Orion & patents

There was a question to my previous article on Orion regarding patent expirations and why I think those have been already discounted in the price of the stock. The reason why I think patent cliff is already fully discounted is the fact that this is widely followed stock in Finland and probably by major stockholders around the world. Information about impending loss of patent protection has been in news for a long time know - especially regarding their Parkinson's disease drugs. Market has a habit of discounting all known information to stock price. However, I wanted to take a deeper look and here is what I found out mainly by reading what Orion has published.

According to Orion's Q3 2011 presentation, Entacapone molecule patent expires in November 2012 in EU. It expires a year later in USA (October 2013). This is the key patent for Stalevo, Comtess and Comtan, which are the best selling drugs of the company related to Parkinson's disease. Combined sales of these drugs was 252,7 million euros in 2010. All proprietary drugs for humans based on a molecule patented by Orion are listed in the following table. As you can see, there are not many of them:

Proprietary drugs for humans based on molecule originally patented by Orion

Stalevo enjoys data protection in EU until October 2013. Thus, it will probably take until 2014 that there will be generic competition for Stalevo in EU (this was an estimate in Orion's CMD 2010 presentation). Comtan has data protection in Japan until 2015. Stalevo has not been yet launched there.
It is in Stage III in R&D pipeline. When approved, it should get 6 year exclusivity (my own interpretation).

According to Wikipedia test data exclusivity is as follows:

• United States: 5 Years for new pharmaceutical chemical entities, 3 years for new indications for pharmaceutical drugs, and 12 years for biologic products.
• European Union: 8 Years (+ 2 Years market exclusivity + 1 year for new indication)
• Japan: 6 Years
• China: The government promised a protection period of 6 years for pharmaceutical drugs, when applying for membership to the World Trade Organization (WTO).

[More about what test data exclusivity means: See http://en.wikipedia.org/wiki/Test_data_exclusivity]

When generic drugs enter the market

Once it is possible for generic drugs to enter the market, they won't eat all of Orions profits overnight. Based on what I found from internet, it seems to be common that generics may take 50% of the market share in 12 months and 80% in 24 months. However, after that the decrease will be slow. The most loyal customers are left. Rather than slashing prices, the company behind the branded drug which has lost protection might actually increase the price of the drug rather than enter into price war with the generic alternatives. Whatever they do they are sure to lose revenue compared to time before the patent expiration.

In case of Orion, it will probably take until 2014 before the effect from losing protection in EU and US for some of its key drugs start to show in results. Meanwhile, a lot can happen. They may launch some new drugs or introduce existing drugs to new markets (like Stalevo for Japan). Also, existing sales of other product segments (>50% of the company) can grow.

Worst case scenario

In the event that they would fail in these actions and top line (net sales) would shrink gradually about 290 million euros by 2020 they could lose 70% of their bottom line unless they would adjust R&D and sales etc. costs. This is very unlikely scenario. Even if they would lose all that sales and get nothing offsetting that they would most certainly adjust their fixed costs (R&D, sales, general costs) to soften the impact on bottom line unless they were sure that investments to R&D and sales would pay off later.

Even in the worst case scenario I would expect them to be able to provide 6,5 euros worth of dividends from the company from years 2011-2020 discounted to this date with 5% rate. All this naturally assumes that they maintain the high payout ratio of over 90% of net result. And even if this worst case would happen you would still have a profitable company although that profits would be smaller and dividend yield not what it is now (compared to current stock price).


Looking at Orion's research areas

In the field of proprietary products, Orion's key compteneces are focused on selected areas of central nervous system disorders and critical care. In recent years, also urology and prostate cancer have become strong areas of expertise. I think these are cleverly chosen areas of expertise. They address mainly aging population. The pharmaceutical industry in general should get lift from this and the fact that the population in developing economies get increasingly wealthy leading to increased standard of living and better access to health care.

R&D pipeline of the company has so far produced 8 proprietary drugs four of which are for humans and four for animals. It has in-licensed patented products such as Enanton, Vantas and Kentera. The easyhaler product line is based on generic active substances. The company does R&D collaboration in cancer research.

The therapy areas of research are:

• central nervous system
• oncology (cancer)
• critical care
• inhaled medical products
• generics
• animal health

R&D pipeline

Stage III (i.e. last clinical phase for marketing authorisation):

• Easyhaler combined formulations for asthma and COPD (chronic obstructive pulmonary disease)
• Stalevo for Japanese market (Parkinson's disease)

Stage II:

• Androgen receptor antagonist for advanced prostate cancer (partner: Endo Pharmaceuticals)
• Alpha 2c receptor antagonist for Alzheimer's disease
• Alpha 2c receptor antagonist for Raynaud's phenomenon

Stage I:

• More effective levodopa product for Parkinson's disease
• Dexmedetomidine (non-intravenous) for pain management (partner: Recro Pharma)

Pre-clinical:

• Projects for prostate cancer, neuropathic pain, Parkinson's disease and Alzheimer's disease

Clinical phases typically last as follows according to Orion:

• Phase III (last stage): More than 3 years
• Phase II: 1-3 years
• Phase I (first stage): 1 year

Orion

During the past week I added Orion to our porfolio. It's a Finnish pharmaceuticals and diagnostics company that derives most of its sales from Europe. Orion pays out most of its profits as dividends. From 2011 it is expected to pay dividend which gives approximately 8,5% yield at current stock price (14,27 euros). I continuously screen Finnish companies and currently Orion is top on that list. The reasons for that are:

• Good past growth
• Good margins
• Excellent ROA, ROI and ROE
• High dividend yield
• Moderate valuation (currently P/E 2011 below 10)

Orion has demonstrated steady growth during last years and had net sales of 849,9 EUR million in 2010. Orions return on equity is excellent. It has been over 30% between 2006 and 2010 reaching 40,7% in 2010 after taxes. Most of company´s net sales comes from two segments

• Patent protected "proprietary products" 44%
• Specialty products 35%

As with all other companies in the pharmaceuticals sector expiry of patents is topical for Orion too. The most important Parkinson's drug patents and product protections will expire in 2012-2013. These drugs contributed 252,7 EUR million to the top line in 2010. I believe patent expirations are already discounted in the stock price and explain the low valuations.

Updated Analysis on Talvivaara

Talvivaara Mining Company Plc. (LSE: TALV; Nasdaq OMX Helsinki: TLV1V) has an open-pit Nickel mine in Sotkamo, Finland. The project leverages one of the largest known sulphide nickel resources in Europe. Talvivaara has 1121 million tonnes of mineral resources in ”measured” and ”indicated” categories and additional 429 tonnes in category ”inferred” (no reserves). Mine life is expected to be close to 50 years. Talvivaara uses a process called "bioheapleaching" to extract the metals from ore.

Production at the mine started in October 2008 and production ramp up is still ongoing. The annual production target for 2011 has been cut multiple times and is now iterated to be minimum 16,000 tonnes of Nickel (it was supposed to be 30,000 tonnes). In the Talvivaara capital markets day 2011 (17th of November) the company estimated the 2012 production to be between 25,000 and 30,000 tonnes of Nickel.

At full planned capacity (50,000 tpa of Nickel) the mine will also produce approximately 90,000 tpa of zinc, 15,000 tpa of copper and 1,800 tpa of cobalt. According to Talvivaara CMD 2011 presentation: "All processes and equipment exist for the 50,000t production level, and have been proven to be capable of running at full capacity "

Also uranium can be extracted profitably from the ore as by-product. Talvivaara has already made an agreement with Cameco regarding building a uranium extraction plant and delivering uranium. The current environmental permit is for 30,000 tonne annual capacity and does not cover uranium extraction.

Back in February I published An Analysis of Talvivaara Mining Company which needs to be updated to reflect the recent guidance. Talvivaara is now experiencing serious headwind pushing stock price to all time lows:
• production problems
• environmental problems leading to bad press, investigation by police and public pressure from Minister of Environment (Ville Niinistö – the chairman of the Green party)
• nickel price has been falling significantly since February (from $28000 USD/tonne used in my first analysis to $18000 USD/tonne used in this update)
• overall economic uncertainty

Valuation of Talvivaara Mining Company

For this update I used the following metal prices:
• Nickel $18000 USD / metric tonne
• Copper $7500 USD / metric tonne
• Cobalt $28500 USD / metric tonne
• Zinc EUR 350 / t + USD 268 / t (Nyrstar 1.25Mt streaming agreement)
• Uranium (Yellow Cake) 55 USD/lb (82 EUR/kg)

Treatment charges are estimated as follows:
• Nickel: 3000 USD/t (2012), 2500 USD/t (2013-2014), 2000 USD/t (2015)
• Copper: 25% treatment charge
• Cobalt: 44% treatment charge

EUR/USD = 1,35

Table 1. Value of production (30ktpa Nickel)

*) Streaming contract.

Table 2. Value of production (50ktpa Nickel)

*) Streaming contract.

Table 3. Value of potential uranium production

The following calculation assumes:

• Operational costs for 2012 (and Nickel production level 30ktpa in general): 250 MEUR
• Operational costs for production level 50ktpa of Nickel: 375 MEUR (Assuming basically 90% of OPEX being tied to the level of production)
• Depreciation etc. 2012: 45 MEUR and 50 MEUR from thereof
• Finance costs: 30 MEUR per year
• Corporate tax level 26%
• Talvivaara stock quote in Helsinki 18.11.2011: 2,42 EUR
• Number of Stocks (millions): 250 (2012), 263 (2013-2014), 290 (2015)
• Attributable to owners: 84%
• Uranium extraction begins late 2012 and it takes until end of 2013 to repay Uranium extraction facility construction ”loan” to Cameco. 

Table 4. Estimated profit levels and P/E

Talvivaara stock price appears to already discount the 30,000 tpa production level (est. 2013). Uranium extraction, if permitted by authorities, will have significant impact on bottom line (est. 2014). Further upside comes from operating at full capacity of 50,000tpa (est. 2015; if permitted by authorities) and ”operation overlord” (expansion to 100,000tpa production). Talvivaara states that they have also excellent near-mine exploration potential especially between Kolmisoppi and Kuusilampi deposits.

There is nothing Talvivaara can do about Nickel prices. There is, however, a lot it can do about environmental problems and bad press. If not handled properly these might become blocking points for uranium extraction and ramp up to full capacity (not to mention production expansion / mine area expansion).

***

Full disclosure: Long Talvivaara at the time of writing.

***

Notes:

 

MEUR = million euros

tonne (t) = metric ton = 1000 kilograms

kt = kilotonne = 1000 tonnes

Mt = Megatonne = Million tonnestpa = tonnes per annum

 

Interesting article about rare earth companies

Streetwise Reports interviewed recently John Kaiser the editor of Kaiser Research Online about rare earth companies. He singles out several companies that have a chance to be producing towards end of this decade (2016-2017) by stating: “The world does not need dozens and dozens of these deposits, however, which is why I think the race has already pretty much been wrapped up by companies Quest, Rare Element Resources, Tasman Metals and Avalon Rare Metals..”. He talks about companies with heavy rare earths prospects [Please check my earlier post about rare earths on why some rare earth elements are more rare than others].

 

His estimate is that Tasman’s Norra Karr deposit could take care of Europe’s needs for 50+ years. The problem with Norra Karr is that it “involves a mineral that has never been commercially exploited. So a key milestone is the publication of a preliminary economic assessment based on a bench scale-established metallurgical flow sheet that establishes the recoveries and the associated energy and reagent costs.”

Note that the following companies mentioned in the interview are sponsors of The Critical Metals Report: Commerce Resources, Quest Rare Minerals, Tasman Metals, Rare Element Resources. Note also that John Kaiser stated that he personally and/or his family own shares of the following companies mentioned in this interview: Quest Rare Minerals and Tasman Metals.

 

The author of this blog also owns shares in Tasman Metals at the time of writing (11/11/11). Please also note that investment into exploration stage companies is highly risky.

Exposure to Emerging Markets via an ETF

A while ago I decided to start a new position in Vanguard MSCI Emerging Markets ETF (NYSE: VWO). The fund holds 540 equity components mainly from Asia (55%) and Latin America (21%). There are mostly large cap corporations scattered over great many industries. Banks (18%) are the largest sector, which is typical to emerging markets.

Country exposure: China (16%), South Korea (15%), Brazil (14%), Taiwan (11%), India (7%), South Africa (7%), Russia 6%), Mexico (4%) and a whole bunch of countries at 3% or below. The largest holdings are Petroleo Brasileiro (2,11%+1,75%), Samsung (2,78%),  and Gazprom (2%) at the time of writing.
In my previous post I discussed direct stock holdings vs. owning an ETF. This particular ETF meets my general conditions for a good ETF:

• seems to directly own the stocks as far as I can tell (as opposed to playing with swap-contracts)
• low expense ratio (0,22%; source XTF)
• average ask/bid ratio of just 0,03% (source: XTF)
• XTF ranks the fund in 78th percentile with regards to structural integrity (takes into account many things such as previously mentioned metrics as well as tracking error etc.)

Vanguard is a big player. This one ETF alone has market capitalization of $46,2 billion USD.

ETFs or direct holdings?

Peter Lynch, the legendary money manager, has called excessive diversification as "diworsification". By this he meant that you should not be afraid of putting a lot of eggs into a single basket. However, unless you happen to devote most of your working time to screen potential investments and looking deep into company files, you are probably not going to have enough confidence to do so. And even if you would, you are probably better off if you diversify (distribute your money over lots of quality companies) anyway. Most money managers don't actually beat their benchmark index.

After reading "Random Walk Down Wall Street" I become believer of investing into index funds. However, after trying it out for a couple of years I noticed some drawbacks in passive-index ETF (exchange traded fund) investing:

• Some ETFs do not replicate index by directly owning the stocks. They do this by swap-contracts. So you have got some level of counter-party risk (in case the other bank defaults and can't make good on the contract).
• Most ETFs are expensive (net fees and costs 0,5%-1% per year or more)
• Most ETFs have very big spreads (difference of buy/sell bid)
• This is typically tied to size of fund and daily volume of it.
• You have to trust the company running the fund
• Even if they claim that the assets are separate, I don't trust any banker 100%.
• Taxation of dividends
• Atleast in Finland, there is a difference in directly holding stocks and holding an ETF
• I get a 30% tax break on dividends from Finland and all countries with whom we have a tax contract. Essentially this means paying capital tax on 70% of received dividends.

Therefore, I mostly invest directly into stocks. Typically I pick big corporations that would anyway be well presented in any passive index. I also diversify over several companies in the same business. Lately, I have noticed that there are several big ETFs (>billion dollars of capital) with very low fees (as in 0,1% or less) and low spreads. Those remove some of my concerns.

Generally I think passive-index unleveraged ETFs are good if you can't diversify otherwise. Also, when investing outside your county and developed markets, it is probably a good idea to use ETFs. However, even with ETFs you need to think about diversification (across multiple funds and money management companies). Don't trust any one money management company too much!

Who pays the bill?

A group of 97 prominent Europeans published an open letter to eurozone leaders on Wednesday 12th of October 2011. In the letter they called upon the governments of the Eurozone to agree in principle on the need for a legally binding agreement to: “1) establish a common treasury that can raise funds for the Eurozone as a whole and ensure that member-states adhere to fiscal discipline; 2) reinforce common supervision, regulation and deposit insurance within the Eurozone; and 3) develop a strategy that will produce both economic convergence and growth because the debt problem cannot be solved without growth.”

While this proposal could work long term, it will take ages to negotiate and faces opposition in countries like the one I live in (Finland). That’s why they insist that the European Financial Stability Facility (EFSF) and the European Central Bank (ECB) would guarantee and eventually recapitalize the banking system.

Sounds easy – but is not. Otherwise, the crisis would be over by now - right?. It’s still about who pays the bill (accumulated losses). Not all countries behind EFSF and ECB are easily going to guarantee everybody else. A joint recapitalization of the entire European banking system is not too popular in countries (like Finland) that do not have banks with big pile of soon-to-be-rotten debt.

George Soros, one of the 97 people behind the open letter to eurozone leaders, published an essay “A routemapthrough the eurozone minefield” the following day. He does not believe banks will be recapitalized by banks themselves or by national governments. Instead Soros believes that the only sensible path is for ECB to solve all problems. He goes actually further than the joint letter and claims that EFSF is actually not even needed short term.

Again: If it would be so easy, why it is not being done?

Continued to tune portfolio risk lower

The situation in eurozone seems to be slipping from bad to worse. Thus, the risk of recession and even full panic (think Lehman 2008) seems to be greater than ever before during the eurozone debt crisis.

Therefore, I decided to lower my exposure to basic minerals and oil, which I presume would be hit the hardest if another recession/slowdown would begin. I sold shares in Talvivaara and Chevron. I completely eliminated the position in Noble Corporation, which represents exposure to offshore drilling contractors in our portfolio along with Fred Olsen Energy. I decided to leave Fred Olsen Energy and Statoil untouched as both are not too far from the lows of 2009 (in terms of Norwegian Krone). Thus, the downside with these seemed to be much less than with the ones I sold (Nickel price is still very far away from lows of 2009 and both Noble Corp. and Chevron are still riding high).

I really don't like holding cash, but now it seems like a good time to hold some for the time being..

Europe's debt crisis as seen by 9-year old

Michael Cembalest, the Chief Investment Officer of J.P. Morgan, describes the European debt crisis in a funny but understandable way in the "Eye of the market" letter dated September 6th, 2011.

For the debt crisis in the European Monetary Union as seen by a 9-year old" see page 2 of the letter.

  

"If today’s diorama analysis borders on the absurd, so does maintaining the fiction that accumulation of massive public and private sector claims in Europe can somehow be engineered away."

10 Most Owned Stocks By 'Super Investors'

Dataroma.com tracks investment activities of successful value oriented “super investors” such as Warren Buffett, David Einhorn and Bruce Berkowitz. Here I examine the top 10 most owned stocks by the 49 investors tracked by Dataroma. Microsoft (MSFT) is the most owned stock currently (24 out of 49 investors holding it).

Read the full article at Seeking Alpha:
http://seekingalpha.com/article/291897-10-most-owned-stocks-by-super-investors

Bye bye Nokia (for now)

It's hard to take loss. It's even harder to admit that the reasons why you bought some stock were wrong. Well, after a review of our portfolio and couple of weeks of thinking I decided to let go of Nokia. It's too hard to value right now.

I sincerely hope they will succeed in the chosen path, but I think it is better for me to reallocate our money to some other stocks in our portfolio. I don't like to wait for turnarounds especially when the company is facing incresingly tough competition in mobile phones and loosing market share so fast.

An Analysis Of Supply And Demand For Gold

Please read my article "An Analysis Of Supply And Demand For Gold" from Seeking Alpha:http://seekingalpha.com/article/290559-an-analysis-of-supply-and-demand-for-gold

UPM

UPM, a Finnish pulp and paper company, calls itself "The Biofore Company". I'm not particularly keen on pulp and paper industry as such, but UPM is much more than #1 producer of graphic paper in the world and a leading producer of chemical pulp: it has substantial forest land holdings and it is a significant generator of low emission energy.

UPM owns 43.09% of "Pohjolan Voima" (PVO) which in turn owns 58.39% of "Teollisuuden Voima" (TVO). TVO operates two nuclear plants in Olkiluoto, Finland and is building a third reactor there. They have also secured permit to build a fourth one! In addition to this PVO has a portfolio of hydropower and condensing power plants. UPM also directly owns hydropower and combined heat and power plants (CHP). At the end of 2010, UPM controlled 2959 MW of nominal power generation capacity

UPM owns 900,000 hectares of forest in Finland (1 hectare = 2.47 acres), 7,000 hectares in UK and 76,000 hectares in USA. UPM’s eucalyptus plantation company Forestal Oriental, that is an integral part of the Fray Bentos pulp mill in Uruguay, owns 200,000 hectares of eucalyptus plantations.

One interesting future project within UPM is BTL-biodiesel (BTL = biomass-to-liquid). The raw material used in the production of advanced biofuels would mainly consist of energy wood: logging residues, wood chips, stumps and bark. The company is also investigating bioethanol and bio oil. All of UPM’s biofuels will be based on non-food raw materials.

The operating profit/loss of the company will be determined for a long time by pulp and paper segments (FY2010 +577 million euros and -254 million euros respectively). Energy is the stabilizing segment with significant operating profit (FY2010 +234 MEUR) compared to revenues. Other segments and their operating profit/loss in 2010 were Forest and timber (+181 MEUR), Label (+87 MEUR) and plywood (-18 MEUR).

UPM has P/B of 0.6 and P/E 2011 estimate of 8.2 (data from Valuatum). Yeild might be as high as 6%. However, dividends have fluctuated in recent years and the company is cyclical so profits and dividends might swing wildly.

For me the company is a long term value and asset play. With the very uncertain outlook for world economy, the cyclicals are dangerous plays. However, the prices of cyclical Finnish companies were slashed in recent weeks due to broad sell off and foreign investors fleeing periphery markets such as Finland. It was a good time to start to add to a new position close to home.

A European REE Play

I have been itching for some time to pick up a pure rare earth play and now the ongoing market turmoil has lowered the values of these companies to some extent. Therefore, I decided to put the money I got from selling half of Nautilus Minerals position to a small company called Tasman Metals. It is equally risky play: another lottery ticket if you will.
"Tasman Metals Ltd (TSX.V: TSM; Frankfurt : T61; Pink Sheets : TASXF) is a Canadian mineral exploration and development company focused on Strategic Metals in the European region."

They are pretty one the only ones having a serious prospect in Europe. Currently high tech companies in both Europe and U.S. are getting their REE metals from China. And China is cutting export quotas for REE metals each year. This is why stock prices of pretty much any serious REE play have been skyrocketing for the last year (many raising 500% or more). There might be some serious shortages in the next 5-10 years as it will take a long time to get the mines outside China rolling big time.

Their primary mineral prospect is located in Norra Kärr in Sweden. It contains a large inferred REE Mineral Resource with unique properties. REE content is tilted towards heavy rare earth elements that are more rare than the other rare earths (most mines coming online in the next 5 years will not provide a lot of heavy rare eart metals). It also does not have a lot of radioactive materials. Many potential REE mines do have radioactive materials mixed with REE to the degree that special permits might be required (depending on country).

They are also active in Finland where I live.

Note that Tasman Metals Ltd. is a very high risk investment and like with any investment, you might end up losing a lot of money. The author holds shares of the company (at the time of writing) and is willing to take the risk of potentially losing all of the capital involved. Please read the disclaimer in the rightmost column of the blog.

Tuning portfolio risk lower

I decided to lower risk a little bit in the portfolio in the face of potential market disruption due to U.S debt ceiling.
Sold half of my BYD position (at loss).
Sold gold (at profit) to keep it inside 10% allocation range.
Sold half of Nautilus Minerals position (at profit).

Out of my all positions these I think BYD and Nautilus are most risky. Gold, on the other hand, is there to keep balance and to speculate. Now it was time to offload it a bit. I believe the gold bubble has still room to grow. So many debt problems and US may keep "printing" dollars ("QE3")..

Earlier this year I have been adding to many positions so before this we were about 0% cash. Now at approx. 5% cash. Planning to wait atleast until early August before putting the cash back to work.

Thoughts on stress tests for European banks

Eight of the 90 banks failed the stress tests. 16 came close to failing.Not bad?

Well, the main question is that were the tests tough enough. I have an engineering background and I have long worked with mission critical systems (i.e. systems in which a system-wide failure is not an option). The very basic questions with these type of systems are: What happens if X fails? What happens if X and Y fail simultaneously? And so on..

Therefore, a real stress test for European banking system should include atleast a single failure (i.e. default by one eurozone country). An even better test would take into account multiple failures and the resulting financial panic.

The now conducted stress tests simulated what would happen to bank finances during a recession where growth falls more than 4 percentage points below EU forecasts.

That sounds of a bit soft scenario given the number of countries facing serious debt problems. You got the usual suspects from Europe, but also USA with its debt ceiling talks and then there is Japan..

10 Good Reasons to Consider Microsoft for Your Portfolio

1. Microsoft (NASDAQ: MSFT) is the most widely held stock among the value oriented ’super investors’ tracked by dataroma.com: 24 out of 49 had it in their portfolio last time they disclosed their positions. It was also the most added stock during the first quarter of 2011 among the tracked investors.

2. The market values Microsoft to be worth 224,6 billion USD. This translates to forward P/E of just 9.6 and Price per free cash flow 11.6. For every share worth $26,63, Microsoft has $5.95 of cash. It gives great return on equity at 44.0% and is highly profitable (Profit Margin 31.8%). It is no wonder that value oriented investors are flocking to Microsoft.

3. Microsoft requires little capital investment. In an inflationary environment, it won’t have the problem of replacing assets at much higher prices. On the other hand, as it is low on debt (Debt/Equity 0.22), it won’t suffer from increasing real interest rates in a deflationary environment either.

4. It’s out of favor – even hated by many. Hot stocks in hot industries are carrying a hefty price premium that may vanish. Stocks that are out of favor are more attractive to value investors – especially when the company is making lots of money and has growing product segments to offset declining ones.

The 6 other reasons you can find from my article published exclusively by Seeking Alpha:

http://seekingalpha.com/article/279355-10-good-reasons-to-consider-microsoft-for-your-portfolio

Disclosure: I am long MSFT, NOK.

The future of electric cars is in China

The economist published recently an article in which it presented an estimate that China would be the biggest electric car market in 2020 with annual sales of 1.9-2.5 million vehicles.

"The Chinese government wants to have 500,000 electric cars, lorries and buses on Chinese roads by 2015 and 5m by 2020. It is providing customers with subsidies worth up to 60,000 yuan ($9,250) and other incentives, too. If it carries on doing so, electric cars and plug-in hybrids could account for 7% of new-car sales in China by 2020, says a forthcoming report by the Boston Consulting Group. That would make China the biggest market for electric vehicles, by volume, in the world."

The article also discusses BYD (HK:1211, Pink Sheets: BYDDF, Frankfurt Xetra: BY6) - the company that claims that their e6 electric car has a range of 300km (186 miles), which is about twice that of Nissan’s Leaf.

"BYD is struggling, however, to get its new e6 electric car to market. It was supposed to go on sale in America last year, but was not ready. It is now being tested by taxi fleets in Shenzhen, where BYD is based."

BYD stock price has been declining for a long time now due to not meeting the high expectations after it became public in September 2008 that Billionaire Warren Buffett's Berkshire Hathaway has bought 10% stake in it through MidAmerican. The stock rallied after the announcement, but has been on the decline now for about two years.

Chart courtesy of StockCharts.com

--
The author was long BYD at the time of writing.

Nautilus Minerals revisited

Nautilus Minerals is the first company to commercially explore the ocean floor for copper, gold, silver and zinc deposits. It holds tenement licences and exploration applications in various locations in the western Pacific Ocean and is establishing a pipeline of prospects for development.

On July 14, 2010 I published an article about Nautilus Minerals (TSX/AIM: NUS), an exploration stage company. Since then it has become the most accessed article in my blog. I continue to hold a small position in Nautilus Minerals and have been following their progress in Solwara 1 project. I decided to write an update to the article since there has been significant progress in the pioneering project.

Picture 1. A black smoker of a seafloor massive sulphide system. Copyright © Nautilus Minerals. Used with permission.

Based on information in the company news releases (latest released 14th of June at the time of writing) Solwara 1 project looks to be progressing nicely. However, the project is not yet sanctioned. If that would occur in the first half of 2011, then it is expected that production may commence on site at the Solwara 1 Project in the last quarter 2013.

  

Joint ventures established for mining and for production support vessel

Picture 2. Ownership of Nautilus Minerals and joint ventures established for Solwara 1 project.

Nautilus Minerals has formed a strategic partnership with German shipping company Harren & Partner. A joint venture (“Vessel JV”) will be formed to own and to operate a production support vessel for Solwara 1. Nautilus Minerals needs to pay 32 million euros for their share in vessel JV. Harren and Petromin will cover the rest. The production support vessel will cost 127 million euros.

Picture 3. 3D model of production support vessel. Copyright © Nautilus Minerals. Used with permission.

The Government of Papua New Guinea has exercised its option for 30% stake in Nautilus Minerals Solwara 1 project (“Mining JV”). The government’s share of the JV will be held in Petromin PNG Holdings Ltd (“Petromin”). A payment between 20 and 25 million U.S dollars (USD) will be made by August 2011 pending an audit. The payment covers development and exploration costs until the date of grant of the mining lease (Jan 2011). From January 2011 onwards, Petromin will contribute funds to the project in proportion to its interest. The Government of Papua New Guinea also took 5% position in the holding company for vessel JV and has made an initial deposit of 1.8 million USD for it.

  

Mining equipment

The key components of the envisioned seafloor mineral production system are seafloor production tools, riser and lifting system and production support vessel. Seafloor Production Tools and Riser and Lifting System are scheduled for delivery in early 2013 and will be wholly owned by the Mining JV.

Picture 4. Seafloor production system. Copyright © Nautilus Minerals. Used with permission.

Permits for Solwara 1

• Environmental permit was granted already in 2009
• Mining Lease granted on January 2011 for 20 years.

  

Mineral Resources and Production estimate

43-101 Resource Estimate for Solwara 1 is still 870 kt Indicated (6.8% Cu, 4.8 g/t Au, 23 g/t Ag and 0.4% Zn) and 1300 kt Inferred (7.5% Cu, 7.2 g/t Au, 37 g/t Ag and 0.8% Zn) [1]. Anticipated daily production rate remains at an average of 3710 tonnes (1.3 Mtpa) excluding site initiation and shutdown. This should translate to annual production of 80kt of copper and 150,000 oz of gold. However, at this rate the Solwara 1 deposit won’t last very long (about two years). The beauty in the underwater mining is that the equipment can be easily relocated elsewhere. The company has not stated which deposit would be next in line for mining. The company does have a lot of promising prospects besides Solwara 1 but only Solwara 1 has an officieal 43-101 Resource Estimate at this point. Given the high daily cost for production support vessel and crew contracted for 8 years at $80.000/day, they need to have more deposits to leverage after Solwara 1 is exhausted.

Cost estimates

Total capital cost for Solwara 1 project excluding capital costs of the vessel JV (production support vessel) is now estimated to be 407 million USD according to recent information from the company. The earlier estimate [1] was 383 million USD including 17.5% contingency as well as ore transport barges. Due to changes in ownership, Nautilus Minerals is no longer the only one providing capital to Solwara 1 project.

Nautilus has decided to charter rather than purchase the barges. This increases operating costs. I calculated that operating cost per tonne would increased by 11.2% [the company has not stated this directly!]. Previous info was 70 USD per tonne (including 10% contingency) so my own estimate based on information available is now 78 USD per tonne.

Financial status

At the end of Q1 2011 the company had 139 million USD in cash and cash equivalents. The company stated that this would be sufficient for the next 12 months. On May 24, 2011 Nautilus Minerals Launches Marketed Public Offering to gather about C$150 million, but later (June 10) withdrew the proposed capital raising claiming “weak financial market conditions”.

Given that the company needs to invest still roughly 300 million USD before Solwara 1 is up and running, they will need more cash from somewhere. Looking at the cash balance and expected money inflow and outflow, my guestimate is that they need 210 million USD at minimum by end of 2013. They have committed to certain amount of exploration, they are spending approximately 12 million a year for G&A and so on. These expenses they need to cover on top of any Solwara 1 capital expenses.

At June 14th Nautilus Minerals reported to have 155,6 million common shares and 9,3 million options outstanding (average exercise price for the options being C$2.67). If they would issue shares (let’s say at around C$2.4 a share) to cover the over $200 million gap in financing they need to issue around 90 million shares more. That’s a lot. Whether they will get the money by issuing more shares or lend it, there will be more people and organisations tapping into the future profits.

Economics of Solwara 1

My assumptions:

• Out of estimated indicated mineral deposits 90% are there and can be extracted

• Out of estimated inferred mineral deposits 60% are there and can be extracted

• Yield recovery (from extracted ore taking into assumption supposedly all costs from royalties to PNG, processing, smelting and so on) as stated in the feasibility study [1]: 70% for copper, 59% for gold, 57% for silver and assuming 60% for zinc (no info found).

• Metals prices: Cu $9000/t, Au $1500/oz, Ag $35/oz, Zn $2200/t

• Metals sold at above prices

Using the above assumptions the indicated resources could be valued at 458 million USD and inferred resources at 555 million USD. Thus the total revenue for the project could be 1013 million USD. I say “could” because it is quite unlikely that all the assumptions will hold. For example, the company could enter into a streaming agreement in which they will get a specific sum of money upfront in the exchange of specific metal they will extract. Typically the money that can be got upfront is only a small fraction of what is calculated above. Companies that need capital in order to ramp up operations enter this type of agreements quite often.

Whatever the revenue from Solwara 1 will be, it looks like the most valuable asset there is copper (69% of calculated project value). Gold comes second with 26% of calculated project value. The rest (5%) is then divided between Silver and Zinc.

Given my estimate of 78 USD per tonne for operational costs and 2170 kt (thousand metric tonnes) of ore to extract, they will spend 169 million USD extracting the ore. That leaves 844 million USD for operational profit from Solwara 1. 70% of this, 591 million USD would go to Nautilus. Given all the operational costs and capital costs, it seems quite unlikely that shareholders will see any profit from Solwara 1 (in form of dividends). However, Solwara 1 is a stepping stone into a whole new industry.

If Nautilus Minerals is successful in Solwara 1, there should be plenty of money to be made in the areas the company has claimed. Nautilus Minerals has grants or applications in place for tenements covering approximately 600,000 km2 of prospective territory. The more projects they have after Solwara 1 the more profitable they will be (Solwara 1 pretty much covers all the needed investments for production system). If they fail with Solwara 1 for one reason or another, all bets are off. Being a shareholder, I naturally believe that they have a decent chance of pulling it off.

Note that Nautilus Minerals is a very high risk investment and like with any investment, you might end up losing a lot of money. The author holds shares of Nautilus Minerals (at the time of writing) and is willing to take the risk of potentially losing all of the capital involved. Please read the disclaimer in the rightmost column of the blog.


Source material:

• Company news releases for 2011
• [1] Offshore Production System Definition and Cost Study

Gold as collateral

Last week one news article in particular caught my eye. Francesca Freeman of Dow Jones Newswires reported that European parliamentary committee approved a proposal to allow clearing houses to accept gold as collateral:

“The European Parliaments Committee on Economic and Monetary Affairs Tuesday agreed unanimously to allow clearing houses to accept gold. The proposal, under the European Market Infrastructure Regulation, will be passed to the European Parliament and the Council of the European Union for another round of voting in July.”

Same type of announcements (but with less significance):

• “In October 2009, CME Group Inc. said it would allow physical gold to be used as collateral for margin requirements, a move that was followed by rival IntercontinentalExchange Inc. in late 2010.”
• “In February this year, JP Morgan Chase & Co. announced its decision to accept physical gold as collateral in some financial transactions.”

Also consider this:

“At the same time, many traditional collateral assets, such as European government bonds, have continued to see a deterioration in credit quality as a result of the sovereign-debt crisis.”

Oh, Really? ;-)

For thousands of years, gold has played an important part in monetary systems of the world. Most central banks still have it in their vaults despite the fact that no modern currency is officially transferable to gold with a fixed exchange rate. It used to be so. I’m not expecting that world is going back to gold standard any time soon. However, the importance of gold is clearly rising.

Book Review: Endgame

I finally finished a book published earlier this year titled "Endgame – The End Of The Debt Supercycle And How It Changes Everything" by John Mauldin and Jonathan Tepper.

The first half of the book deals with basics of economics and looks at recent research about sovereign debt problems. Besides some economics 101 they explain the concepts of the debt supercycle, deflation, inflation and hyperinflation. In the second half the authors look at various countries and their specific problems: The United States, The European Periphery ("PIIGS"), Eastern Europe, Japan ("the bug in search of a windshield"), The United Kingdom and Australia.

The authors argue that we are in a balance sheet recession which is the end of the 60-year long debt supercycle. They write: "The recovery time in much of the developed world is going to be measured not in months but in years, perhaps decades for some. It will be a much more volatile economy with more frequent recessions. For some countries, this will be very deflationary; for others, not so much. And for some, the risk of high inflation is very real.”

The full review is available only via Seeking Alpha:
http://seekingalpha.com/article/271521-book-review-endgame-the-end-of-the-debt-supercycle-and-how-it-changes-everything

Our portfolio grows with Statoil

I decided to add Statoil (OSE: STL, NYSE: STO) to our portfolio after following some time the overall decline in the oil-related stocks. A while back I wrote an article about Statoil to Seeking Alpha and the conclusion was that I wasn’t overly excited about the stock, but thought that it is certainly worth to consider Statoil as an oil & gas play.

Chart courtesy of StockCharts.com.


The reason why I finally decided to add Statoil was simply that it was time to grow the portfolio with an additional company from oil and gas sector to complement Chevron (producer), Noble Corporation (drilling rig provider) and Fred Olsen Energy (drilling rig provider). I don’t expect that one can really find bargains in companies of this size. They are all equally fairly priced in the market. It would seem rather stupid to assume anything else. Even more stupid would be to expect that I would be the one spotting a true bargain. Therefore, the main drivers behind the decision were the fact that the company was high in my short list for this sector and the fact Statoil is a Norwegian company. Not quite local (i.e. Finnish), but close.

Statoil is already taxed quite heavily. Therefore, I do not believe that the tax burden will grow from the current level unlike what can happen to companies elsewhere in the world. Given that the state of Norway has majority of the shares it is unlikely that resources would be nationalized. They pretty much already are (given the combination of government ownership and taxation). Despite of this the company offers dividend yield which is among the best in the industry as well as healthy net income. Also, given that most of the production happens near Norway Statoil seems like a very safe play in this sector.

The company is much smaller than Exxon and other giants in terms of market cap and revenue. Therefore, it is easier to get a meaningful growth rate. The gross margin of the company is among the best in the whole industry so the company can afford to invest. They have technical skills to operate in tough environments and have experience in exploiting ever harder-to-find and harder-to-drill pockets of oil and gas. They are also tapping into unconventional oil deposits (tar sands) in Canada as well as shale gas in USA.

As always, I started with as small position as it is meaningful to have given the size of the overall portfolio and the transaction costs related to buying stocks. As I don’t believe in timing the market, I continue to add to existing positions regularly and especially if there is a good buying opportunity (and if I happen to have cash available at the time ;-).

Rocking The EU-boat

The faith of Portugal-bailout by EU is now in the hands of these three Finnish political figures. One of them OKs the rescue package, one of them said NO to all kinds of bailouts (for any country) and one of them isn't quite sure.

Here they are from right to left in terms of political views:

Jyrki Katainen

Jyrki Tapani Katainen (born October 14, 1971) is chairman of the Finnish National Coalition Party (Kokoomus) and the Finance and Deputy Prime Minister of Finland. He wants to bail out Portugal and has been the Finance Minister in charge of previous EU-bailouts. He doesn't like it, but he says that it is the lesser of two evils (the other being another EU/World-wide financial panic).

source: Wikipedia

Timo Soini

Timo Juhani Soini (born May 30, 1962) is a Finnish politician, and co-founder and current leader of the True Finns party. The party combines left-wing economic policies with strongly conservative social values. They are basically against EU and not surprisingly against any EU-level bailouts. Just a few months ago, the party was a rather small player, but is now third biggest party and very close to #1 (Finnish National Coalition Party) and #2 (Social Democratic Party). It will be extremely hard to not to let these guys to next cabinet.

source: Wikipedia.

Jutta Urpilainen

Jutta Pauliina Urpilainen (born 4 August 1975 in Lapua) is the Chairman of the Social Democratic Party of Finland (SDP). She is the joker in the deck. It is basically up to Social Democratic Party whether the EU-bailouts get a green light from Finnish parliament. So far SDP have demanded that investors of Portugal and other EU-countries in trouble will be made partly accoutable. However, it seems that there is no way to re-negotiate the already negotiated EU-bailout packages. Therefore, it remains to be seen what SDP and Urpilainen does.

source: Wikipedia

Jyrki Katainen have been forced to invent an ad-hoc process to get the Portugal bailout approved. The ex-Prime Minister Mari Kiviniemi has said that they won't advance the matter and she will not present anything to Finnish parliament regarding bailouts. Her party lost big time in the election - a lot of their seats in parliament went to True Finns. The position taken by Kiviniemi and Soini puts Jyrki in a tough spot. The solution that he came up is to try to get approval from each party separately. Without the support of Jutta and SDP it looks like he will not get majority behing the package.

What happens if Finland does not support the bailout is unknown.

The Helsingin Sanomat newspaper listed today some pros and cons if Finland rocks the EU-boat big time. The pros include:

• People living in EU and Portugal in particular will remember that Finland is part of EU.
• Finnish citizens have been wining for a long time that why Finland needs to always be the model member of EU. Not anymore.
• EU gets slap in the wrist and reminder that the national parliaments still have a lot of power.

OK. Maybe so, but the list of cons is a long one and at the extreme end of it looms another financial panic. The cost of yet another panic would by likely be much larger than any foreseeable cost of bailouts.

By 13th of May we will know.

I am glad I have put together a fairly defensive portfolio. At the moment I am also letting cash to pile up.

Statoil: The Goose That Lays the Golden Eggs for Norway

Full article at Seeking Alpha: http://bit.ly/h58wfp


Statoil (OSE: STL, NYSE:STO) is an international energy company primarily focused on upstream oil and gas operations. The company is headquartered in Norway and employs over 30,000 people worldwide in 42 countries. The Norwegian state is the largest shareholder in Statoil, with a direct ownership interest of 67%.

Statoil has 40 producing oil and gas fields and is one of the world's largest net sellers of crude oil. It is also the second-largest exporter of gas to Europe. Approximately 80% of oil and gas production of the company comes from Norway. The rest of the operations are scattered throughout the rest of the world.

Strategically, Statoil is positioned as a technology-driven upstream energy company. Currently some 80% of oil and gas production of the company comes from Norway, but in the long run this is likely to change. While the production outlook remains stable towards 2020 in Norway, according to Statoil, it's looking for growth elsewhere in the world.

The Norwegian state benefits immensely from Statoil. It is the largest shareholder in Statoil and also imposes high taxes on the profits (above 70%). Therefore, Statoil is the goose that lays the golden eggs for the state of Norway. Looking at the key figures and the peer review, Statoil is a good choice also for an individual investor. It offers an excellent alternative to US- and UK-based oil giants in a stable region.
I have no position in Statoil.

How High Can Gold Go?

No matter which gold price diagram you look, the price of gold seems to be going upwards. We are above old all time highs. Is it just a huge bubble or is the price justified? I wanted to look further than the customary 10 year charts available. In my previous article about gold, I took a look at 110 years of gold price history. In this article I examine gold price history from 1971 until today in various currencies:

• US Dollar
• Australian Dollar
• Canadian Dollar
• Euro
• UK Pound
• Yen
• Indian Rupees
• South African Rand

The article has been exclusively published via Seeking Alpha so you need to read it from there:
http://seekingalpha.com/article/261185-how-high-can-gold-go

The Intelligent Investor (part I)

I have been reading Benjamin Graham's book "The Intelligent Investor". Some thoughts of the first five chapters of the book that Warren Buffett has stated to be “by far the best book on investing ever written”:


Graham advices you never to have more than 75% of your total funds in stocks (the rest being allocated to bonds). His advice is probably valid for most investors and especially the ones who can’t afford to take significant losses or are in it for the short run (in which case you should not in my opinion be invested into stock market at all). One of the earliest books I read on investing stated “never to invest more money than you can’t afford to loose”. I live by that advice.
In my opinion, to be 100% invested into stock market you should:
• set aside pension etc. related investments that you can’t afford to lose (in Finland this is automatic – I have zero control over my work pension because of how our system works – unfortunately so in my opinion)

• set aside enough cash to cover any foreseeable sudden (unplanned) expense (e.g. broken car/refridgerator etc.). Our buffer is approximately what our family spends in three months. This has proved to cover even multiple large sudden expenses.

• have adequate protection in case of unemployment (in my case, I am guaranteed at least 6 months full pay + 500 days of partial salary – what happens after that is then up to combined income of me and my wife. However, in Finland everyone is guaranteed minimum amount of income for the very basic needs indefinitely)

• be debt free

• preferably own a house / apartment (i.e. limit your monthly payments and diversify your assets - a house is also a very long term investment like stocks should be)

• not be planning to use the money for anything in the foreseeable future


Graham advices you to “have adequate though not excessive diversification”. By this he means between 10-30 stocks. I don’t want to put myself any specific limit, but his advice seems like an excellent starting point. Even 20 stocks or so requires quite much work to select and manage. This I already know. I consider exchange traded index funds (ETF) to be an excellent way to diversify without having the need to do a lot of research.

However, if you have the interest and the time to do research then picking a few large cap stocks from inside an index fund may be a good idea. If you are in it for the long run, then you will save a lot of money. Total expense ratio of an average index fund ranges from 0,3% to 1% annually. On top of that, many ETFs have way larger spreads than most of their holdings. This means you pay additional 0.5-1% or so extra every time you buy or sell.

10 Most Owned Technology Stocks Among 'Super Investors'

Dataroma.com tracks investment activities of successful value oriented “super investors” such as Warren Buffett and Bruce Berkowitz. I wrote an exclusive for Seeking Alpha about top 10 most owned technology stocks by the 49 investors tracked by Dataroma (full article available only via Seeking Alpha – here is only my conclusions).
...

Top 10

Microsoft Corporation
Cisco Systems, Inc.
General Electric Co.
Dell Inc.
3M Co.
Intel Corporation
Hewlett-Packard Company
Texas Instruments Inc.
International Business Machines Corp.
Automatic Data Processing, Inc.
...

It is interesting to see that in many cases insider actions are opposite to those of fund managers. This might be due to the different time period observed or because they simply have different views and investment goals. In most of the cases, insiders are selling. In case of Microsoft, HP (HPQ) and IBM insiders sold $606 million, $59 million and $48 million worth of stocks respectively. At Dell (DELL), insiders bought some $100 million worth of Dell stocks.
...
All things considered, Microsoft and Intel seem to be the most attractive ones out of the examined stocks. Cisco, GE, Dell and HP are also worth considering in my opinion.

Disclosure: I am long MSFT, CSCO, INTC.

Riding The Second Gold Bubble

No matter which gold price diagram you look, the price of gold seems to be going upwards. We are above old all time highs. Is it just a huge bubble or is the price justified?


The price of gold in dollar terms was pretty flat until 1934 when dollar was devalued against gold by 69%. In the previous year Franklin D. Roosevelt declared gold ownership illegal and U.S citizens were required to sell all their gold to Federal Reserve at the official exchange rate $20.67 an ounce. Gold ownership in USA was illegal until 1975.

After the Second World War, a system similar to a Gold Standard was established by the ”Bretton Woods Agreement”. Under this system, many countries fixed their exchange rates relative to the U.S. dollar and U.S. promised to fix the price of gold at approximately $35 per ounce. [Wikipedia]

The system broke down in 1971 when U.S. announced that dollars were no longer convertible to gold. This was the result of France converting its dollar reserves to gold (calling U.S. bluff), fiscal strain of federal government due to expenditures for the Vietnam War and persistent balance of payments deficits. [Wikipedia] After 1971 the price of gold soared due to the reasons stated before and due to high inflation.

The full article with charts of gold price and U.S Dollar purchase power over 110 years is published exclusively via Seeking Alpha.

Book Review: 'Fooling Some of the People All of the Time: A Long Short (And Now Complete) Story'

“Fooling Some of the People All of the Time: A Long Short Story” by David Einhorn, the President and founder of Greenlight Capital was published before credit crisis of 2008. The update to the book titled “Fooling Some of the People All of the Time: A Long Short (And Now Complete) Story” was recently published. The original book has been updated with new epilogue that concludes the story about Allied Capital.


The name of the book describes the content very well. Apart from the first four chapters that introduce readers to Mr. Einhorn and to the history of Greenlight Capital the book is a long story about selling short Allied Capital and trying to get others to see the same problems that Einhorn and a few others saw in it.

As foreseen by the writer already in the introduction chapter, I did say to myself before even reaching the midpoint of the book: “Enough! I get it already! You have made your point!” Apparently regulators, media and government officials are much harder to convince. And that is why the book is so long and why the title also says “fooling some of the people all of the time”.

Einhorn claimed already in 2002 in public that Allied Capital was using questionable accounting practices to prop itself up. In 2008, he made similar claims about Lehman Brothers and shorted it too.

...

Read the full arcticle from Seeking Alpha:
http://seekingalpha.com/article/256575-book-review-fooling-some-of-the-people-all-of-the-time-a-long-short-and-now-complete-story

Buffett's 2010 letter

Warren Buffett's annual letter to the shareholders of Berkshire Hathaway is absolutely a must read for every value investor. In addition to discussing Bershire's business, holdings and investments in detail Buffett gives his opinion on market uncertainty ("tomorrow is always uncertain") and US economy in the long run. He also explains his management style ("hire well, manage little").

A section titled "Life and Debt" discusses using leverage (debt). It's no news that Buffett isn't keen on companies that have a lot of debt. He shares a letter that was sent by Buffett's grandfather Ernest to Buffett's uncle Fred. The letter talks about importance of keeping some cash for unexpected events (i.e. an emergency fund). Buffet keeps $20 billion and stated that they will always keep minimum of $10 billion as cash or equivalents (US treasury bills). Hurricane "Katrina" cost Berkshire $3 billion. However, the cash is also there in case of sudden panics in the market. Buffett invested $15.6 billion in the 25 days following Lehman bankruptcy in 2008.

In the end Buffett shares his biennial letter to CEOs of Berkshire subsidiaries. He states how important reputation and good business practises are. Then he asks his managers to tell him who is their primary candidate for succession at their company in case something happens to them. That's it.

Impressive.

An Analysis of Talvivaara Mining Company

Executive summary

Talvivaara Mining Company Plc. (LSE: TALV; Nasdaq OMX Helsinki: TLV) has an open-pit Nickel mine in Sotkamo, Finland. The project leverages one of the largest known sulphide nickel resources in Europe. Production at the mine started in October 2008 and production ramp up is still ongoing. The planned annual nickel production is 50,000 tonnes. As by-products the mine will also produce approximately 90,000 tpa of zinc, 15,000 tpa of copper and 1,800 tpa of cobalt. Also uranium can be extracted profitably from the ore if Finnish state gives OK for this. Talvivaara uses a process called "bioheapleaching" to extract the metals from ore.

Talvivaara has 1121 million tonnes of mineral resources in ”measured” and ”indicated” categories and additional 429 tonnes in category ”inferred” (no reserves). Mine life is expected to be close to 50 years. This analysis concludes that Talvivaara, once in full production, should have revenues at close to 1,2 billion euros (at current metal prices). Possible uranium extraction, end of Zinc streaming agreement and near mine exploration will be increasing the revenues and the result in the long term.

Given the current stock price of 6,6 euros (Helsinki stock exchange), to me it seems that market values Talvivaara at P/E 9,5-11,8 against intermediate 30ktpa Nickel production (target 2011, but there are concerns to that end). However, given full capacity of 50ktpa Talvivaara is undervalued at current metal prices at P/E below 4.

I personally like Talvivaara because it is a local (Finnish) project, has long expected mine life and to me looks like attractively valued when taken into account the full production targets.


Introduction

Talvivaara Mining Company Plc. (LSE: TALV; Nasdaq OMX Helsinki: TLV) has an open-pit Nickel mine in Sotkamo, Finland. The Talvivaara polymetallic deposits, Kuusilampi and Kolmisoppi, comprise one of the largest known sulphide nickel resources in Europe.

Production at the mine started in October 2008 and production ramp up is still ongoing. The target for year 2011 is to produce 30,000-35,000 tonnes of nickel. However, since they could not sustain 30,000 tpa production rate in 2010 than only for a while, the target seems to be tough to say the least.

The planned annual nickel production of 50,000 tonnes is anticipated to be reached in 2012, but let’s see first what happens in 2011. At any rate, I will be analysing the company with the full production rates in mind. It may happen 2012 or then get delayed. To me it does not matter as it does not fundamentally change the outcome of the analysis.

Picture 1. A Chunk of Nickel. Source: Wikimedia Commons.

As by-products the mine will also produce (at full production) approximately 90,000 tpa of zinc, 15,000 tpa of copper and 1,800 tpa of cobalt. Also uranium can be extracted profitably from the ore if Finnish state gives OK for this. Talvivaara use a process called "bioheapleaching" to extract the metals from ore.

Talvivaara has launched ”Operation Overlord” to study and implement expansion beyond 50,000 tpa Nickel production. Scoping study is scheduled for 2011 and production ramp up target is 2015. Talvivaara states that they have also excellent near-mine exploration potential especially between Kolmisoppi and Kuusilampi deposits.

Mineral Resources

Talvivaara has 1121 million tonnes of mineral resources in ”measured” and ”indicated” categories and additional 429 tonnes in category ”inferred”. Resources in the lowest category (”inferred”) have more uncertainities regarding tonnage and grade compared to highest category (”measured”).

Table 1. Mineral Resources.

Talvivaara does not have Mineral reserves (either ”proven” or ”probable”) yet. The reason for this is unknown to me, but according to the Australasian Code for Mineral Resources and Ore Reserves or ”JORC code” that Talvivaara have used as basis of its resource statement it requires not only geological facts, but also ”Consideration of mining, metallurgical, economic, marketing, legal, environmental, social and governmental factors” to upgrade ”measured” resources to ”proven” and ”indicated” resources to ”probable”.

Picture 2. The relationship between mineral resources and Ore Reserves as described in the JORC code (2004 Edition).

Chris Morrissey, a former chief geologist of the Rio Tinto Group, explains the ins and outs of resource/reserve statements in the arcticle titled ”In the opinion of a Competent Person” published Rio Tinto Review magazine, issue 80: ”With some deposits there is so much natural variability, for instance in grade and shape, that the high levels of confidence needed for proved reserves are impossible to achieve. Nuggety gold veins are an example of that, as are diamond deposits in which much of the value comes from stones of exceptional size and quality which are so rare that no amount of sampling can safely indicate how often they will be mined."

"Reserves are the highest form of mineral asset a mining company can have. They are not as good as money in the bank, but they can be given a monetary value in the company’s balance sheet. They are normally replenished from resources attributed to the same operation, by building up positive information on the largely non geological matters listed. Technical and economic matters are only part of it; reputational considerations are very important too, as well as questions of title and ownership. It is a two way street, meaning that reserves can be “demoted” if crucial information proves faulty or turns negative.”

Calculating from the resource statement one can get the amount of each metal Talvivaara assumes to be in the ground. The calculation assumes 100% accuracy in the statements 100% recovery of each metal.

Table 2. Amounts of metals in the ground.

I have seen statements of mine life varying from 46 years to 60 years. If calculating from the above table, one gets 52 years and 69 years for mine life assuming 100% accuracy/100% recovery for M+I and total resources respectively. Clearly, Talvivaara does not assume 100% recovery so their statements regarding mine life are less than the ”ideal” calculation suggests. In any case, 50 years or so is eternity in the modern investment world.

Metal Prices

In my analysis, I use the following metal prices (USD / metric tonne):

Metal: 5 Year Lows: Current Price level

Nickel $10000 $28000

Copper $3000 $9750

Cobalt $30000 $42000

”Base case” will later indicate ”Average of Current price and 5 year lows” for these metals.

EUR/USD = 1,35

Zinc* $472.5/t

Uranium (Yellow Cake) 50 USD/lb (82 EUR/kg)

*) The Zinc price reflects the 1.25 Mt streaming agreement that will be in place for the next 14-17 years depending on production ramp up (i.e. when 90 ktpa capacity is reached). According to the agreement there will be 350 EUR/t fee and 335 million USD pre-payment against the first 1.25 million tonnes of Zinc from Talvivaara.

Below you can see 5 year price level in the London Metal Exchange for each metal courtecy of metalprices.com.

LME Nickel Prices 5 Years

LME Zinc Prices 5 Years

LME Copper Prices 5 Years

LME Cobalt Prices 5 Years

Value of Talvivaara production

Assumptions: Copper 75% net smelter return. Cobalt 59% net smelter return.

Production level 30 ktpa Nickel (2011)

Table 3. Value of production (30ktpa Nickel)

*) Streaming contract.

Production level 50 ktpa Nickel (2012)

Table 4. Value of production (50ktpa Nickel)

*) Streaming contract.

Potential additional profit

Uranium

Table 4. Value of potential uranium production

Zinc

Table 5. Additional profit from Zinc production once the streaming contract ends.

Valuation of Talvivaara Mining Company

The following calculation assumes:

• Operational costs 2011: 245 MEUR, 2012: 270 MEUR
• Depreciation etc. 2011: 60 MEUR, 2012: 64 MEUR
• Capital expences 2011: 80 MEUR, 2012: 30 MEUR
• Finance costs: 30 MEUR/a
• Corporate tax level 26%
• Talvivaara stock quote in Helsinki 25.2.2011: 6,6 EUR
• Stocks (fully diluted): 263,669,291
• Attributable to owners: uses same ratio as used in 2010 annual P&L calculation

Table 7. Estimated profit level for 30ktpa (2011) and full capacity (2012).

Talvivaara stock appears to be cheap if compared to what it is capable of producing at full capacity at current price levels of Nickel and other metals. On the other hand, it does not appear to be that cheap compared to 2011 production target given that it may be hard for Talvivaara to reach the announced 30-35 ktpa capacity this year. If it does achieve this and it seems that 50 ktpa production target is feasible and probable, then the stock is likely to soar as P/E 2012 under 4 is very low indeed. Even in the case of lower metal prices (assuming ”base case”) the P/E is below 7.

Another way to value Talvivaara is to look at statements it is has made regarding net cash cost of Nickel. Talvivaara states that they expect net cash cost of Nickel to be 2.3 EUR/lb in 2011 and 1.6 EUR/lb in 2012. ”Net cash cost” means in this case ”net of by-product credits”. That is, all other metals are sold to lower the production cost of Nickel. Using these the Net cash cost of production for 2011 is 152 MEUR (30ktpa) and 176 MEUR (50ktpa) for 2012.

 Table 8. Estimated profit level for 30ktpa (2011) and full capacity (2012-2013).

In the long term the following factors drive revenue and the result upwards:

• Increase inmetal prices (speculative)
• Possible increase of production capacity beyond 50ktpa (Operation Overlord)
• Zinc production valued at market price (takes 14-17 years)
• Increase of mineral resources via near mine exploration
• As emerging major player in Finnish mining scene, Talvivaara is well positioned to aquire projects from junior mining companies.

I personally like Talvivaara because it is a local (Finnish) project, has long expected mine life and to me looks like attractively valued when taken into account the full production targets.

Full disclosure: Long Talvivaara at the time of writing.

***

Source material used in the analysis:

• http://www.talvivaara.com/about-us/key-facts
• http://www.talvivaara.com/operations/Talvivaara_operations
• http://www.talvivaara.com/operations/Talvivaara_operations/Mineral_resources
• http://www.talvivaara.com/operations/Talvivaara_operations/Exploration_and_Development
• http://www.talvivaara.com/operations/technology/advantages-of-bioheapleaching
• http://www.talvivaara.com/files/talvivaara/CMD_%20_%20others/CMD_package_2010_FINAL.pdf

Notes:

JORC refers to ”The Joint Ore Reserves Committee of The Australasian Institute of Mining and Metallurgy, Australian Institute of Geoscientists and Minerals Council of Australia”.

Tonne = metric ton = 1000 kilograms
kt = kilotonne = 1000 tonnes
Mt = Megatonne = Million tonnes
tpa = Tonnes per annual

ktpa = 1000 Tonnes per annual