Kazakhmys looking vulnerable

IC Tip rating

Risk rating: High

Timescale: Short-term

Shares in Kazakh-based miner Kazakhmys have had a great run over the past year, achieving more than twice the gain of the FTSE 350 Mining index, which itself comfortably outperformed the FTSE 100 index. Indeed, Kazakhmys was the FTSE 100's best-performing constituent over 2009 by quite some margin. However, several factors suggest the share price may run into trouble.

First, there's the copper price. That, like Kazakhmys's share price, has enjoyed a phenomenal recovery. During 2009 its price rose from around $3,000 (£2,000) per tonne to almost $7,000 per tonne. The copper recovery can largely be attributed to China's hugely successful economic stimulus, which stoked demand for the metal for use in wiring, plumbing and construction, but possibly also because it was so cheap.

China's restocking has now largely been completed and the high level of demand seen in early 2009 has waned. In addition, in January China told its banks to raise their reserves, a move interpreted as the first stage of monetary tightening aimed at preventing speculative bubbles in various assets. This tightening has raised concerns that China's demand for resources will cool, prompting fears of a downturn in copper prices. What's more, the prospects for speculators in the developed world to buy copper, which was also a feature of 2009's rally, now look muted.

Second, Kazakhmys's copper production in 2009 fell by 7 per cent to 320,000 tonnes. Many of the group's mines and smelters are old and use outdated technology. This results in operational inefficiencies and shutdowns, which would require heavy capital spending to address. Yet Kazakhmys already two major capital-intensive projects at Bozshakol and Aktogay on which it completed pre-feasibility studies last year.

Now that it has completed a $2.7bn loan facility, Kazakhmys aims to complete the feasibility study on Bozshakol this year, and the project could be in production by 2014. Meanwhile, it is seeking funds for the study on Aktogay. The group has reduced net debt, but management may still seek to extend the repayment schedule of some of the remaining borrowings. This would reduce near-term cash outflows, but could ultimately prove more costly as current borrowings enjoy very low interest rates.

The group suspended operations at four high-cost mines in early 2009, and a recent trading update confirmed that these four will not be brought back into production this year. At Akbastau, the most significant of these, the group is exploring the economics of building a concentrator close to the mine so as to reduce costs.

Kazakhmys also plans a series of mid-sized projects to increase output, but, overall, its copper production is likely to stay flat. For 2010, management targets production of 300,000 tonnes - the same level as last year - but, with lower levels of stockpiled materials, output could end up falling.

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Production costs have fallen significantly, helped by a sharp devaluation of the Kazakh currency, lower input prices and cost-reduction measures. However, managements admits that costs are likely to increase this year because of rising input costs, lower ore grades and domestic inflation of 10 per cent.

Major mining groups ride out commodity cycles by producing a variety of products. Kazakhmys, by contrast, has little diversification. The copper mines produce by-products of gold, silver and zinc, but the dedicated gold operation is small and getting smaller. Production fell from 56,000 ounces in 2008 to just 47,000 ounces in 2009 after one of the three gold mines closed. With the gold grade continuing to decline in the two remaining mature mines, production this year is liable to fall even lower. Kazakhmys is likely to give up the struggle and close both mines next year.