A New Mining Investment Landscape Explained

investingBrian Sylvester: Life is difficult for junior resource companies. Not only are stocks and commodity prices moving sideways, but tax changes in Canada may signal less friendly treatment for exploration investment. But not all is grim, according to Arie Papernick, the head of equity capital markets at Secutor Capital Management Corp. in Toronto. In this interview with The Metals Report, Papernick says investors can still make money if they focus on companies that are producing or near production with an attractive capital structure and strong balance sheets. Royalty plays are another favorite. He reveals that the next big opportunity may be coming in the energy metals space.

The Metals Report: Arie, the Canadian government recently introduced a new budget that contains changes to the tax code that are expected to affect mining companies with producing mines. John Gravelle, a mining expert for PricewaterhouseCoopers, recently called this legislation “a form of stealth resource nationalism.” What’s your view?

Arie Papernick: The budget proposes reductions to some of the tax benefits that can be passed to flow-through shareholders. The major impact is that some traditional pre-production expenses, also called Canadian exploration expenses (CEE), which previously could be 100% written off in the year incurred, will be phased out over the next few years. Starting in 2018, only 30% of these expenses can be deducted on a declining basis as Canadian development expenses (CDE). This will potentially hurt resource companies’ ability to raise capital through flow-through shares as the flow-through investor community generally insists on receiving only CEE deductions.

The changes will also be troublesome for junior companies that are developing new mines, because they will have to start paying taxes much sooner if CEE can no longer be used to reduce taxable income on a 100% deduction basis.

TMR: Do the budget changes suggest Canada is becoming a less viable place to start a mine?

AP: Not at all. Of course, any time you mess around with tax benefits or the deduction rates on capital equipment, it affects cash flows and makes capital investment less attractive. But at the same time, Canada is a pretty safe jurisdiction. And flow-through shares are a terrific way of raising capital that is unique to Canada. On the positive side, the budget extended the investment tax credit for flow-through shares in respect of certain grassroots mining expenses. The combination of federal and provincial tax credits provides powerful incentives. It’s unfortunate that Canada is proposing tweaks in this budget that may make flow-through investment a bit less attractive.

TMR: How would Arie Papernick fix what is happening? Could this be done by legislation?

AP: I think maintaining the benefits of flow-through investment for the Canadian resource market is key. If anything, the government should be going the other way. In certain areas that are more remote, there should be additional tax benefits for investing in these projects. Experts believe the proposed budget changes are trying to align the mining industry with the oil and gas industry, but there are significant differences between the two, and, if anything, the mining space needs more tax incentives to motivate investment.

TMR: Funding for exploration is very difficult right now. What fallout do you see in the market if this dearth of financing persists?

AP: I see a future with a lot fewer mining companies. We’ll see more mergers and acquisitions (M&A) as well as property acquisitions due to interest from Asian and South American companies. You’re also going to see a lot of a junior exploration companies looking for opportunistic property acquisitions. I’m getting a lot of calls from clients on that. Smaller companies that have good balance sheets are looking for opportunities. You’re going to see a lot of combinations of smaller companies to create a new company with more assets. Combining companies is a good reason to restructure and make companies more attractive as investments. In the current market, the capital structure of many junior miners won’t attract institutional investment capital and that has to be fixed.

TMR: Recently we’ve been seeing more royalty companies than we’ve ever seen before especially in the junior side of the precious metals business. What’s your view of royalty companies and which ones do you like?

AP: At Secutor, I specialize in raising private placement financings, providing M&A advice and structuring royalty strategies for issuers that conduct exploration in Canada. As an example, Gold Royalties Corp. (GRO:TSX.V) is a terrific alternative investment vehicle to provide non-dilutive, hard-dollar financings for exploration companies. The company is mainly focusing on both producing and near-production net smelter royalties, with full cycle exposure to exploration royalties on mainly Canadian projects.

Franco-Nevada Corp. (FNV:TSX; FNV:NYSE) is a partner, and that, in my opinion, speaks indirectly to the competencies of Gold Royalties’ current management. I believe the company has also received capital fromCallinan Royalties Corp. (CAA:TSX.V). Gold Royalties has recently received its first payment from Metanor Resources Inc. (MTO:TSX.V) on the Bachelor Lake royalty. The company is clearly carving out a niche for itself in this space.

TMR: Gold Royalties has a portfolio of 10 royalties. Which ones stand out to you?

AP: Right now, Bachelor Lake, which I think was Gold Royalties’ first, is the standout because it’s the only one producing. Eagle Zone, given its 6 million ounce resource, is also of interest. Gold Royalties has multiple royalties on Stillwater Mining Co.’s (SWC:NYSE) Bermuda platinum group metal property in Ontario. I’ve spoken to management many times and Gold Royalties clearly has a healthy long-term time horizon on the portfolio it’s amassing.

TMR: Are we going to see more of these types of companies come to market as this weak price environment for junior miners persists?

AP: We’ve seen a few and we’ve seen a few new ones spin off. Most of the market is concentrated at the higher end. Sandstorm Gold Ltd. (SSL:TSX), Silver Wheaton Corp. (SLW:TSX; SLW:NYSE), Gold Group and Franco-Nevada are chasing larger producing-streaming and royalty transactions. At the lower end, there aren’t a lot of players with experience and a proven track record. This space isn’t going to get very crowded. It takes a lot of skill to understand what you’re buying.

TMR: Which junior mining companies are you most familiar with?

AP: I was recently involved in the financing of a junior mining company called NexGen Energy Ltd., which is a private uranium company that is planning to go public very shortly through a reverse takeover with a shell company called Clermont Capital Inc. (XYZ.P:TSX.V). NexGen’s main property is called Radio, which is adjacent to the Rough Rider deposit that Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) bought from Hathor Exploration for $600 million ($600M). The huge success of Alpha Minerals Inc. (AMW:TSX.V) and Fission Energy Corp. (FIS:TSX.V; FSSIF:OTCQX) at the Patterson Lake South project has attracted a lot of attention on another NexGen property called Rook 1, which is directly northeast of Patterson Lake South.

The market is giving Patterson Lake South over a $150M valuation and there is a massive gravity low coincident with the conductor just as it crosses onto Nexgen’s boundary. Actually, the main discovery hole is about 2 kilometers from the NexGen’ Rook 1 border and NexGen is going to do some physical surveys and drilling later on this year. In addition, NexGen also acquired properties in the Athabasca basin from Mega Uranium.

TMR: When is NexGen going public?

AP: It’s on the exchange’s desk but my best estimate would probably be in the next couple of weeks.

TMR: What junior precious metal miners are you familiar with?

AP: We also follow St Andrew Goldfields Ltd. (SAS:TSX). The company posted net income of $26M in 2012 and gold production was about 95,000 ounces (95 Koz). St Andrew is focused on growth and producing free cash flow. It has a strong balance sheet and is well positioned to take advantage of the current market climate. St Andrew would be a potential acquirer of an attractive junior that has fallen in this current market. The company is targeting similar production at similar costs for 2013, and for 2014 is targeting gold production of 120–130 Koz. The increased production target will be made possible once its Taylor project comes on-line. The company is waiting on results from the initial 15,000-ton bulk sample taken at Taylor, and then will take a second bulk sample at a deeper level to help mitigate risk.

St Andrew also continues to be active in exploration and has been focusing on extending the mine lives of its three producing mines, Holt, Holloway and Hislop. It’s also doing technical work on its Aquarius project to see how this fits into the future growth profile.

TMR: Is St Andrew going to need to do any financings anytime soon?

AP: St Andrew has a very strong balance sheet and it is cash-flow positive. I don’t see any need in the near term but I wouldn’t feel comfortable speaking for management. There’s always the potential that a company like St Andrew would want to take advantage of flow-through shares for exploration work.

TMR: Are there any other junior precious metals mining companies you like?

AP: Another one we chatted about before is Metanor Resources, which is a new producer. Gold Royalties has a royalty on Metanor’s Bachelor Lake property, which produced about 13 Koz from July 2012 to February 2013. It produced 3 Koz in February and its goal is to produce about 5 Koz/month, targeting 50–60 Koz/year.

The mill is running at 96–97% recovery and the mining rate has increased over time. So the Bachelor Lake mine seems to be ramping up quite smoothly and Metanor continues to do exploration work. In January, the company announced some really good intercepts: one was about 30 grams per ton (30 g/t) over 4.5 meters (4.5m); the other was 15 g/t over 14m. So we like this one as well.

TMR: How about one more?

AP: Integra Gold Corp. (ICG:TSX.V) is a non-producer in the Val d’Or area of Quebec. It is exploring its Lamaque property, which features high-grade plugs with really good grade continuity. The company is working on an initial preliminary economic assessment (PEA) that it planned for release this year, so it is carrying out metallurgical testing and environmental studies in preparation for the report. Integra also has continued to hit high-grade intersections including approximately 44 g/t over 2.9m and 173 g/t over 3m at its No. 5 plug, which is a new exploration target that won’t be included in the PEA. The company is planning to drill an additional 5,000m at this target after in-fill drilling in the main zones has been completed.

Integra’s properties are right on the Cadillac Break, so it’s surrounded by lots of mills that aren’t being used or are incredibly underutilized.

The company has been around for a long time and changed its name from Kalahari Resources Inc. about two years ago. It was re-organized with new management. The company has been able to finance itself on a pretty regular basis and has strong key shareholder support.

TMR: What commodities are you most bullish on right now?

AP: The action seems to be focused on uranium. We’re seeing a few successes in that space, namely Fission Energy and Alpha Minerals. Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) is also completing its acquisition of Fission, with Fission spinning out its Patterson Lake South assets into a new publicly traded company. So uranium exploration around the southwest of the Athabasca basin seems to be where the interest is building. There have also been a lot of acquisitions and land deals in the area and the price of uranium has been going in the right direction.

TMR: What’s your outlook for the junior mining equity space over the rest of the year?

AP: It’s still going to be tough. The main problem stems from a few years ago when the major miners overspent on acquisitions and subsequently wrote them off. In the past, the majors were always viewed as the exit strategy for the juniors, and so those exit dreams are being questioned. The other major reason for our weak market is basically flow of funds. Major indices are hitting all-time highs, so a lot of portfolio managers are moving money out of the juniors and into large-cap plays. They’ve been able to chase returns on much bigger non-resource names.

For these reasons, the problems in the resource space are likely to continue for some time. Moreover, resource issuers are highly dependent on financings and the amount of money available is much less than the number of people looking for it. It’s going to take some time and a couple of things will need to happen. A lot of experts believe there are too many public resource companies. A lot of them won’t be able to continue. This will help the survivors get access to the limited available funds.

We’ve seen over the last few months numerous very small financings, sub-$500,000, some even less than $100,000. You can’t further exploration on that kind of a shoestring budget. As such, a lot of resource companies just won’t make it. As I mentioned, there will be a lot of consolidation with a lot of juniors pairing together, people in similar jurisdictions trying to work together to increase their asset base in order to survive.

TMR: Do you have one last piece of advice for investors in this space?

AP: Companies need to have the ability to finance themselves, but if successful, they then need to be able to use the money as wisely as possible and continue to be active and create news. Many of the companies that have cash are so worried about the market that they tend to hoard the cash. Cutting back dramatically on their programs leads to less news, and when there is less news, there’s no reason to buy the stock. That keeps the downward pressure on the share price, and that can put companies into a lousy position when eventually they will need to finance again. Operating a junior resource company is not easy; it is a constant battle. Most do not produce any revenue, so they are just spending. They constantly need sources of funding, and as soon as they get money, they are in a race to produce results to keep the share price attractive, so that further financings don’t totally dilute existing investors. I don’t envy the position of junior resource executive.

TMR: Thank you for your insights, Arie.

Arie Papernick runs the Equity Capital Market’s team at Secutor Capital Management Corp. in Toronto. His team specializes in raising private placement financings, structuring royalty strategies and providing M&A advice for the junior resource sector that conducts exploration in Canada. Papernick brings over 17 years of hands-on capital markets experience to his clients. After completing an honors Bachelor of Commerce degree at McMaster University in Hamilton, Ontario, he started his finance career in Toronto. He completed the Chartered Financial Analyst program in 2000. Papernick has established a successful role for himself among issuers, institutional and high net worth investors.

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1) Brian Sylvester conducted this interview for The Metals Report and provides services to The Metals Reportas an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Metals Report: Gold Royalties Corp., Franco-Nevada Corp, St Andrew Goldfields Ltd. and Fission Energy Corp. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Arie Papernick: I or my family own shares of the following companies mentioned in this interview: NexGen Energy Ltd. I personally or my family am paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Nexgen Energy Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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