HIGHLANDS PACIFIC A well funded optionof Chinese approval of last year's merger between the...

RESEARCH NOTE – PATERSONS SECURITIES LIMITED 1

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RESEARCH NOTE

HIGHLANDS PACIFIC

Investment highlights

Highland Pacific Limited (HIG) is edging closer to realising value from its portfolio of assets in Papua New Guinea (PNG). HIG is fortunate to have a healthy bank balance ($6.5m) with a further $5m due later in the year. We believe that HIG is well placed to provide higher risk exposure to the growing investment trend in PNG as well as base and precious metals. As a result we are amending our recommendation from hold to speculative buy with a price target of $0.08/share.

• Frieda River – The transaction between Glencore Xstrata and

PanAust (PNA) is dependant on the regulatory approvals for the merger between Glencore and Xstrata. These apporovals will be granted once Glencore Xstrata sells its interest in the Las Bambas project. Earlier this quarter, Glencore Xstrata announced that it had signed an agreement with a Chinese consortium to sell its Las Bambas interest, which is expected to close next quarter. This will allow the Frieda River transaction to be completed.

• Ramu - Mining rates and production continue to improve at Ramu as key technical modifications are introduced. During the March quarter the plant operated at an average of 52% of nameplate capacity against a planned rate of 60%. At this stage the bottleneck appears to be with the mining operation rather than the processing.

It was good to see that the triple train HPAL operation operated during the quarter with all major operating elements of the treatment plant working as designed.

• Star Mountains – HIG has regained full control of the four exploration leases that make up Star Mountains following the expiry of an option held by Xstrata Frieda River Limited (a subsidiary of Glencore Xstrata). The project remains on care and maintenance, however the lapsing of the option has allowed HIG to engage with potential partners to recommence exploration.

• Catalysts – 1) consummation of the PNA and Glencore Xstrata Freida River transaction, 2) Star Mountain exploration partner, 3)

Frieda River DFS, 4) Commercial production at Ramu.

6 June 2014

12mth Rating Speculative Buy

Price A$ 0.06

Target Price A$ 0.08

12m Total Return % 28.7

RIC: HIG.AX BBG: HIG AU Shares o/s m 853.4

Free Float % 72

Market Cap. A$m 50.4

Net Debt (Cash) A$m -6.23

Net Debt/Equity % na

3m Av. D. T’over A$m 0.02

52wk High/Low A$ 0.10/0.05

2yr adj. beta 1.21

Valuation:

Methodology DCF

Value per share A$ 0.08

Analyst: Matthew Trivett

Phone: (+61 7) 3737 8053

Email: [email protected]

12 Month Share Price Performance

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Performance % 1mth 3mth 12mth

Absolute -6.7

-22.2

-16.4 Rel. S&P/ASX 300 -5.0 -18.1

-20.8

A well funded option

Year End December 31 2012A 2013A 2014F 2015F 2016F

Reported NPAT ($m) (13.4) (37.2) (3.0) 15.7 17.7

Recurrent NPAT ($m) (13.4) (37.2) (3.0) 15.7 17.7

Recurrent EPS (cents) (1.7) (4.2) (0.3) 1.5 1.7

EPS Growth (%) na na na na 12.8

PER (x) (3.6) (1.4) (20.1) 3.9 3.4

EBITDA ($m) (13.4) (37.1) (3.0) 17.1 19.1

EV/EBITDA (x) (3.3) (1.2) (14.5) 2.6 2.3

Capex ($m) 0.0 0.0 0.0 1.8 1.8

Free Cashflow (17.4) (10.8) (4.9) 13.3 15.2

FCFPS (cents) (2.1) (1.2) (0.5) 1.3 1.5

PFCF (x) (2.8) (4.8) (12.4) 4.6 4.0

DPS (cents) 0.0 0.0 0.0 0.0 0.0

Yield (%) 0.0 0.0 0.0 0.0 0.0

Franking (%) 0.0 0.0 0.0 0.0 0.0

6 June 2014 Highlands Pacific




Investment Thesis

Highland Pacific Limted (HIG) is edging closer to releasing value from its portfolio of assets in Papua New Guinea. This portfolio includes Frieda River, one of the largest undeveloped copper projects in the world, the Ramu Nickel Cobalt Project, a nickel laterite project that is in the ramp-up stages of operations and Star Mountains, a highly prospective exploration package only 20km to the north of the Ok Tedi mine. HIG is also fortunate to have a healthy bank balance of an estimated $6.5m and another $5m placement to Pan Aust (PNA) due later in the year. As a result we are amending our recommendation from hold to speculative buy with a price target of $0.08/share.

Recent developments include; the increased certainty of the Frieda River agreement between Glencore Xstrata and PanAust to be completed in the September Q, the lapse of a long standing option over a Star Mountains tenement which allows HIG to engage with exploration partners and the ongoing ramp up of the Ramu Nickel Cobalt Project which will

provide a modest cash flow to HIG once commercial production is achieved.

The major hurdles facing HIG primarily revolve around the scale of the capital required to explore and develop these assets. However, HIG utilises the PNG and mining experience of its Board and Management to structure deals that minimise HIG’s funding requirements for a minority share in the project. Ramu and Frieda River are both examples, and we expect HIG will replicate this type of deal in regards to the development of Star Mountains.

Contingent on completion of the transaction, PNA will replace Glencore, as the majority investor in Frieda River. HIG will retain 15% - 20% depending on the amount the PNG Government elect to participate as a direct equity interest (up to 30%) in the project. PNA is responsible for 100% of the costs incurred by the Frieda River joint venture to finalise a Definitive Feasibility Study (DFS) for PNA’s development concept. Consummation of the

deal and ongoing feasibility work will be future value drivers.

The Ramu project has been fully funded by the project operator, Metallurgical Corporation of China Limited (MCC). HIG will own 11.3% of the operation once its 8.6% of the project financing is repaid with the right to acquire a further 9.25% at market rates. Ramu has had a number of operational and litigation issues to overcome including 2 years in the courts. The plant is currently operating at 52% of capacity and MCC has forecast 22kt of nickel for the 2014 year before reaching full production in 2015. We are not as optimistic in our modelling, but once at full production, it will provide free cash flow to HIG. Until then, and during this ramp-up period, there has been no recourse on HIG for operating cash flow shortages or capital overruns.

Valuation

Our valuation has remained essentially unchanged despite the volatile metal prices. The value of Ramu has increased as the project moves closer to commercial production. After including cash, corporate expenses and a nominal value for Star Mountains, we estimate HIG’s Net Asset Value of $250m. We have assumed the Frieda River JV will be able to raise at least 50% of the capital requirement from debt, leaving HIG to raise $130m which we assume is done at a 10% discount to the current share price.

Figure 1: Valuation

Valuation Equity (%) A$m A$/sh

Freida River 20% 175 0.051

Ramu Nickel Cobalt Mine 8.6% 78 0.023

Star Mountains 100% 10 0.003

Corporate (20) (0.006)

Cash est. 6 0.00

NAV @ 10% Discount Rate 250 0.073

Source: Patersons Research





Company Overview

Highlands Pacific Limited (HIG) is a mining and exploration company operating in Papua New Guinea (PNG), since it was spun out of Mt Isa Mines (MIM) in the early 1990’s. It has minority stakes in the operating Ramu nickel cobalt project and the Frieda copper gold project which is at the DFS stage. HIG’s main exploration project is the 100% owned Star Mountains project, located approximately 20km north of the Ok Tedi mine. HIG also has exploration tenements at Muller Range on the border of the Western and Southern Highlands Provinces and on Normanby Island (Sewa Bay).

Figure 2: Location map

Source: Highlands Pacific

Frieda River Joint Venture

On 1 November 2013, PNA announced that it had entered into a share sale and purchase

agreement with a subsidiary of Glencore Xstrata plc (Glencore) for the 80% interest in the Frieda River Copper Gold project. The deal is dependant on Glencore meeting a condition of Chinese approval of last year's merger between the London-listed Glencore and Xstrata, for the sale of the Las Bambas project.

On 14 April 2014, Glencore announced that it had signed an agreement with a Chinese consortium to sell its entire interest in the Las Bambas project. The announcement stated that the transaction is subject to certain regulatory approvals and is expected to close prior to the end of September 2014. Once the regulatory approvals are received the HIG-PNA-Glencore transaction can be completed.

The Frieda River copper gold project is 70km south of the Sepik River, 500km upriver from the coast and on the border of the Sanduan and East Sepik Provinces. The Frieda River project is PNG’s largest undeveloped copper gold project and one of the top 10 undeveloped

open pit copper mines in the world. With a resource inventory of 13Mt of copper and 20Moz of gold, Frieda River has double the in-ground metal content of all the copper extracted in the past 25 years from the Ok Tedi mine.

The Horse-Ivaal-Trukai Mineral Resources are constrained by topography and approximately US$400m has been spent on exploration drilling, community consultation and project study work. Exploration and geotechnical drilling ceased in 2011 after more than 140km of drilling. In September 2011, a resource upgrade was announced for the Horse-Ivaal-Trukai deposits. Using a cut-off grade of 0.20% copper, the Horse-Ivaal-Trukai deposit is estimated to contain 2,090Mt of copper mineralisation at a grade of 0.49% copper and 0.25g/t gold.





Once PNA gains control of the majority share, a development decision is still likely to be two years away. Fortunately for both HIG and PNA a significant amount of work has been completed including environmental studies, which will form part of a formal development application for a Special Mining Lease (SML). It is at this time that the joint venture partners would arrange project finance and the PNG Government can elect to take a direct equity interest in the project of up to 30% at a pro-rata cost of the sunk cost of the project,

approximately $450m to date.

As project manager, Xstrata completed an extended Scoping Study in December 2008 followed by an 18-month Pre-feasibility Study in November 2010. Delivery of the Feasibility Study was extended by agreement until December 2012 to allow more time to consider alternative power and development scenarios. The Feasibility Study and Extended 2012 Study was delivered by Xstrata in December 2012 and outlined the options and alternative scenarios for a potential US$5-6bn project focused on the Horse-Ivaal-Trukai deposits.

Frieda River is very similar in terms of topography and ore body to PNA’s Phu Kham operation in Laos. This helped expedite PNA’s due diligence work and the resultant scoping study based on a smaller operation, 24Mtpa conventional open pit and flotation operation producing a copper-gold concentrate for export to custom smelters. This reduced scale quartered the development capital to the range of US$1.5bn to US$1.8bn (100% basis),

which is more manageable in the current market environment. However, it is still a significant hurdle for a company the size of HIG to raise the required capital. PNA is now doing preliminary work on a DFS that is expected to take 12 to 18 months, assuming the Glencore deal is consummated.

Figure 3: Comparative pit designs Figure 4: Original Horse-Ivaal-Trukai pit design

Source: Highlands Pacific Source: Highlands Pacific

PNA and HIG have agreed that the two parties will hold interests of 80% and 20% respectively. The terms of agreement provide that, should the Government of PNG elect to take up its right under PNG Law to 30% of the project, PNA will sell down the first 20% of its joint venture interest and thereafter the parties will sell down in equal amounts. Under a scenario where the Government of PNG elects to take up its maximum 30% of the project, the respective joint venture interests would be PNA 55%, the Government of PNG 30% and HIG 15%.

PNA is responsible for 100% of the costs incurred by the Frieda River joint venture to finalise a DFS for PNA’s development concept. PNA will also be responsible for 100% of the costs to maintain the Frieda River project site, assets and community relations programs up to the point in time of lodgement of the Mining Lease or Special Mining Lease application.





Ramu Nickel Cobalt Project

The Ramu project comprising of the Kurumbukari mine, Basamuk process plant and the 135km slurry pipeline is a joint venture between HIG, the PNG Government and Landowners, and a consortium of Chinese partners led by the Hong Kong and Shanghai listed Metallurgical Corporation of China Limited (MCC).

Mining rates and production continue to improve at Ramu as key technical modifications are introduced. These include a further hydro-sluicing trial, an improved ore crushing and sizing system and additional ore washing train. During 2013, 11.4kt of nickel was produced and MCC is confident it can produce 22kt of nickel in concentrate in 2014 (70% of name plate capacity) and reach full capacity of 31.1kt in 2015.

During the March quarter, the plant operated at an average of 52% of nameplate capacity against a planned rate of 60%. At this stage, the bottleneck appears to be with the mining operation rather than the processing. It was positive to see that the triple train HPAL operation operated during the quarter, with all major operating elements of the treatment plant working as designed. However, due to the slow ramp up of mining operations, the treatment plant has not been tested at the designed capacity for an extended time.

Figure 5: Quarterly production summary

Mar Q Jun Q Sep Q Dec Q Mar Q

2013 2013 2013 2013 2014

Ore Mined (wet tonnes) 671,550 837,484 909,600 1,063,166 1,283,975

Ore Processed (dry tonnes) 221,769 282,609 309,766 438,854 454,466

Mixed Hydroxide Product Produced 5,922 6,607 7,308 9,899 10,871

Contained Ni 2,285 2,537 2,749 3,799 4,080

Contained Co 189 215 239 370 317

Mixed Hydroxide Product Sold 5,447 7,879 12,299 13,847 5,433

Contained Ni 2,068 3,007 4,720 5,328 2,081

Contained Co 185 259 418 477 203


The Basamuk process plant is designed to treat 3.3Mpta (dry) feed with metal contents of typically 1.04% nickel and 0.11% cobalt. The plant incorporates three High Pressure Acid Leach (HPAL) trains (autoclaves). MCC continues to investigate the optimisation of the plant. Currently an improved ore crushing and sizing system continues to be studied with installation to occur at the mine washing plant in 2014. A hydro-sluicing operation was trialled by an external contractor during the quarter with positive results and a permanent operation will now be studied further.

The Kurumbukari nickel cobalt deposit is a low strip ratio (0.28:1), free digging open pit mine. Face shovels and backhoe configured excavators mine the average 12m thick ore-

body and load into trucks for delivery to the washing plant and then by a short pipeline to the beneficiation plant.

The beneficiation plant removes the chromite and creates a correctly sized and consistent slurry feed for overland pipeline transport to the Basamuk process plant. Trial mining began in 2009 and mining operations commenced at Kurumbukari in late 2011. In calendar year 2012, 1.54 million (wet) tonnes of ore was delivered to the Beneficiation plant. In the September Q 2013, 910kt (wet) were mined and delivered to the beneficiation plant.

A 135km slurry pipeline runs from the Kurumbukari mine/beneficiation plant to the Basamuk process plant, with a drop in elevation of about 680m. The majority of the pipeline has been buried.





Figure 6: Basamuk process plant


The Joint Venture ownership breakdown is MCC and the Chinese consortium holding 52% and 33% respectively through the MCC Ramu NiCo Limited. The PNG Government and HIG own 6.44% and 8.56% respectively in the project. HIG’s holding will increase to 11.3% at no cost after internal project debt has been repaid from operating cash flow. HIG also has an option to acquire an additional 9.25% from MCC, at fair market value, which could increase its interest to 20.55%.

The Ramu project debt funding is non-recourse to the minority Joint Venture partners, HIG and the PNG Government, and therefore HIG is protected from the capital cost increases and ramp-up operating losses that have occurred and could potentially occur.





Star Mountains

HIG has regained full control of the four exploration leases that make up Star Mountains following the expiry of an option agreement held by Xstrata Frieda River Limited (a subsidiary of Glencore Xstrata). The project remains on care and maintenance, however the lapsing of the option has allowed HIG to progress exploration options with potential partners. The next stage of exploration could take the form as a farm-out/joint venture agreement.

The prospects are located in far west PNG near the border with Indonesia, approximately 20km to the north of the Ok Tedi mine and approximately 25km from the support town of Tabubil. Tabubil is accessible via a 2 hour plane trip from Port Moresby. HIG has established an exploration support camp at Tifalmin which supports the transport of drilling equipment and consumables via fixed wing cargo flights from Tabubil. The project is currently dormant due to the Glencore divestment process and the expensive nature of exploration in the

area.

Figure 7: Exploration Licenses Figure 8: Location map

Source: Highlands Pacific Source: Highlands Pacific

To date HIG has preliminarily drilled six of 17 targets with the majority of the targets producing shows of porphyry style copper - gold mineralisation. In 2012, 5,600 metres of diamond drilling was completed with all but one of the 5 targets drilled, intersecting copper and gold mineralisation. Highlights include;

• Olgal: 596ms at 0.61% copper and 0.85g/t gold starting 24m below the surface.

• Kum Kom: 68ms at 0.97% copper and 0.37g/t gold from 280m and 22m at 1.42% copper and 0.57 g/t gold. 14 holes have been drilled at Kum Kom with all but two

producing copper and gold mineralisation.

The exploration success at Olgal during 2012 crystallised the potential benefits for the Ok Tedi Mine when its 63.4% owner, PNG Sustainability Development Program Limited (PNGSDP), became a cornerstone investor in HIG.





Corporate structure

Highland Pacific is listed on the Australian Securities Exchange (ASX: HIG) and Port Moresby Stock Exchange (PoMSoX: HIG). There are 853.8m shares and 9.6m options on issue, which derives a current market cap of $48.7m. The Company has approximately $6.5m in cash. PNA will have the right to subscribe to a second tranche of $5m at 7.76cps once the PanAust Glencore Agreement is completed.

Figure 9: Substantial Shareholders

Substantial Shareholders Shares (m) %

PNG Sustainable Development Fund 102.6 12.0

Baker Steel 71.0 8.3

PanAust 64.4 7.5

National Super Fund 48.1 5.6

Source: Bloomberg

Investment risks

HIG is subject to various financial and operational risks and uncertainties that could have a significant impact on potential profitability and levels of operating cash flow. These risks and uncertainties include, but are not limited to: fluctuations in metal prices (principally the price of gold, copper and nickel), capital and operating cost estimates, borrowing risks,

production estimates, need for additional financing, uncertainty in the estimation of mineral reserves and mineral resources, the inherent danger of mining, infrastructure risk, hedging activities, insured and uninsured risks, environmental risks and regulations, government regulation, ability to obtain and renew licenses and permits, foreign operations risks, title to properties, competition, dependence on key personnel, currency, repatriation of earnings and stock exchange price fluctuations.

Financials

HIG is a Company limited by shares that is incorporated in, and domiciled in Papua New Guinea. The Company is subject to the Companies Act 1997 of Papua New Guinea and not the Corporations Act 2001 of Australia. The PNG Securities Act 1997 (the “Securities Act”) also applies to the Company and its shareholders. The Securities Act governs the offering of securities to the public in PNG and deals with the requirements for a prospectus to be prepared in connection with the offering of securities.

HIG’s audited financial statements for the year ended 31 December 2013 highlighted that the Company is hedge and debt free and it incurred a loss of US$37.1m primarily due to an impairment charge on the Company’s investment in exploration, development and commercial activities in Papua New Guinea.





Highlands Pacific Ltd 0.059Valuation Equity (%) A$m A$/sh Commodity Assumptions 2013A 2014F 2015F 2016FFrieda River 20% 175 0.05 A$:US$ 0.97 0.91 0.90 0.90Ramu Nickel Cobalt Mine 8.6% 78 0.02 Copper (US$/lb) 3.26 3.15 3.16 3.24Star Mountains 100% 10 0.00 Gold (US$/oz) 1410 1303 1310 1315Exploration 0 0.00 Nickel (US$/lb) 6.83 8.14 9.53 9.53Listed Investments 0 0.00 Zinc (US$/lb) 0.87 0.93 0.99 1.00Corporate (20) (0.01) Silver (US$/oz) 23.87 20.40 20.93 21.50

Unpaid Capital 0 0.00 Cobalt (US$/lb) 15.00 15.11 15.69 16.32Debt 0 0.00Cash est. 6 0.00 Production Summary 2013A 2014F 2015F 2016FNAV @ 10% Discount Rate 250 0.08 Frieda RiverPrice Target 0.08 Cu in Concentrate (kt)

Sensitivities -10% 0 10% Cash Costs (US$/lb)A$ : US$ $0.08 $0.08 $0.07 Price ReceivedCopper Price (US$/lb) $0.04 $0.08 $0.14 Ramu Nickel Cobalt MineNickel Price (US$/lb) $0.07 $0.08 $0.08 Ni in Concentrate (kt) 2.6 2.6

Cash Costs (US$/lb) 4.56 4.25Valuation Summary of Assets Price Received 9.54 9.56

Production kt 2.6 2.6Cash Cost (US$/lb) $4.56 $4.25Price Received $9.54 $9.56

Profit & Loss (US$m) 2013A 2014F 2015F 2016FSales Revenue 0.0 0.0 47.4 47.7Other Income (27.4) 0.2 0.7 1.4Operating Costs 0.7 0.0 27.8 26.7Exploration Exp. 4.1 0.0 0.0 0.0Corporate/Admin 4.8 3.2 3.3 3.3EBITDA (37.1) (3.0) 17.1 19.1

Copper Production Summary Depn & Amort 0.1 0.0 1.4 1.4EBIT (37.2) (3.0) 15.7 17.7Interest 0.0 0.0 0.0 0.0Operating Profit (37.2) (3.0) 15.7 17.7Tax expense 0.0 0.0 0.0 0.0Minorities 0.0 0.0 0.0 0.0Abnormals and FX adjustments 0.0 0.0 0.0 0.0NPAT (37.2) (3.0) 15.7 17.7

Normalised NPAT (37.2) (3.0) 15.7 17.7

Cash Flow (US$m) 2013A 2014F 2015F 2016FAdjusted Net Profit (37.2) (3.0) 15.7 17.7+ Interest/Tax/Expl Exp 4.1 0.0 0.0 0.0- Interest/Tax/Expl Inc 5.3 2.0 2.0 2.1+ Depn/Amort 0.1 0.0 1.4 1.4+/- Other 27.5 0.1 0.0 0.0

Reserves & Resources Operating Cashflow (10.8) (4.9) 15.0 17.0

Measured & Indicated (Mt) grade - Capex (+asset sales) 0.0 0.0 1.8 1.8- Other investing cashflow 0.0 0.0 0.0 0.0

Horse-Ivaal-Tukai Copper 1190.0 0.49% 5831 kt - Working Capital Increase 0.0 0.0 0.0 0.0Gold 0.25 g/t 9.3 Moz Free Cashflow (10.8) (4.9) 13.3 15.2

Nena Copper 33.0 2.81% 927.3 kt - Dividends (ords & pref) 0.0 0.0 0.0 0.0Gold 0.65 g/t 0.7 Moz + Equity raised 4.7 4.7 0.0 0.0

+ Debt drawdown (repaid) 0.0 0.0 0.0 0.0Net Change in Cash (6.0) (0.2) 13.3 15.2Cash at End Period 8.6 8.4 21.7 36.9Net Cash/(LT Debt) 8.6 8.4 21.7 36.9

DirectorsName Position Balance Sheet (US$m) 2013A 2014F 2015F 2016FKen MacDonald Non-Executive Chairman Cash 8.6 8.4 21.7 36.9John Gooding Managing Director Total Assets 71.0 65.8 87.2 104.9Mike Carroll Non Executive Director Total Debt 0.0 0.0 0.0 0.0Dan Wood Non Executive Director Total Liabilities 6.9 0.0 5.7 5.7Bartholomew Philemon Non Executive Director Shareholders Funds 64.1 65.8 81.5 99.1

Substantial Shareholders Shares (m) % RatiosPNG Sustainable Development Fund 102.6 12.0 Net Debt/Equity (%) na na na naBaker Steel 71.0 8.3 Interest Cover (x) na na 0.0 0.0PanAust 64.4 7.5 Return on Equity (%) na na 19.2 17.8National Super Fund 48.1 5.6 EBITDA margin na na 36.0 40.0

contained metal

Ramu Nickel Cobalt Mine

30%

Frieda River66%

Star Mountains4%

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Frieda River Ramu Nickel Cobalt Mine

Cash Cost (US$/lb) Price (US$/lb)





Recommendation History

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02 Dec 13 Research Note 0.09 0.07 H

03 Feb 14 Research Note 0.07 0.07 H

Current Share Price 0.06

Stock recommendations: Investment ratings are a function of Patersons expectation of total return (forecast price appreciation plus dividend yield) within the next 12 months. The investment ratings are Buy (expected total return of 10% or more), Hold (-10% to +10%

total return) and Sell (> 10% negative total return). In addition we have a Speculative Buy rating covering higher risk stocks that may not be of investment grade due to low market capitalisation, high debt levels, or significant risks in the business model. Investment ratings are

determined at the time of initiation of coverage, or a change in target price. At other times the expected total return may fall outside of these ranges because of price movements and/or volatility. Such interim deviations from specified ranges will be permitted but will become

subject to review by Research Management. This Document is not to be passed on to any third party without our prior written consent.

HIGHLANDS PACIFIC A well funded optionof Chinese approval of last year's merger between the...

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