Iron ore prices in China are surging on expectations that the government will once again open the easy-money credit spigots in an effort to stabilize flagging economic growth.
I don't think this is a good idea for China's long-term economic health, but that's neither here nor there. In this case, what would be bad for China's financial future is good for Canadian investors in the mining sector.
A potential resurgence of China's "build it whether we need it or not" economic growth strategy would be a huge boost to the beleaguered global mining sector. So, I screened all members of the S&P/TSX Global Mining Index for stocks trading at a discount to their five-year average price-to-cash flow ratios.
As an added bonus, mining companies with large short positions were also highlighted. If Chinese commodity demand recovers to previous levels, it is entirely likely that investors who have shorted the stock will be forced to scramble and cover, providing further upside pressure on the stocks.
The table below shows the results of the screen, ranked in order of largest price-to-cash flow discount relative to the five-year average.
|Current P/CF||% discount to 5Y Ave PCF||Short Interest % of Float|
|Centerra Gold Inc||CG||2.52||75%||0.6%|
|Major Drilling Group Intl||MDI||4.09||71%||3.3%|
|Silvercorp Metals Inc||SVM||4.30||68%||0.5%|
|First Majestic Silver Corp||FR||9.28||60%||9.5%|
|Eldorado Gold Corp||ELD||12.34||48%||1.7%|
|Kinross Gold Corp||K||6.74||38%||2.0%|
|Teck Resources Ltd-Cls B||TCK.B||4.81||34%||2.1%|
|Peabody Energy Corp||BTU||6.04||32%||8.3%|
|Coeur Mining Inc||CDE||8.01||32%||4.1%|
|Silver Wheaton Corp||SLW||16.70||29%||1.9%|
|Southern Copper Corp||SCCO||13.21||28%||6.1%|
|Royal Gold Inc||RGLD||22.94||27%||6.2%|
|Fortuna Silver Mines Inc||FVI||11.37||23%||0.3%|
|Natural Resource Partners Lp||NRP||6.22||22%||1.8%|
|First Quantum Minerals Ltd||FM||13.17||20%||2.1%|
|Alamos Gold Inc||AGI||14.69||15%||0.7%|
|Compass Minerals Internation||CMP||11.57||14%||2.0%|
|New Gold Inc||NGD||15.53||13%||7.9%|
|Newmont Mining Corp||NEM||7.57||12%||3.4%|
|Alpha Natural Resources Inc||ANR||8.61||5%||22.7%|
|Hudbay Minerals Inc||HBM||10.30||4%||3.3%|
|Alliance Resource Partners||ARLP||4.41||4%||2.1%|
|Stillwater Mining Co||SWC||11.75||4%||16.3%|
A couple of housekeeping notes are necessary. A lot of companies had to be kicked out of the analysis because they did not generate positive cash flow in each of the past five years, and had no historical average to compare with current levels.
Also, the gold miners are still on the table for reference, but unlike copper, coal and iron ore, there's no guarantee that increased infrastructure development in China will result in higher gold demand.
The companies that jump out from the screen are Peabody Energy Corp., Southern Copper Corp (full disclosure: I am personally long a Southern Copper debt issue), Alpha Natural Resources Inc., and Stillwater Mining Co.
Coal producer Peabody is the cheapest on cash flow. The current price-to-cash flow ratio of six times represents a 33 per cent discount to the five-year average. In addition, there is a huge short position on the stock at 8.3 per cent of the float.
Southern Copper is not as attractive on valuations but the current 13 times trailing cash flow is still a 28 per cent discount to the five-year average. The short interest stands at 6.1 per cent of the float.
Coal producer Alpha Natural Resources and platinum and palladium miner Stillwater Mining Co. look very much like high-risk propositions. The valuation discount is small and the short interest is huge at 23 per cent and 16 per cent of the float respectively. Investors can't assume that all of the shorts are misguided.
Stock screens are only useful to a certain point and investors must complete fundamental research before buying any of these stocks. Some may be cheap, and widely shorted for a reason.
It's also the case that the investment success of any of these ideas is based on expectations of renewed fiscal stimulus in China – which might not happen.
Follow Scott Barlow on Twitter at @SBarlow_ROB.
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