4 winning resources small caps (and what it takes to make them)

A pinch of proven management, a dash of project location and a teaspoon of great assets are just three of the essential elements that go towards making a successful resources small-cap company. But there are others, and seldom has it been more timely to dig into the sector and find out what they are. 

After all, resources have been on a tear recently. Consider two of the firms mentioned in the last episode of Buy Hold Sell. Pilbara Minerals (ASX: PLS) has risen 464% in the past year, while Aeris Resources (ASX: AIS) has jumped 167%.

But then this cyclical and capital-intensive sector is also prone to dramatic peaks and troughs. For this reason, it's important for investors to be able to recognise the signposts, macro and micro, that signal just where we are in the cycle.

In this thematic episode of Buy Hold Sell, Livewire's Ally Selby is joined by two small-cap resources specialists, Eley Griffiths Group's Tim Serjeant and Argonaut's David Franklyn who share their insights into when to buy, and the ideal combination of ingredients that make a resource company successful enough to reward your investment.

Note: This episode was filmed on Wednesday, 27 October 2021. You can watch, listen or read an edited transcript below.

Edited Transcript

Ally Selby: Hello, and welcome to this thematic episode of Livewire's Buy Hold Sell. I'm your host, Ally Selby. And today we're joined by two small-cap resources specialists for their insight into digging up undiscovered gems. It's certainly an exciting time to be investing in the sector. We've seen the share prices of names such as Pilbara Minerals, Lynas Rare Earths and Liontown really take off.

But how do you invest in these undiscovered winners before they become household names? Well to figure that out, we're joined by Tim Serjeant from Eley Griffiths Group and David Franklyn from Argonaut. David I'm might start on you. What are the three essential ingredients of successful small caps in this sector?

David Franklyn: Thanks Ally. The first ingredient is strong and proven management teams. They're more likely to execute the development and production plans effectively and the market will rate them at a higher level and, finally, it's easier for them to raise money. 

The second ingredient is project location. It's important that they operate in a country that has stable political situations, established mining codes and consistent royalty and tax structures. And then thirdly great projects drive great companies. 

So we're looking for good quality assets, high grade, low OpEx, low CapEx and long mine lives.

Ally Selby: Over to you, Tim. What are your three essential ingredients when investing in this sector?

Tim Serjeant: Thanks Ally. I agree wholeheartedly with David. Number one is management. It's a cyclical and capital-intensive industry. Capital allocation decisions at the right point in time of the cycle are absolutely paramount. So entrusting the right people to do that is critical. 

The second one is I think you need to be growing volumes and doing it in a sustainable manner.

Mining is a fixed-cost business and invariably cost will creep higher and you're also dealing with a finite life resource in itself. Typically, you mine the best stuff first. If you're not growing volumes down the track, trouble tends not to be far away. 

And I think the third point is companies that explore, exploration is the most capital-efficient way of growing your business, whether it's through increasing reserve and resource that translates to increased mine life. And you're also leveraging off the existing capital that you've sunk. So I think companies that explore are certainly valuable.

Ally Selby: This is definitely a time and resources heavy industry, Tim, what are some of the signals that investors can look out for to know when to buy?

Tim Serjeant: I'll start with the macro because I think that's paramount and that's probably three quarters of getting things right.

Understanding the commodity - where you are in that cycle - is of paramount importance. 

And the one thing I'd say on that is the market tends to underestimate the peaks and the troughs. So things can go a lot further down as they can go a lot further up than you think. And we're seeing that at the moment.

I think, secondly, there are also transactions, or signposts I like to call them, that mark the beginning or the end of the cycle. And I think recently (Pilbara) buying the assets off the receivers at Altura was a really good signpost that the lithium cycle was turning.

 In terms of the micro drivers, there's two that I rely on.

One is looking at the grade profile because that's the one thing about an asset you can't change is the grade. And of particular importance is the trajectory. You want to see it going up because that's your best lead indicator on production and costs. 
And the second one is I like to find companies where they've identified or undertaken an acquisition for a second operation or they've developed one organically.

That typically leads to a diversification of cash flows. It leads to better decisions. You're not pushing an asset. The first asset is hard. You can step back and think about the bigger picture. And it tends to mark a turning point, I think for companies.

Ally Selby: David, over to you, particularly in the smaller emerging company area of this sector, what are the signal that investors can look out for to know when to buy?

David Franklyn: We take what we describe as a top-down meets bottom-up type of approach. 

So what we are looking for is commodities that have resilient growth profiles, and then we look for the best quality companies that are exposed to that commodity. I think that's pretty important.

The second is to look for catalysts. If a company is about to move into production, that's likely to lead to an adjustment in the risk profile that might have been applied during that development phase. 

We're also looking for any changes in management, good or bad, you know we've seen a couple of companies recently, Genesis and Breaker where you've had good appointments driving the price higher.

Asset purchases and asset sales. We've seen Sandfire recently make an acquisition that's really transformed their business. And then, finally, just results: quarterly results. Often the market can over or under-react and that could create some opportunities.

Ally Selby: There's also been this explosion in battery material, explorers and producers over the past 18 months. How big is this opportunity? And does it still have legs?

David Franklyn: We see the energy transition thematic, as you know we're in the early stages of a multi-decade opportunity. 

That's going to see the decarbonization of the power generation sector, the electrification of the transport sector. And it's happened quickly. It's in the mainstream now, 12 months ago, people weren't really focused on it whereas now they are.

We're seeing a lot of statistics and a lot of reporting and everyone's slightly different but the trend is the same, demand is increasing. 

Ally Selby: Tim, over to you. Do you feel like this sector still has legs?

Tim Serjeant: I think it depends certainly on your time horizon Ally, but absolutely. If you sort of step back and look at where we are, just from penetration of some of those EV related metals, lithium, copper, rare earth, et cetera, where we are in terms of their penetration of that thematic. 

And if I look at lithium, that's probably the most penetrated at maybe 20% of lithium case uses, but it's in an industry that's sort of 500,000 tonnes. That's growing 20% to 30% compound.

Copper and nickel (are) much bigger, slower-moving industries. But their penetration's only sort of 5% of EV related uses and rare earth is probably somewhere in between. 

I think just on the penetration story alone, there's 70, 80, 90%, much further they can compound through time. I think that talks to the multi-decade opportunity that David was referencing earlier.

Ally Selby: We're talking here about copper, nickel, lithium and rare earth. Is there a different commodity that you think investors should be paying attention to?

Tim Serjeant: Well, there's certainly one at the moment where certainly my views changed and the markets have changed and that's uranium. 

It's got a lot of traction of late and I think what's changed is if you look back a couple of years, a lot of people positioned in uranium for the supply side, what was happening with the likes of [inaudible 00:08:06] Proman Cameco sort of pulling their heads in and managing the market so to speak.

But the thing with uranium that always sort of confounded me was that the demand outlook was actually very tepid.

And whilst it was going to be a supplier aside response on the demand side what we're really going to see - and that's really, I guess, accentuated that, but what's transitioned in the last six or nine months is a couple of important developments.

One firstly is the institutionalisation of the sector. We've seen financial players emerge with their spot vehicles the most high-profile, but there have been others prior to yellowcake and there's a couple of other hedge funds. 

And because they had a problem themselves of even in a vehicle now buying physical uranium. So I think that's changed it and that's certainly put it on the radar.

The second thing is, and we've touched on it is the global decarbonization story. And I guess the widening attention and the role that uranium could potentially play in that. 

And we're seeing countries like Japan and possibly even Germany sort of seeking to potentially unbend their hawkish view on nuclear.

Ally Selby: David, over to you, is there a different commodity that you think investors should be paying attention to? Is it uranium like Tim mentioned there?

David Franklyn: I would comment on uranium as well. I think what's really fascinating is again, as Tim alluded to, I think where the market was even a few months ago was there's probably a shortage in delivering the amount of uranium required from the existing producer base globally.

Whereas now I think people are saying, "Well, can nuclear power become a bigger part of the global energy generation mix?" And I think the answer is probably yes. And the question is by how much? And I think that's encouraged those financial buyers to come into the market, which is putting pressure on price. 

I think how uranium is perceived publicly will be really fascinating, but there is an opportunity there and it's probably the one commodity that could really build market share in power generation globally.

Ally Selby: Okay. David, I'm really excited for this. We asked you to bring along two stocks that are really exciting you in the small-cap resources sector, what have you brought for us today?

David Franklyn: Thanks, Ally. The first one is in Centaurus Metals (ASX:CTM). It's developing a nickel sulphide project in Brazil. It's aiming to be in production by 2024 producing 20,000 tonnes per annum, it's obviously very well timed with the nickel sulphide market required for batteries. What really appeals to its a low carbon intensity project.

Its easy processing has a low carbon footprint and its long mine life. So 13 years, the resource is close to the surface and CapEx is manageable at about $400 million. 

The second one is Sandfire Resources, (ASX: SFR) which has been a bit unloved really over the last year as DeGrussa Copper Mine moves to completion over the next year. What they've announced more recently is the acquisition of the MATSA mining complex in Spain for just under 1.9 billion U.S. And that's going to deliver an asset that's producing between 100,000-120,000 tonnes per annum for 10 years. So, a lot of operating costs. So it's going to push it into a higher as a major Australian copper producer.

The transaction was well-timed. They're also developing a 50,000 to 60,000 tonnes per annum project in Botswana. Within a couple of years, they could be producing over 150,000 tonnes of copper at a low cost. And with their current market cap of only 2.4 billion there's good scope for re-rating.

Ally Selby: Okay, Tim, your time in the hot seat. What are the two most exciting, small-cap resources or material stocks in your view right now and why?

Tim Serjeant: I've gone a bit off-piste, Ally, from the themes we've been talking about, but leveraging off the first question and that's backing improvement management teams with a track record. So I've got two gold stocks for you today.

The first one is Capricorn Metals. (ASX: CMM). They're a gold producer. They produce about 120,000 ounces or so at the Karlawinda Gold Mine up in iron ore country near Newman. 

But why I like Capricorn specifically is the management team led by Mark Clark and proven through time that highly backable team that were Regis resources in a previous decade. 

Prior to that they were Equigold and even going back there's a lot of them have related to the Samantha Gold day. So, you know unrivalled I'd suggest, management team in that space.

But the other point too, is they just acquired a second asset. And I mentioned earlier about sort of looking for turning points, and I think this is one, the Mt Gibson asset they've purchased for about $40 million. 

I think it's a carbon copy of Karlawinda in three years time. And if I'm right, that'll see them producing closer to 250,000 ounces production per annum, all in Western Australia. And I think there's more for them to do.

So Capricorn is a stock I'm really excited about at the moment. And the second one is Genesis Minerals (ASX: GMD) and Dave referenced it earlier. 

And I think it's Capricorn probably three or four years ago. And what's transpired there is Raleigh Finlayson has joined as managing director and he was the MD and the sort of the major architect, I guess, of Saracen over the last seven or eight years prior to its merger with Northern Star in the last 12 months. 

Raleigh stepping in as MD and a major shareholder.

Genesis is a gold exploration/development play, but their assets are where it's right between where Saracen's were in and around Leonora, so really sticking to what he knows and I'm excited because we were fortunate to be on the Saracen journey for much of it. 

And it's good to be back at the start again, hopefully emulating some of that success would be great.

Ally Selby: Well, that was four spicy small-cap resources and material stocks. We hope you enjoyed this somatic episode of Buy Hold Sell. If you did, why not give it a like and subscribe to our YouTube channel. We're adding new content every week.

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