By Chris Shaw

Copper remains the preferred base metals exposure of BA Merrill Lynch, so the stockbroker is particularly interested in companies offering high leverage to the copper price. To reflect this, BA-ML has initiated coverage on PanAust ((PNA)) with a Buy rating, liking the combination of production growth from new and existing operations and potential earnings upside from stronger copper prices.

PanAust produces from the 90%-owned Phu Kham copper/gold mine in Laos, where production is currently 60-65,000 tonnes of copper and 40-45,000 ounces of gold annually. The company also has the Ban Houaxyai gold/silver project where production is expected to commence in late 2011 and an interest in the Inca de Oro project in Chile.

Phu Kham is the main focus of the company at present, as BA Merrill Lynch notes the company is currently undertaking an expansion study to lift output. This could see copper production grow to around 72,000 ounces annually.

There is scope for additional upside to production as PanAust is considering a tailings recovery project at Phu Kham, which would boost current recovery rates of about 70% for copper and around 40% for gold. If recoveries could be increased to 95% for copper, BA Merrill Lynch estimates this could add as much as 15,000 tonnes per year of output.

Ban Houaxyai should see average production of 100,000 ounces of gold and around 800,000 ounces of silver annually, which adds to the longer-term earnings growth outlook for PanAust in BA-ML's view.

The broker is forecasting earnings per share in US dollars of 5.4c this year, rising to 7.3c in 2011 and 7.8c in 2012. This puts BA Merrill Lynch's forecasts broadly in line with the other brokers covering PanAust in the FNArena database.

As PanAust has limited hedging in place, earnings remain very exposed to copper prices. BA Merrill Lynch estimates for every US10c per pound increase in copper prices, PanAust's earnings stand to increase by around US$10 million.

This implies some upside risk to estimates if copper prices rise strongly as BA Merrill Lynch notes in high copper price environments, which implies prices above US$3 per pound, PanAust is cheap given an earnings multiple of 6-8 times.

The stock is not as cheap based on the broker's long-term copper price forecast of US$1.77 per pound. This implies an earnings multiple of around 11 times, so in part the positive view on PanAust reflects positive expectations for the copper price.

As with the other base metals, copper prices have suffered in recent months from ongoing uncertainty with respect to economic growth in both China and the world in general. But BA Merrill Lynch suggests for those willing to take a 12-month view current market concerns are offering a good buying opportunity.

As Ban Houaxyai is being developed this will require funds to be invested, the good news in BA Merrill Lynch's view being PanAust has a strong enough balance sheet to meet its requirements going forward.

BA Merrill Lynch's modelling of PanAust has generated a price target for the stock of $0.65, which compares to an average price target according to the FNArena database of $0.67. The database shows PanAust is rated as Buy seven times and Hold once, this courtesy of Macquarie.

Earlier this week PanAust announced a reserve upgrade that should add two years to production at Phu Kham, news that saw Credit Suisse upgrade to a Buy rating on valuation grounds, from Hold previously. While Deutsche Bank made no change to either its earnings estimates or its Buy rating on the news, it viewed the announcement as a positive from a valuation perspective.

Shares in PanAust today are slightly higher and as at 11.45am the stock was up 0.5c at $0.485. This compares to a trading range over the past year of $0.30 to $0.65 and implies upside of around 34% to the average price target according to FNArena's database.

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