Investment Comment Base metal producers enjoying life

Like all the best things in life, the recent surge in base metals prices may just be a temporary respite from the dark days of 1982/83.

But for the moment at least, a tight nickel supply and a 4.1% increase in world copper consumption is having a dramatic effect on the balance sheets of Canada’s major base metal producers.

After copper and nickel prices doubled on the London Metals Exchange from an average 61 cents (US) and $1.60 per lb in January, 1987, to $1.30 and $3.48 in December, three of Canada’s largest metal producers reported their best results in years.

Rebounding from losses of $15.5 million in 1986, Falconbridge Ltd. (TSE) reported a profit in 1987, before extraordinary items of $29.7 million, or 42 cents per share. When the company’s first quarter results are announced, Falconbridge expects to have pared down its long- term debt to $509 million from $1.4 billion in 1986.

High metal prices spurred Inco Ltd. (TSE), the world’s largest nickel mining company, to its best earnings in five years. Profits increased to $125.2 million(US) from a meagre $200,000 in 1986. Lower unit production costs — 30% below their 1982 peak — have also contributed to Inco’s recovery.

Riding on higher prices and a 50% ownership in the huge Highland Valley Copper operation, Vancouver-based Cominco Ltd. (TSE) cut its long-term debt load to $325 million from $643.9 million last year. Nickel prices

Since many analysts agree that copper and nickel prices, which stood at $1.36 and $9.05 per lb respectively on April 12, will stay close to current levels, the potential exists for an across-the-board improvement in the Inco, Falconbridge, and Cominco balance sheets, writes analyst John Lydall in the April edition of First Marathon Securities Metals and Mining Digest.

However, he notes that high metal prices are not the only reason for the recent upturn in the fortunes of Inco et al.

During the recession period in 1982 and 83 when Inco and Falconbridge shifted into a market- imposed survival mode, key elements of the survival strategy were tight control of operating costs, focus on core businesses, debt reduction and curtailment of capital spending programs.

Since that strategy is still largely in place, high metal prices and low operating costs are a double-edged sword which should enable Falconbridge, Cominco and Inco to report record earnings and discretionary cash flows, said Lydall. Previous cycle

“In most cases, capital spending programs remain relatively small, particularly when compared with the major expansion programs in progress late in the previous cycle,” he said.

“As a result, not only are each of the companies well positioned for a sharp slowdown in economic activity, but also, for the first time in many years, it raises the possibility that the three companies could be essentially debt-free by the 1990s.

With a commitment to cost reduction and higher productivity, Cominco, for example, can expect to be debt-free within 1.3 years, said Lydall.

Under new management, the Vancouver-based producer increased its earnings to $172 million in 1987 compared to a $151.6 million loss in 1986.

With four new mines under construction, estimated cash flow this year is expected to be $330 million, said Lydall.

Based on an average 1988 price of $3.25 per lb for nickel and 90 cents for copper, he predicts that Falconbridge will be debt-free within a year while Inco would take 2.5 years to reach that plateau.

In his report, Lydall notes that higher metal prices have already influenced the share prices of the three companies and he anticipates further increases.

“After all the excitement in the nickel market over the last two months, it is perhaps unnerving to look back and discover that during the first quarter of 1988 (when nickel prices moved from over $3.50 to over $9 per lb), Inco’s share price rose to $29.88 on March 31 from $28.50 on Dec 31, said Lydall. Dominican Republic

It jumped 75 cents last week and is currently trading on the Toronto Stock Exchange at around $32.75, in a 52-week range of $34 and $16.38.

Falconbridge, which has lagged behind Inco because of a dispute with the Dominican Republic, gained more than $1 recently to close at $24.63.

Last November, the Dominican government imposed a 25% export duty on the ferronickel output of Falconbridge subsidiary Falconbridge Dominicana C. por A. Falconbridge has suspended production at the Dominican operation (see front page story) so the dispute has yet to be resolved.

Assuming that nickel remains at $3.25 per lb and copper 90 cents , Falconbridge’s per-share earnings should increase $3.50 in 1988, Inco would be just ahead at $4.50 and Cominco’s earnings per share will be $2.50, he predicts.

“After years of struggling with debt-laden balance sheets, today’s high metals prices could not have come at a better time,” said Lydall.