ARAFURA RESOURCES LTD. //Rare Earths S T O R M C R...
Transcript of ARAFURA RESOURCES LTD. //Rare Earths S T O R M C R...
DEC 08, 2014 ASX-ARU
TARGET A$0.35
ARAFURA RESOURCES LTD.
//Rare Earths
INITIATING COVERAGE Magnet Materials Matter
Magnet Materials Matter – Arafura’s Nolans Project can produce an
industry leading amount of neodymium and praseodymium, to be used by
rare earth magnet makers whose products are destined for the automotive,
alternative energy and aerospace industries.
Stable Location – Australia is as good and as stable a mining jurisdiction as
one could find.
Decades of Production – Nolans has a 40+ year mine life, at planned 20,000
tpa equivalent TREO production rate.
Economically Viable – Our worst-case REO price deck suggests that Arafura
can generate slim but positive cash flows in any rare earth market, and this
with current estimated production costs. If programs with Chinese partners
bear fruit and operating costs can be driven lower, then Arafura will reap
additional rewards.
Known Minerals – The minerals in the Nolans deposit are rare-earth bearing
phosphates and silicates, which makes their processing a low-risk affair.
Societal Acceptance – The region around the proposed mine is mining
country. The project should not suffer from protests regarding its operation
in the area.
Positive Recommendation – Using our recently published base-case REO
price deck, we are initiating coverage on Arafura with a AU$0.35 target
price. We believe that every rare earths investor should hold Arafura, as it is
one of a very few strategic-grade projects outside of China.
Jon Hykawy, PhD President
Tom Chudnovsky Managing Partner
S T O R M C R O W
New
Old
Rating Positive N/A
Target A$0.35 N/A
Shares O/S FD ~451.7M
Recent Price AUS$0.05
Market Cap AUS$22.5M
Net Cash ~AUS$20M
See the end of report for important disclosures
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Summary
It would be a considerable understatement to say that rare earths (REEs) are
out of favour with financial investors. What was one of the hottest areas in
the resource investment universe in 2010 and 2011 has become colder than
almost any other segment of the resource market. The two companies at the
forefront of the REE industry outside China, Molycorp (MCP-NYSE) and Lynas
(LYC-ASX), have been unable to generate profits, with market consensus
laying the blame at the feet of ongoing technical problems. As far as financial
investors are concerned, both Molycorp and Lynas are essentially worthless.
Still, there is a continuing strong need for REEs among end-users, and the need
for a reliable and secure supply of REEs is especially important to users outside
China. The mantra for end-users of all materials for which the supply is
controlled by China seems to be geographical diversification. It naturally
follows that it is necessary to finance new projects to meet this need.
There are a number of reasons why REEs remain important in the foreseeable
future, and why unreliable and restrictive supply from China carries too much
risk for end-users. Rare earth-based magnets, especially the neodymium iron
boron (NdFeB) magnet, remain the highest strength magnets available. In
various uses, such as for motors in the automobile industry, within direct-
drive generators in the wind industry, or many electrical applications within
the aerospace sector, NdFeB magnets provide a combination of performance,
size and weight that is unobtainable without sacrificing other criteria using
substitutes. The issue of cost is always a factor, but at current rare earth
prices, and indeed the historical prices of rare earths outside of the bubble
years of 2010 and 2011, REEs have been cost effective for all the above
industries.
Yet at the same time as many industries would benefit from enhanced access
to reasonably priced rare earths, China is consolidating its REE industry using
six state-owned or state-controlled enterprises. While the WTO ruling against
China regarding export quotas on a number of materials, including REEs, was
initially viewed as a victory, even the most benevolent observer would allow
that consolidation such as this creates a less transparent rare earth market.
The US Department of Energy has certainly taken notice, and its First Strategic
Pillar within its Critical Materials Strategy, “Diversifying global supply chains
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to mitigate supply risk”, is nothing but a call to action regarding critical
materials that are controlled by any one nation. It is clear that there is a
definite need for new REE mines in order to guarantee a reliable ex-China
supply.
Nolans – The Magnetic Materials Mine
Arafura Resources (ASX: ARU) of Perth, Australia, is 100% owner of the Nolans
Rare Earths Project in the Northern Territory, Australia. At present, the
Nolans Project is at an advanced feasibility stage. The Nolans Bore rare earths
deposit, with defined resources of more than 1.2 million tonnes of REO
extending from surface to a depth of 220 meters, is one of the largest and
lowest risk REE deposits in the world.
Exhibit 1: Nolans Project location in Northern Territory, Australia
Source: Arafura Resources
Arafura is planning to locate facilities for mining, ore beneficiation and
hydrometallurgical processing on site at Nolans. The refining of
hydrometallurgical concentrates into five saleable products (oxides of
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neodymium/praseodymium, samarium/europium/gadolinium, a mixture of
all the heavier REEs, lanthanum and cerium) will take place offshore.
Exhibit 2: Schematic View of Project Components
Source: Arafura Resources
What makes the Nolans Bore deposit truly interesting is the proportion of
certain critical rare earths within the deposit, most especially the magnet
materials neodymium (Nd) and praseodymium (Pr). Nd and Pr are the REEs
used in the highest-strength permanent magnets, important to the
automotive, wind turbine and aerospace industries. This resource
composition positions Arafura as a prospective world-leading feedstock
provider for the growing rare earth magnet market.
Planned output from Nolans of 20,000 tonnes of TREO each year includes
11,350 tonnes of TREO in hydrometallurgical concentrates earmarked for
offshore separation. At this level, production of mixed Nd/Pr and dysprosium
(Dy), which is vital to the use of NdFeB magnets in high power applications,
stands above all other existing light REE producers. In fact, production from
Nolans would rival the combined Phase 1 production levels from Molycorp
and Lynas. Production from Nolans is scheduled to commence in 2019.
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Exhibit 3: Planned Production of Didymium (Nd/Pr) and Dysprosium
Project Company Annual Production (tpa) Nd/Pr (tpa) Dy (tpa)
Mountain Pass Molycorp 22,000 3,586 11
Mount Weld Lynas 11,000 2,561 28
Nolans Arafura 20,000 5,420 53
Source: Company reports, Stormcrow
There is one issue with the deposit itself, and that is a high level of associated
radioactivity stemming from significant levels of thorium and uranium within
the rare-earth bearing minerals, most especially allanite and monazite. The
proposed solution to this issue is long-term management of these process
residues in tailings storage. It should be noted by readers that the Northern
Territory of Australia has extensive experience with uranium extraction,
hosting the Ranger mine, and has a very mature regulatory environment with
respect to low-level radioactive wastes and materials.
Low Cost Production
A series of good decisions have been made, in our opinion, by Arafura
management over the past two years. These decisions have centered on
efforts to reduce costs, capital but most especially operational, and have
increased the viability of the Nolans Project substantially, in our view.
Several steps have been taken to reconfigure the production process and
reduce the costs of the project. Intermediate chemical processing was
relocated to the Nolans Site, generating a considerable cost saving with
respect to transportation. Refining, the separation of the REEs into five
products, will be relocated from an Australian facility to a facility likely in the
Gulf Coast region of the United States.
Experience Counts
In September 2013, Arafura entered into a memorandum of understanding
(MoU) with Shenghe Resources (600392.SS), a leader in rare earth production
and technology development in China. This collaboration was aimed at
identifying further capital and operational cost savings for the Nolans Project.
These savings should be quantified upon completion of initial test programs,
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and will be incorporated, along with results from an ongoing Chinese
optimization program of ore beneficiation and hydrometallurgical processes,
in the Definitive Feasibility Study (DFS) that is scheduled to be completed by
the end of calendar 2015.
Sales and Marketing Uber Alles
It is clear that we are no longer in the REE boom period of 2010 and 2011,
when financial investors supported several viable “cheap and cheerful” rare
earth projects, and, let us be honest, a host of poor projects that never stood
any chance of becoming producers. In the wake of skyrocketing prices
through latter 2010 and early 2011, avoidance of rare earth use became a
priority, demand and then prices collapsed, and financial investors lost all
interest in the space, including the best projects. What this means for
prospective rare earth producers today is that success can only come with the
support of strategic investors or end-users from the established REE markets
in Japan, Europe, South Korea and the United States. And we have also had
conversations with end-users that have indicated that they would even be
happy buying their REEs from a Chinese company, or Chinese-backed
company, providing the production of those REEs remains outside direct
Chinese governmental control.
To this end, Arafura has been taking steps in the right direction. The company
has signed a MoU with ThyssenKrupp (TKA.DE), for supply of up to 3,000
tonnes per year of REE products, and a more formal off-take agreement is
now being negotiated. Arafura has also signed a MoU with a South Korean
multinational organization for the sale of another 3,000 tonnes of REE
products. It is true that a pessimist might note that MoUs for 6,000 tonnes of
product per year does not guarantee the sale of the full 11,350 tonnes per
year of production. However, we would note that pessimists have also
insisted that the rare earth market has vanished, so for a company that will
not even begin ramping commercial production until 2019, we would suggest
that negotiating 6,000 tonnes of sale at this point in time represents a very
strong start.
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Ticking Every Box
As we have noted in the discussion regarding our recently published base-case
REO price deck, the lack of financial investor interest in the space means that
it will be the needs of strategic investors and/or large end-users that will
dictate the projects chosen to become future suppliers. And these strategic
parties have a slightly different emphasis on the criteria that identify the best
projects. Stormcrow believes these criteria will include factors such as the
ability of a prospective mine to supply for a long period of time, geopolitical
stability of the nation hosting the deposit, a low level of remaining technical
and social acceptance risk, high levels of production of the truly critical rare
earths, and economic viability of the project, itself.
Arafura delivers on all counts. With a mine life of more than 40 years, it is
clear that operational life is not an issue. Australia, and more particularly the
Northern Territory, is as stable a mining jurisdiction as one could hope to find.
Nolans Bore contains monazite, and monazite is a well-known REE-bearing
mineral with well understood flow sheets for production. The proposed
operation is in a mining area sufficiently removed from major communities,
and thus does not present an overly large risk regarding project acceptability
among the local population. We have already seen that Nolans would rank
among the best producers of magnet materials for its size. Finally, we can
show that even using our pessimistic REO price deck, one that was built to
answer questions regarding just how bad the rare earth market can possibly
get, Nolans would generate positive cash flow at currently projected costs per
kilogram of TREO produced of AU$15.67. The financial returns are
considerably stronger given our base-case price deck, as we shall see.
Cash Flow Model
We have recently published our argument for a “base-case” price deck for
REOs, through 2025. Please see our report entitled The Rare Earth Market
Keeps Changing, published in November 2014. The results of this pricing
study are shown below:
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Exhibit 4: “Base Case” REO Price Deck
Source: Stormcrow
We use this “base-case” rare earth price deck as one of our assumptions. To
simplify our analysis further, we also make the following assumptions:
1. We do not ascribe any value to any other project, owned in whole or in
part by Arafura, or to any other resources, other than REEs mined from
Nolans Bore.
2. We assume the production of five saleable products from Nolans Bore:
lanthanum oxide, cerium oxide, didymium oxide, samarium-europium-
gadolinium (SEG) mixed oxides and all heavier rare earths as a mixed
oxide (HREOs).
3. We ascribe no value to the final potentially saleable product from the
project, cerium carbonate. The only likely market for this product is in
China, and given that domestic Chinese production of all cerium
chemicals is likely sufficient for some time to come, we will be
conservative and not attribute revenue to this product.
4. We assume that the values of lanthanum and cerium oxides are as given
by our pricing model.
5. We assume the value of didymium oxide is given entirely by the price of
neodymium oxide in our pricing model, as recent prices for
praseodymium oxide are likely skewed higher by purchases made for the
ceramics market for small quantities of pure praseodymium oxide.
Magnet use does not require separated praseodymium oxide.
6. We assume the value of SEG oxide is its value as separated and purified
REOs less 20%.
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7. We assume the value of HREO from Nolans Bore is its value as separated
and purified REOs less 15%.
8. We believe that the above discounts are reasonable for mixed
concentrates in this form. We have analyzed historical pricing of
separated rare earths produced from ionic clays and the price paid for
ionic clay mixed concentrate, all quoted by Asian Metal. These data show
a 28% discount for a mixed concentrate that still contains large amounts
of lanthanum, cerium and didymium oxides. We believe it correct that a
purer concentrate can command a higher price, as there is simply less
refining to do.
9. We assume operating costs of AU$15.67 per kg, as per Arafura’s
September 2014 Nolans Development Report, and assume operating
costs in their entirety are borne by the project starting in 2019.
10. We assume capital costs of AU$1.41 billion, as per Arafura’s September
2014 report. Capital costs are split 60% debt, 40% equity. Debt carries a
10 year term, with interest rates of 6%.
11. The project takes two years to ramp to full production, with production
of 5,000 tonnes of TREO in 2019 and 9,000 tonnes of TREO in 2020.
Annual production of 20,000 tpa equivalent is achieved in 2021.
12. We apply a 8x terminal multiple to the project in 2026, owing to decades
of remaining production. It would be incorrect to assign zero value to the
remaining production levels.
13. Our DCF analysis assumes a discount rate of 19%. We believe that
venture capital discount rates of 20% or higher are excessive, given the
lack of technical and market risk, and we believe our chosen rate properly
reflects the capital risk of the project.
14. We assume, as have Arafura management, an AU$ to US$ exchange curve
sourced from Access Economics, a leading Australian forecaster. The
curve predicts an exchange rate of 0.838 in 2016, when the bulk of capex
is shown to be injected to the project. We assume rates in 2019 and later
are the average of the curve, at 0.855, as we do believe that China and
the global appetite for commodities will improve, and the AU$ will
strengthen compared to the US$. The current exchange rate is roughly
0.84.
So, with these assumptions we obtain the following cash flow model
through 2025:
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Exhibit 5: Arafura Cash Flow Model
Source: Stormcrow
Our analysis suggests a target price of AU$0.35 per share, rounded down, with
the stock trading in the AU$0.05 range of late.
Note, too, that we have applied our “pessimistic” rare earth price deck to the
same model. The result is slim but positive cash flows once full production
rates are achieved in 2021. From our analysis, it appears that Arafura is one
of very few projects that can weather the storm of the worst pricing that the
rare earth market is likely to be able to produce. It is also clear to us that such
pricing cannot last for very long, as it is likely to kill a number of the
hypothetical producers that are necessary to create sufficiently large supplies
outside of China to drive down pricing to these levels. For our pessimistic REO
price deck, please see our report The Rare Earth Market Keeps Changing,
published in November 2014.
Management Team
Gavin Lockyer, Managing Director Qualifications: BBus, CA Appointed: 23 July 2013 (current position) Mr. Lockyer graduated with a Bachelor of Business degree in Accounting and Finance from Western Australia in 1987, and has subsequently become a
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member of both the Institute of Chartered Accountants and the Finance & Treasury Association of Australia. He joined Arafura in 2006 as CFO and Company Secretary after having served as Financial Controller with the Tethyan Copper Company Limited. Mr. Lockyer previously held a number of senior finance and treasury positions in global mining companies Newcrest and Newmont following an international investment banking career with BankWest and ANZ in Australia, and Bankers Trust and Deutsche Bank in London.
Peter Sherrington, Chief Financial Officer & Company Secretary Qualifications: BBus, CA Appointed: 24 July 2013 (current position) Mr. Sherrington holds a Bachelor of Business in Accounting and Finance, and is a member of the Institute of Chartered Accountants. He commenced employment with Arafura in 2008 as Commercial Manager and was appointed CFO in July 2013. He has in excess of 20 years experience in professional and corporate roles in Perth. Prior to working with Arafura he held senior finance and commercial positions with a number of ASX and unlisted entities. He has also worked in accounting public practice for 10 years in the areas of business services and corporate advisory.
Richard Brescianini, General Manager Exploration & Development Qualifications: BSc (Hons) Appointed: 18 March 2007 Mr. Brescianini is a graduate in Geology and Geophysics, and has extensive private and public sector experience in the minerals industry, in a career that spans over 20 years. From 1987 to 1999, he worked with BHP Minerals on base and precious metals exploration programs throughout Australasia and North America, contributing to significant economic discoveries at Eloise (copper-gold) and Cannington (silver-lead-zinc). Mr. Brescianini led the Northern Territory Government’s Geological Survey as its Director from 2003 to 2007, and was responsible for major geoscience initiatives and investment attraction strategies. Prior to that, he was the Survey’s Chief Geophysicist.
Neil Graham, General Manager Operations & Technology Qualifications: BSc (Hons) Chemical Engineering, C.Eng. Appointed: 1 September 2010 Mr. Graham has more than 25 years of international experience in the chemical industry, encompassing design, construction, and commissioning of both start-up and brownfield installations, in addition to substantial
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operations management experience of facilities in several different countries. He is a chartered engineer who commenced his professional career at BP prior to joining ICI, where he was involved in major project design and implementation roles. He developed the Asian market presence of Rittershaus & Blecher and subsequently completed several technical and site manager roles with Huntsman Pigments before becoming the Group Sulphate Manufacturing Director. More recently, Mr. Graham was responsible for Orica’s largest and most complex facility, worldwide, at Gladstone, Queensland, producing ammonium nitrate, sodium cyanide and chloralkali products. He joined Arafura Resources in September 2010.
Brian Fowler, General Manager NT & Sustainability Appointed: 24 July 2013 (current position) Mr. Fowler has worked for over 40 years in private sector mineral companies, developing a range of commodities, including rare earths, base metals and gold. He has significant experience in a number of disciplines including environmental management, safety management, community engagement, project permitting and approvals, and land access. He has worked at various mining operations and in exploration throughout Australasia. In these roles, Mr. Fowler has been involved in taking projects from discovery, through production, to mine closure, rehabilitation and compliance management. Prior to joining Arafura in 2007, Mr. Fowler worked with Newmont Australia and Normandy Mining in a variety of senior management roles. He is a member of the Northern Territory Mining Board, Management Board of the Northern Territory Minerals Council of Australia, and a member of Work Health & Safety Advisory Council of the Northern Territory.
Conclusions – Magnet Materials Matter
We will reiterate our opening thought. Most financial investors have chosen
to ignore rare earth companies at present. We believe this is a mistake,
because REEs are a critical material with long-term value. Investors that are
interested in the space strategically, those that have to remain interested in
the REE industry, are not likely to let a good opportunity go to waste.
We believe that Arafura remains one of the best opportunities in the rare
earth market. Arafura represents a low-risk, prospectively very long-lived
producer of low-cost critical rare earths. Financially, it can suffer the very
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worst that the rare earth market can throw at it, and generate strong profits
in a base-case market. It remains one of the very few companies in the space
that can make those claims, joining Molycorp, Lynas, Rare Element Resources
(RES-US) and Quest Rare Metals (QRM-TSX). This does not imply that all of
these companies will survive to reach production, but they stand a far better
chance in this market than most of their so-called peers.
We are initiating coverage on Arafura Resources with a positive
recommendation and a target price of AU$0.35. Arafura has every
characteristic of a project that will be supported by strategic investors,
including end-users. The Nolans Bore deposit is located in mining-friendly
Australia, and can produce for many decades. Arafura can produce industry-
leading levels of neodymium and praseodymium, to be turned into magnets
and used in the automotive, alternative energy and aerospace industries. The
project is economically viable, even if REE prices approach worst-case levels.
And the company has few, if any, remaining technical or social acceptability
hurdles. We believe that Arafura is a name that every interested rare earths
investor must own.
Keywords
Important Disclosures
Stormcrow Capital Ltd. (“Stormcrow”) is a financial and technical/scientific consulting firm that provides its clients with some or all of the following services: (i) an assessment of the client’s industry, business plans and operations, market positioning, economic situation and prospects; (ii) certain technical and scientific commentary, analysis and advice that is within the expertise of Stormcrow’s staff; (iii) advice regarding optimization strategies for the client’s business and capital structure; and (iv) opinions regarding the future expected value of the client’s equity securities so as to allow the client to then make capital market, capital budgeting and capital structure plans. Stormcrow does not provide securities trading services, equity sales or distribution services, securities underwriting services, or investment banking services. Stormcrow does publish research reports for general and regular circulation. With the consent of Stormcrow’s client, the client and/or its industry sector may be the subject of an investment or financial research report, newsletter, bulletin or other publication by Stormcrow where such publication is made publicly available at www.stormcrow.ca or elsewhere or is otherwise distributed by Stormcrow. Any such publication is limited to generic, non-tailored advice or opinions and should not be construed as investment advice that is suitable for the reader or recipient. Stormcrow does not offer personalized or tailored investment advice to anyone and its research reports should not be relied upon in making any investment decisions. Rather, investors should speak with their personal financial advisor(s).
The primary issuer discussed herein is a client of Stormcrow, and as such, Stormcrow has agreed to provide the Company with a variety of consulting services. The fixed rate fee that the Company pays to Stormcrow is not contingent on the content or conclusions of any of Stormcrow’s research reports and is not contingent on the price, or price movement, of any securities.
None of Stormcrow’s officers, directors, or significant shareholders own, directly or indirectly, shares in the Company. It is a policy of Stormcrow and its employees to refrain from trading in a manner that is contrary to, or inconsistent with, Stormcrow’s most recent published recommendations or ratings, except in circumstances of unanticipated extreme financial hardship.
Stormcrow intends to provide regular market updates on the affairs of the Company (at Stormcrow’s discretion) and make these updates publicly available at www.stormcrow.ca. Readers who wish to receive notice when such updates become available, should email to [email protected] with the subject heading “Get Update Notifications”.
All information used in the publication of this report has been compiled from publicly available sources that Stormcrow believes to be reliable. Stormcrow does not guarantee the accuracy or completeness of the information found in this report and Stormcrow may not have undertaken any independent investigation to confirm or verify such information. Opinions contained in this report represent the true opinion of Stormcrow and the author(s) at the time of publication.
The securities described in this research report may not be eligible for sale in all jurisdictions or to certain categories of investors. This report and the content herein should not be construed by anyone as a solicitation to effect, or attempt to effect, any transaction in a security. This document was prepared and was made available for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned herein. The
Industry Rare Earths, Critical Materials, Critical Metals, Mining, Industrial Minerals
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STORMCROW.CA | PAGE 15
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Sovereign Metals Inc. (SVM | ASX)
securities referred to herein should be considered speculative in nature and should be considered to involve a high amount of financial risk where investors may lose all of their investment.
Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. No representation is being made that any investment or security will or is likely to achieve the return or performance estimated herein. There can be sharp differences between expected performance results and the actual results.
Dissemination of Research
Since Stormcrow does not rely on earning commission fees from institutional agency trading services, or investment banking revenues, this research report is widely available to the public via its website: www.stormcrow.ca
Investment Rating Criteria
We do not provide an investment rating, beyond indicating whether the target price exceeds current trading ranges by a reasonable range, indicated as “Positive”, or whether the target price is either below or roughly equivalent to the current trading range, indicated as “Negative”. Each investor has an individual target return in mind, we leave it to the individual investor to determine how our target and the current price fit within their portfolio.