The Mining Report interviews Luke Smith, head of mining research at Canaccord Genuity in Melbourne, Australia.
The Mining Report: Australian mining shares had a great July. Was that a one-off or indicative of a trend?
Luke Smith: July tends to be good because the fiscal year-end for most personal investors in Australia is June 30, so there is tax-loss selling up to that date. That said, this July was better than average. The gains slowed down at the end of the month, but we’ve seen a liftoff again from the middle of August. Hopefully, this trend will continue, and we’ll see the revival of Australia’s small-resources sector.
TMR: Asian countries such as China and Indonesia are moving toward added-value mining. What implications does that have for Australian mining?
LS: Indonesia is a large supplier globally of tin, nickel and pig iron. The decrease in tin from there is counteracted to some degree by Myanmar becoming a tin producer overnight. The decrease of Indonesian nickel has already been positive for Australian nickel producers and explorers and the nickel price on the London Metals Exchange.
“Syrah Resources Inc. owns the Balama project, which contains close to 1.2 Bt with about 10% total contained graphite.”
TMR: Newcrest Mining (NCMGY), Australia’s biggest gold miner, has suffered a lot of bad news lately, including a $2.5 billion ($2.5B) writedown and a class action suit. To what extent do its woes mirror that of Australia’s gold industry as a whole?
LS: Newcrest is the big daddy of Australian mining companies. Because of its size, it is held by retail investors, as well as by institutions. Obviously, the big gold price decline last year did hurt everyone in that sector. And yet, what happened to Newcrest was very company specific.
Despite the much lower gold price, several Australian gold producers have taken that hit in their stride, moved forward and are prospering.
TMR: Newcrest released its year-end financials Aug. 18, reporting a statutory loss of $2.2B and an underlying profit of $432 million ($432M). Did this match your expectations?
LS: Pretty much. We have seen a shake-up of management there, and I think this will continue. The company has announced it will not shelve its Lihir gold project in Papua New Guinea, neither will it put some of its assets on care and maintenance. Marginal levels of free cash flow have appeared, but there is a lot of work to do over the next 12–24 months before Newcrest restores its credibility.
TMR: Newcrest shares have recovered from a low of under $10 in June to more than $11 today. Will shares continue to rise?
LS: Newcrest shares dropped from about $40. I think the share price has stabilized around the $9–11 mark. Share recovery is going to take time.
TMR: The company’s all-in sustaining cost of gold production was reported at $976/ounce ($976/oz), 24% lower than the previous year. Is this something we’ve seen from other Australian gold producers?
LS: Absolutely. One nice aspect about gold mining is that companies can react relatively quickly to lower prices, unlike iron ore and coal companies. Newcrest is not alone in reducing its all-in costs by raising head grades and cut-off grades. All across our coverage list, from the smaller miners to the larger, companies are making the changes necessary to maintain margins.
TMR: How difficult is it for Australian gold miners to make profits at current prices?
LS: Some are struggling, particularly in the bottom quartile. We have seen all-in costs drop between $100/oz and $300/oz for most of the companies we cover. The profitability is there. What we focus on at Canaccord Genuity are increased free cash flows and improving net-cash positions.
TMR: What do you expect from the gold price for the remainder of 2014?
LS: There will still be rises and falls of $20–30/oz on particular days, but we forecast the price trend toward the $1,300–1,350/oz range over the remainder of 2014.
TMR: Would you comment on the prospects for some of the Australian junior gold producers you follow?
LS: I’ll talk about two. The first is Beadell Resources (BDREF), which has Tucano, a very good gold operation in Brazil’s Amapá State. It’s been operational since late 2012 and has nameplate throughput of around 3.5 million tons per annum (3.5 Mtpa). However, in the last three quarters it’s been running at 4 Mtpa. It has about 5 million ounces (5 Moz) in gold resources and roughly 2 Moz in reserve. We expect it to produce around 190,000 oz (190 Koz) at an all-in sustaining cost of around $800/oz.
Beadell’s market cap is around $400M, and it has a mine life of at least eight years. It should delineate its maiden underground reserve sometime in the next six months, which should in turn extend mine life or lift the production profile. I like this company because its all-in sustaining cost is in the lower quartile for Australian producers, and it is in a pretty stable jurisdiction.
TMR: Wasn’t Beadell’s most recent quarterly production a disappointment?
LS: It was. Due to torrential rains, many other Brazilian miners suffered similar disappointments. Not just gold miners but iron ore as well. Amapá recorded 46% more rain than average during the June quarter. As a result, material movements fell to 2.1 million tons (2.1 Mt) from 3.4 Mt a year earlier, and guidance has been downgraded by 20 Koz to 180–200 Koz. At this month’s Diggers & Dealers conference, however, Beadell reiterated that guidance, and reported much improved mining operations in the September quarter to date.
TMR: What’s your rating and target price for Beadell?
LS: We have a Buy rating and a target price of $0.86. It trades currently at $0.475. Its price/net asset value ratio looks very attractive.
TMR: What’s the second Australian gold producer you wanted to discuss?
LS: Silver Lake Resources (SVLKF). It’s been a producer since 2008. Earlier this month I visited its key asset, a high-grade, underground mine called Daisy Milano in Western Australia. Things are looking good there. The company has no debt and about $30–35M cash and bullion. It has a market cap of just under $200M.
TMR: How good are its all-in cash costs?
LS: For FY/15, we forecast the all-in cash costs to be just over AU$1,000. The Aussie gold price is about AU$1,400/oz, so it has a margin of about AU$400/oz. I estimate it will produce around 139 Koz for FY/15. That means a significant amount of free cash flow. That’s why we believe Silver Lake has strong appeal.
TMR: Silver Lake just bought the last 15% of the Mount Monger joint venture from Newcrest for $1.5M. What’s the significance of that?
LS: It’s a good little deposit less than 20 kilometers (20km) from its mill, with 100 Koz gold in reserve: part open-pit, part underground. The underground reserve is running over 7 grams per ton (7 g/t), pretty strong for an Australian mine, and the open pit is running around 3.5 g/t. Now that the company owns 100% of this asset, it’s ready to spend money on it and, hopefully, expand and improve it. Drill rigs are on site as we speak. If drilling success can increase the reserve profile, it should enhance mine life.
TMR: What’s your rating and target price for Silver Lake?
LS: A Buy rating and a $0.66 target price. It trades currently at $0.44.
TMR: Moving on to graphite, China has announced it will replace green petroleum coke with graphite in its aluminum production. How important is this?
LS: It could expand the graphite market considerably. However, commercial decisions must be made, such as, what kind of graphite will be used? Flake graphite? Medium graphite? Amorphous graphite? Chinalco (Aluminum Corporation of China ACH) and Chalieco (China Aluminum International Engineering Corporation) are leading this research.
TMR: You’re bullish on graphite. How would you compare your view of this sector today to the graphite boom earlier this decade?
LS: In Australia, the boom occurred around May 2012. Some graphite companies and junior explorers really did take off. They then fell just as quickly. Two years later, Australian graphite companies have learned that success depends on end markets: knowing your customers and what kind of graphite they demand. We are still in the early stages of understanding this sector, however, because producing graphite is much more complicated than producing copper cathode or gold bars.
TMR: How much is expected growth in the graphite industry dependent upon popular adoption of the electric car?
LS: Not much, actually. Less than 10% at the moment. However, the sentiment is much stronger than that, and sentiment is what often drives share prices. Graphite company managements are keen to point out that electric vehicles will be very good for graphite. It is worth noting, however, that the evolution of lithium-ion batteries and electric vehicles is ongoing. The materials going into these batteries can and probably will change. Right now, less than 5% of graphite production goes into lithium-ion, but there is potential for that to increase considerably.
TMR: Will Elon Musk’s Gigafactory for Tesla (TSLA) advance the graphite market appreciably?
LS: It will. The Gigafactory will require a lot of graphite and lithium, but we don’t know how much. Will the new generation of lithium-ion batteries used in the Tesla require 20 kilograms (20kg) per battery or 50kg? This question affects lithium demand as well, and I don’t think the market completely understands these variables. Tesla could lift graphite demand by, let’s say, 5% or perhaps 15%.
TMR: Which is your favorite near-term graphite producer?
LS: Syrah Resources (SYAAF) is the frontrunner. Its market cap is about $900M. It owns 100% of the Balama project in Mozambique, which contains close to 1.2 billion tons with about 10% total contained graphite. I’ve visited Balama, and it is effectively a 6km-long topographic high rising out of the countryside.
Syrah has signed a number of memos of understanding (MOUs) for offtake, one with Chalieco, a company we mentioned earlier. That created a lot of credibility. The company could produce somewhere north of 300,000 tons per annum (300 Ktpa) graphite, roughly 30% of the known traditional graphite market. That could possibly push down graphite prices, but the X factor in demand is the growth of the electric vehicle market and, as mentioned earlier, the substitution of graphite for green petroleum coke in aluminum production.
TMR: Can we expect the Balama bankable feasibility study (BFS) in September, as scheduled?
LS: A BFS for the world’s largest graphite operation requires a great deal of work. Now, Balama won’t need a large plant because the in-situ deposit grade is exceptionally high. We’re looking at front-end throughput around 2 Mtpa. I expect publication sometime between October and December.
TMR: Will Balama be required to sell enormous amounts of graphite to be profitable?
LS: No. It could sell a small amount of graphite and still be profitable. Syrah is focusing first on customer demand and will then work backwards from there. Demand from the two MOUs already announced totals 240 Ktpa graphite concentrate annually. The company is likely talking to more customers and could potentially sign further offtake agreements in 2014. Syrah understands the market.
TMR: Production is scheduled for March 2016. Is this a firm date?
LS: Syrah’s senior management team is based here in Melbourne, and we meet with them regularly. I think Q1/16 is a reasonable timeframe and still very much achievable. Locking in the offtakes and then securing financing on the back of this are the key hurdles the company must clear to meet that date.
TMR: How important to the project is Balama’s vanadium component?
LS: Vanadium is a byproduct and thus not crucial to commercial success. It could be put out into the tailings or the gangue material and then be forgotten forever, and Balama, in my view, would still be extremely profitable. It’s the icing on the cake. The just released first scoping study for the vanadium demonstrates additional net present value and value accretion to Syrah.
We should have a Balama vanadium feasibility study soon after the release of the graphite BFS. The company has a number of options. It could create a semi-vanadium concentrate that would then be upgraded in the secondary and tertiary processes. Capital expenditures (capexes) for producing vanadium pentoxide, which Syrah is looking to produce, do not need to be funded upfront. The vanadium processing stream might be added two or three years after the graphite stream is up and running.
TMR: What’s your rating and target price for Syrah?
LS: A Buy rating and a target price of $8.76. When I initiated coverage a year ago, shares were $2.55. They’re around $4.82 now.
TMR: How many new graphite producers will be required by 2020? Several analysts interviewed by The Mining Report are convinced we will see no more than three or four winners. What do you think?
LS: I think that’s possible. There are many listed graphite companies, but few have the grand plan Syrah does. Some of the smaller projects can succeed, as the graphite market serves a number of different kinds of end users. Not all graphite is the same, of course. It varies in kind, flake size and purity, and these different kinds of graphite have different uses.
TMR: Let’s talk about lithium. Is it more or less important than graphite to the battery revolution?
LS: There is a lot less lithium used in a lithium-ion battery than graphite at the moment, but lithium is more important and less likely to be substituted. If you remember your high school chemistry class, lithium is the third element on the periodic table. It’s one of the lightest metals out there and a fantastic conductor of electricity. It has great energy-storage and energy-density principles. What lithium can deliver in rechargeability and energy density makes it fantastically attractive for use in electric vehicles, where weight is a significant design factor.
Lithium is not so critical for residential and static energy storage, however, as weight and size there are not as important. The vanadium redox battery might become more prevalent in those sectors. As far as transportation usage goes, however, the lithium-ion battery is likely to remain at the forefront for at least a decade.
TMR: How much will lithium production increase by 2020?
LS: There has been about 8% compound annual growth since the beginning of the decade, and it’s still growing. The electric vehicle lithium-ion battery portion of the lithium market remains relatively small, but it is in this sector that we have exponential growth. A wide range of estimates exists, but it would be reasonable to predict 10% annual growth to 2020 or 2025.
TMR: What’s your favorite near-term lithium producer?
LS: There are not many to choose from. Lithium, unlike graphite, is much harder to find in deposits and, more important, in economic quantities. RB Energy (RBEIF), formerly Canada Lithium Corp., is just finishing the commissioning of its Quebec lithium project. That’s a hard rock asset, like Talison’s Greenbushes operation in Australia, which is now held 51% by Chengdu Tianqi Industry Group and 49% by Rockwood Holdings (ROC). The near-term lithium producer I like is Orocobre (OROCF).
TMR: What distinguishes Orocobre?
LS: Orocobre owns 66.5% of the Olaroz lithium-brine project in Jujuy Province, Argentina. The company announced Aug. 18 that commissioning will begin by the end of the month. What brings a great deal of authority to Olaroz is that 25% is owned by Toyota Tsusho (TYHOF), a subsidiary of Toyota (TM), and much of the debt funding for this project has come from Japanese banks.
Olaroz should start production of lithium carbonate and battery-grade lithium carbonate in October. It has a nameplate of about 18 Ktpa lithium carbonate, about 10% of the current world market. Roskill, the industrial-commodity expert, has stated that it believes Orocobre will be the lowest-cost producer of lithium carbonate globally. It will have an exceedingly long project life.
TMR: What is Olaroz’s sustaining capex?
LS: The project will produce lithium from a salar, a salt lake, and this has enabled a capex of only $230M. This is not traditional mining; there are no trucks or shovels, no crushing or grinding. The majority of the capex went into the infrastructure, which includes evaporation ponds that stretch over many hectares and a gas pipeline for the gas power station, which was built on site. The rest went into the pumping stations and the lithium-carbonate plant.
TMR: Should an Argentinean project worry investors?
LS: No. I’m quite familiar with Argentina, having traveled there many times for almost two decades. Olaroz is in Jujuy, an impoverished Andean province, and it will be a significant source of economic development and provincial revenue. To underline this, 8.5% of the project is owned by the provincial government, and it was signed off by President Christina Kirchner herself. The joint-venture entity, which legally owns the asset, is actually domiciled in Singapore, which provides stability and confidence.
TMR: Olaroz has potash and borax as well. How significant are these to profitability?
LS: The potash will be a byproduct credit, which will become more important in two to three years. The borax, of which Orocobre owns 100%, is actually quite important now. It produces cash flows, which are expanding. The company has just finished relocating the borax plant closer to the mine site, which will further increase margins.
TMR: What’s your rating and target price for Orocobre?
LS: A Buy rating and a target price of $3.77. The current price is $3.30. Our price target is based solely on the discounted cash-flow valuation for the Olaroz lithium-brine project. As this moves into production, I would anticipate a revisit of the price target, and I expect the stock will be rerated by the market. This is what makes Orocobre so exciting.
TMR: In Australia, as in Canada, there has been grave concern about the amount of “zombie” companies on the national stock exchange. Has the necessary purge been completed, and is the Australian Stock Exchange (ASX) much healthier as a result?
LS: Unfortunately, no. As of the last quarter, 226 ASX-listed companies don’t have enough cash to cover the next quarter of proposed cash outflows. They continue to find ways to stay afloat and listed, but I believe that further purging and consolidation will be required for the ASX to be restored to health.
TMR: Luke, thank you for your time and your insights.
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Luke Smith is head of mining research at Canaccord Genuity in Melbourne, Australia. He worked previously as an analyst and fund manager for Ord Minnett and the Lion Selection Group. He holds a Bachelor of Engineering in mining, honors, and a Master of Commerce in finance. Smith was a mining engineering consultant for several years.
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