 3.5%

PCU Soutrn Peru 33M Tons Copper - - - -
$198Bn $12.9Bn 6.50%

ETQ* Corriente 4.3 M Tons Copper 4M ou Gold 30MouSilver - $24.2Bn $200M 0.8%

CUP* Peru Copper 20Bn lbs copper 444 M ou Silver 758Mol
$57Bn $468M 1%

TCK Teck Cominco ~20M Ton Zinc ~4M T Copper ~10M ouGld ~7MT Pb 250K TMoly $86Bn ($ 125B/Cl $15.0Bn 17.4% (12%)

EZM EuroZinc 4.55M Ton Zinc 2.55M T Copper - - - $13.5Bn $1.49Bn 11%

SIL* Apex Silver 467 M Ou Sil 3.7M tons Zinc 1.3MT lead - - $15.8Bn $1.6Bn 10.10%

HL Hecla Mines 49.4M ou Silver 618K ou Gold 185mP 265Z - $1.86Bn $584M 31.4%

CDE Coer’s D’Alene 230.7M Ou Sil 1.5M ou Gold - - - $3.1Bn $1.12Bn 36.1%

SLW Silver Wheaton Corp 144.0M ou Sil - - - - $1.58Bn $2.26Bn 143%

SSRI* Silver Standard Res 1100M Ou Sil - - - - $12.1Bn $1.05Bn 8.7%

PAAS Pan American Silver 647 M Ou Sil - - - - $6.2Bn $1.5Bn 24.20%

NILSY Norilsk Nickel 8.13 Bl ton Nickel 140m ou Pd 40.2M ou Pt 16.M TCu 8.8mou Gold $280.4Bn $19Bn 6.70%

N Inco 4.5 Bl ton Nickel 2.8M Tons Cu ? Pd Pt - - $66.3Bn $11.2Bn 16.90%

AGGPY Anglo Platinum 103M ou Pt 85M ou Pd - - - $132Bn $24Bn 18.20%

IMPUY Impala Platinum 41.8M ou Pt 33.2M ou Pd - - -
$49Bn $15Bn 30.00%

POT Potash Corp Sask 15.1 bn Tons K 122.7M Ton Phos - - - $6 T $10.9Bn 0.20%

CCJ Camaco Corp 160M lbs U3O8 - - - -
$8Bn $13.3Bn 166%

Price Assumptions Metals (note: intended to be conservative):
Nickel: $6.00/lb Copper: $2.50 lb Platinum: $1100 ou Potash: $0.22 lb Zinc: $1.30 lb Molybdenum: $10/lb
Gold: $600ou Silver: $9.50 ounce Pallidum: $350 ou Uranium: $50 lb Lead: $1,400 ton