BlackRock World Mining boosts income

"Recently the trust's shareholders have been insulated to a certain extent from the poor performance of the mining sector by a significant narrowing of the fund's discount, which now stands at 3.76 per cent," add analysts at Winterflood.

This is partly due to the trust's dividend increasing over recent years so that the yield is 4.52 per cent. The trust increased its dividend considerably in 2012 (read our tip on this), and maintaining a good level of payout remains a focus.

Although there was a reduction in special dividends paid by the sector in 2012, this was compensated for by growth in ordinary dividends and coupons from fixed income securities. The trust holds resource company debt, mostly convertible bonds. Because debt is cheap at the moment it can get a better rate on bonds than it pays for debt. "The arbitrage opportunity creates a huge income boost," says Evy Hambro, manager of the trust.

About half the trust's income comes from ordinary dividends, which Mr Hambro says are on the rise, but it has also boosted its income by investing in royalties. This is where in exchange for putting money into a company the trust, for example, receives a percentage of the revenue from the company's mine over its life. The trust holds three royalties, though can invest up to 20 per cent of its portfolio in these and is looking to increase exposure.

It entered into its first royalty agreement in 2012 with London Mining (LOND). For a consideration of $110m, the trust gets a 2 per cent revenue related royalty calculated from iron ore sales over the life of the mine from London Mining's Marampa licence in Sierra Leone. This is paid quarterly.

BlackRock World Mining says the royalty gives direct long-term commodity price exposure to iron ore, while avoiding mining sector cost inflation. The trust also holds a gold preference share in Banro, and in October last year invested $12m in Avanco Resources for a 25 per cent royalty payment on gold production and 2 per cent on production of other metals including copper from its from Stage 1 and 2 licensed area. A flat 2 per cent royalty is applied to all other projects from the rest of Avanco's licensed area.

"This is something which could be worth considerably more in the future," says Mr Hambro. "And this type of revenue is less volatile. As the royalties start to mature they will replace the arbitrage opportunity we have with bonds ahead of interest rates starting to rise. We can provide a solution by refinancing a company and putting it on a secure footing, unlock value and get in at an attractive entry point."

BlackRock should be able to identify further royalty-deals. Traditional sources of finance for the resources industry have reduced and the market is now short of capital. The bond market is mostly an option for only large-cap mining companies. "With these royalties only now beginning to materially contribute to income, there is scope for further increases in the trust's dividend," comment analysts at Winterflood.

They also think that if sentiment towards the resources sector improves and the dividend continues to increase the trust could trade at a premium to its net asset value (NAV). "For investors willing to take a contrarian view on an out of favour sector, the fund is attractive," they add. "In the absence of any immediate recovery in valuations, the 4.5 per cent dividend yield also means shareholders are paid to wait."

BlackRock World Mining's managers are generally optimistic about the mining sector. "At the beginning of 2014, a number of the downside risks for this sector have reduced, albeit not disappeared," they say. "The industry has made good progress in refocusing its strategy: operating costs have been aggressively targeted and investment in projects reassessed."

Examples include Australian-listed Fortescue Metals, which focuses on iron ore and is moving from high capital expenditure to high cash flow. It has made voluntary debt repayments of S$3.1bn over the six months to January 2014 and reduced the cost of its remaining debt, saving around $300m in interest annually.

Many commodities are trading close to or below their marginal cost of production, implying that price downside should be limited, in the absence of a collapse in demand. But Mr Hambro expects commodity prices to remain range bound, with steady, improving demand being catered for by moderate supply growth, albeit with disruptions and challenges.

He says that the market is in a transition phase and the cut in operating costs and capital expenditure value is starting to come through to investors. "BHP Billiton (BLT), for example, has talked of making a significant increase in what it pays out to investors while analysts are starting to forecast dividend increases for 2014, even though free cash flow is not coming through yet," he says. "But the mining sector now has a very healthy level of yield and it is likely to improve."

Mr Hambro said in January that the trust's largest exposure was to copper, followed by iron ore because that is where companies are making most money. But the trust is starting to add to other areas. He says zinc and nickel are also showing signs of momentum, demand is outpacing estimates, with massive falls in copper and zinc inventories which should be supportive of current price levels. Mr Hambro also thinks demand should benefit from global growth, and investors are also showing interest in the mining sector again.

Mr Hambro believes most write-downs for large mining companies are over, but adds: "The gold sector has got some pain to come."

Read our last interview with Evy Hambro

Source: Morningstar

Source: Morningstar as at 2 February 2014

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