This commentary is being submitted to Seeking Alpha by Robin Goad, President and CEO of Fortune Minerals Limited (OTCQX:FTMDF) (Fortune) in response to the recent article published June 7, 2016, authored by Itinerant, and entitled: Fortune Or Mis-Fortune?. The Itinerant article followed an earlier article published on June 1, 2016 by Mathew Bohlsen entitled, Fortune Minerals Could Make Investors A Fortune.
Fortune is submitting the commentary below to provide clarity to some of the statements made by Itinerant and to allow for a more comprehensive review of our Company and its investment thesis. We feel that Fortune is particularly well positioned with the "shovel-ready" NICO Cobalt-Gold-Bismuth-Copper (NICO) development asset, which contains significant cobalt reserves from which it plans to produce chemicals used in the manufacture of lithium-ion batteries. The demand for these batteries is rapidly growing due to their use in portable electronic devices, continued proliferation of electric vehicles, and new markets in stationary storage cells to store wind and solar generated power, and off-peak charging from the electrical grid. NICO also contains more than 1.11 million ounces of gold and 12% of global bismuth reserves - a metal also experiencing increasing demand due to its unique physical and chemical properties and as a non-toxic and environmentally safe replacement for lead.
Fortune has invested more than C$115 million toward the development of its flagship NICO project, having evolved from an in-house discovery in 1996, through several resource cycles, to the point where the Company is now focused on securing off-take agreements and project financing for construction. The NICO development is comprised of a planned mine and concentrator in Canada's Northwest Territories and refinery in Saskatchewan where concentrate from the mine will be processed to value-added products. The primary products include battery-grade cobalt chemicals for lithium-ion batteries, gold doré and bismuth metals and chemicals, with minor by-product copper. The refinery is designed to have flexibility to adjust production to other cobalt and bismuth products as markets dictate and to be able to toll process concentrates from other mines with similar metal concentrates. The longer-term vision of the facility is to diversify production into the metals recycling business.
The NICO development has already been assessed in a positive feasibility study, test mining has been done to verify the grade and geometry of the deposit, and to collect bulk samples for pilot plant testing, which confirmed the process flow sheet, projected metal recoveries, and produced samples of products that meet or exceed the specifications required from potential customers. NICO has also received its environmental assessment approvals in the Northwest Territories and Saskatchewan , has undergone Front-End Engineering & Design (FEED) studies by a consortium of respected engineering firms, and has an Execution Plan for project delivery.
Contrary to the allegation in the Itinerant article, NICO was not an opportunistic rebranding of a project to capitalize on recent investor interest in Energy Metals and cobalt, the project has always been represented as a polymetallic deposit, with three principal co-products, and with cobalt typically being the dominant source of revenue. NICO has Proven and Probable Mineral Reserves of more than 33 million metric tonnes, containing 1.11 million ounces of gold, 82.3 million pounds of cobalt, 102.1 million pounds of bismuth, and 27.2 million pounds of copper to support a 21-year open-pit mine life at a mill rate of 4,650 tonnes of ore per day (see Fortune filings on the SEDAR website) for details and the Company news releases, dated April 2, 2014, and May 7, 2014). Fortune has been a long-term outspoken advocate for the opportunities of both cobalt and bismuth, and also pointed to the benefit of having significant gold as a highly liquid co-product that is counter cyclical and can be used to help finance the development. In the 2014 feasibility study for NICO, base case price assumptions result in 39% of the revenues from cobalt, 33% from gold, 27% from bismuth and 1% from copper. Metal price volatility sometimes produces scenarios where the gold can dominate the revenue stream, and we have always noted the importance of the gold contained in the deposit.
Fortune produced cobalt sulphate in a 2012 pilot plant designed to meet or exceed the specifications required by lithium-ion battery producers and support the conclusions of our subsequent 2014 feasibility study. Early recognition of the opportunity in cobalt sulphate was the result of our thorough understanding of the cobalt market and proactive engagement with large battery producers in Asia as a result of our pursuit of strategic partners for project financing. This work allowed the Company to design a project producing the best products to meet market needs from the growing demand in batteries, and notably cobalt sulphate also typically receives a premium price for the cobalt contained as compared to the price for cobalt metal. This was obviously not an opportunistic reaction to recent interest in Energy Metals as we produced our first cobalt sulphate sample two years prior to Tesla's (NASDAQ:TSLA) Giga-factory announcement.
NICO will also produce a highly liquid gold co-product and has projected average annual production of 1750 tonnes of bismuth contained in metal and oxide. Bismuth is used in pharmaceuticals, automotive pearlescent paints, anti-corrosion coatings, and windshield frit, and a non-toxic replacement for lead in plumbing and electronic solders, brass, steels and aluminum alloys, cosmetics, paint pigments and free-machining steel. NICO will also have tax advantages over Asian producers under the North American Free Trade Agreement, and notably 80% of current bismuth supply is from China.
The principal use of cobalt is in the cathodes of high-performance lithium-ion rechargeable batteries, which now account for about 50% of cobalt demand in an annual global market of approximately 110,000 metric tonnes. Cobalt demand has grown at a compound annual growth rate (CAGR) of 5-6% for more than two decades during which cobalt use in batteries has grown from about 1% of the market in the mid-1990s. This demand growth in batteries evolved from cobalt's use in Nickel-Cadmium (Ni-Cd) batteries, to Nickel-Metal Hydride batteries containing more cobalt, to today's lithium-ion batteries with up to 60% cobalt by weight. Lithium-Cobalt-Oxide (LCO) batteries have the greatest cobalt content and are used principally in small electronic devices such as mobile telephones, portable computers, power tools and toys. Lithium-ion batteries with Nickel-Cobalt-Aluminum (NCA) and Nickel-Manganese-Cobalt (NMC) cathode chemistries contain 10% to 20% cobalt by weight and are favored in electric vehicles and stationary storage cells. The lithium-ion battery was invented in the early 1980s, and variants of these batteries are expected to dominate the rechargeable battery industry for at least the next decade because of the long lead times required from the invention of new products through to customer validation with minimal liability risks.
Cobalt is also contained in superalloys used in the aerospace industry, magnets, cutting tools and cemented carbides, pigments, and catalysts used in the manufacture of PET plastics, tires and petroleum refining to remove sulphur and other impurities. Cobalt is used in agriculture and is the source of Vitamin B-12.
While cobalt is facing the same demand pressures as lithium, it has different supply characteristics. It is primarily produced as a by-product of copper and nickel mining, and as the price of these metals has declined, a number of mines have closed, resulting in tighter supply and greater geographic concentration of supply. The Democratic Republic of the Congo (the DRC or Congo) is responsible for about 65% of cobalt mine production and is a politically unstable country that is prone to violence and civil war. It also has labor practices that were recently the subject of an Amnesty International Report highlighting the use of child labor and unsafe working conditions from artisanal production (about 20% of DRC mine production). Additionally, about 52% of cobalt refinery production is in China, primarily from raw materials procured from the Congo, and this compounds the risks associated with geographic concentration of supply with policy risk. The concentration of cobalt supply risk will be exacerbated if Freeport-McMoRan (NYSE:FCX) completes its recent announced sale of the controlling interest in the Tenke Fungurume mine in the Congo to China Molybdenum (OTC:CMCLY) for US$2.65 billion (up to US$3 billion if the Kokkola refinery in Finland and other development assets are also included).
Supporting the positive outlook for cobalt, Tesla Motors, in partnership with Panasonic (OTCPK:PCRFY), is constructing the US$5 billion Giga-factory in Nevada to produce lithium-ion batteries with NCA cathode chemistry to reduce the price of Tesla's cars by lowering the cost of batteries through economies of scale. Tesla made automotive history on March 31, 2016, with the launch of its Model 3 electric vehicle, receiving US$325 million in deposits for 325,000 preorders of these cars in the first week (now ~400,000 orders). If these orders are converted into annual sales, production of the Tesla Model 3 would be comparable to the top selling vehicles in North America. Mainstream interest in electric vehicles has therefore been validated by thousands of people lining up to make a US$1,000 down payment for a car that will only be available in late 2017.
Due to the strong growth in demand for cobalt in batteries, Commodities Research Unit (CRU) and other analysts are projecting the cobalt market will transition to a supply deficit in 2016, extending into the foreseeable future, and should result in stronger prices, at least to historical averages. A June 1, 2016, Metal Bulletin article noted that the cobalt price is currently at the very low end of its price range over the past four decades. Cobalt metal had highs of over US$50/lb in 1978 and 2008 and has bounced between US$15/lb and US$30/lb regularly over this period. The price has only dipped briefly below US$10/lb on three or four times over the period. Cobalt metal has recently been trading around US$10-11/lb.
Fortune's NICO asset is well positioned to become a reliable, vertically integrated North American supplier of battery grade cobalt chemicals with supply chain transparency and custody of raw material from ores through to the production of the value-added chemical products.
In his June 7 article, Itinerant correctly points out that the development of NICO will not solve the world's demand for cobalt. That is because many NICO-sized projects will be needed to satisfy the continued growth in cobalt demand. With 6% CAGR of an 110,000 tonne market indicates that an additional 6,600 tonnes of new cobalt production will be needed just to satisfy next year's demand growth - let alone service a projected increasing rate of growth from greater acceptance of electric cars. With life-of-mine average annual production of 1,615 tonnes of cobalt contained in a 20.9% cobalt sulphate heptahydrate product from NICO, the world would need two to three new NICO-sized projects to come on stream each year just to satisfy near-term growth.
Itinerant is correct to point out that cobalt did not receive significant investor interest until the demand from batteries became more universally recognized - in part due to the profile of companies like Tesla. However, we respectfully disagree with his characterization of cobalt as an obscure metal that no one cared about. Cobalt is an essential metal needed in many critical applications where it cannot be easily substituted - such as superalloys used in jet engine turbines, Co-Sm magnets, and catalysts. Due to its critical defense applications, the U.S. Defense Logistics Agency (DLA) has kept a strategic stockpile of cobalt and recently announced that it will begin stockpiling cobalt battery chemicals in addition to metal. Since September 2015, China's State Reserve Bureau has stockpiled 5,000 tonnes of cobalt metal and is expected to purchase another 2,000 tonnes by the end of 2016. Both cobalt and bismuth were identified in a recent report of critical minerals to the U.S. Congress as, "having a supply chain that is vulnerable to disruption, and that serve an essential function in the manufacture of a product, the absence of which would cause significant economic or security consequences". Cobalt and bismuth are also on the Critical Minerals list for the European Union.
We respectfully disagree with Itinerant regarding his statement that supply used to be practically guaranteed. Most cobalt is produced as a by-product of Copper-Cobalt mines in the Central African Copper Belt (DRC and Zambia) and in Nickel-Cobalt Laterite and Nickel-Cobalt Sulphide deposits. Many of these mines are currently uneconomic because of low metal prices, resulting in the closure or production cuts at Katanga (Congo), Mopani (Zambia), Votorantim (Brazil) and QNI (Australia). Near-surface oxide deposits in the DRC that are commonly exploited by artisanal miners and their production sold to China, because the materials are amenable to atmospheric acid leach processing to recover copper and cobalt are being depleted. Mining of these near-surface deposits is transitioning to deeper sulphide ores that require more expensive pyro-metallurgical or pressure acid leach processing to recover the metals. The DRC has also had an unstable political history including several civil wars, which has contributed to the volatile cobalt price. There are elections planned later this year to choose a new president, and additional violence has been predicted because the current president, Joseph Kabila, has indicated he will likely not abide by the Constitution precluding him from running for a third consecutive term.
Most Nickel-Cobalt Laterite projects are also currently losing money on a cash basis and will likely never repay invested capital, typically in the multiple billions of dollars. Glencore (OTCPK:GLNCY), Vale (NYSE:VALE) and the owners of other Nickel-Cobalt Laterite deposits are conducting reviews to determine if their mines are viable and should be closed. Nickel-Cobalt Sulphide deposits are treading water at current metal prices. The price of nickel must go up or other suppliers will be forced out of business further impacting cobalt supply. Geographic diversification of supply is also needed to alleviate supply chain risks and the dominant position in the market by the DRC and China.
In his June 7 article, Itinerant correctly notes that there has been a devastating resource bear market since 2011, but suggests Fortune's share price performance over this period was a negative outlier from the rest of the sector. In fact, this has been one of the worst, if not the worst "Bear" resource market in many decades that not only impacted the juniors, but also challenged the viability of the very largest companies in the sector. The S&P/TSX Venture Index is considered a proxy for the junior resource space even though other sectors are also represented in the index (currently materials and energy account for ~70% of the index). The Venture Index declined from a peak of 2,450 in 2011 to below the 500 level in early 2016 - an 80% drop in value. Many companies over this period have simply gone bankrupt. Major mining companies have had similar issues of share price declines leading to dilutive share offerings, asset sales, dividend cuts, mine closures or other actions necessary for survival. In 2015 alone, Glencore declined 70% to hit record lows on fears of insolvency and has since eliminated its dividend, sold assets and issued shares to reduce debt levels. Other industry giants such as BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), Anglo (NYSE:AU) and Vale also experienced massive share price declines and conducted asset sales to mitigate losses. BHP, for example, slashed its dividend by 75%, abandoning a long policy of steady or higher payouts, and Anglo restructured to cut its work force by 85,000 people.
The major companies, particularly the gold producers, have started to recover, and confidence is returning to the junior market for companies with real assets like Fortune. Some junior companies may never recover, resulting in a further culling of companies that do not have attractive assets. At the 2016 PDAC, John Kaiser noted that, "Almost three-quarters of the companies have been side-lined, marginalized and taken out of the equation. The garbage is gone."
Itinerant points out that these sector challenges contributed to Fortune's share price declines, but was critical of the Company's default on the debt used to finance the acquisition of the Revenue Silver Mine in Colorado. This silver mine was acquired in its commissioning phase with the intent to generate cash flow from a producing mine and minimize share offerings to maintain working capital. The mine was also intended as a means to deploy the operating team the Company had assembled to develop NICO. Silver prices had declined from US$35/oz to US$23/oz at the time of the acquisition, and downside risk was considered to be US$18/oz. The Company did not foresee US$13/oz silver, and we suspect few investors did. The effective closure of the capital markets in 2014 and 2015 also required the Company to complete the staged acquisition of the mine with an expensive streaming/debt instrument. Add operational issues, primarily inherited from the mine's previous ownership, and the need to constantly modify the mine plan and incur additional development work cost to access higher-grade areas of the deposit in response to declining metal prices - and the result was a default on the debt repayment. However, Itinerant failed to recognize the significant achievement by management in saving Fortune and the restructuring of US$55 to US$85 million in debt that was previously secured by its assets - to an C$8.75 million unsecured debenture with interest at 5% per annum accruing semi-annually and repayable at maturity in 2022.
Itinerant was also critical of the sale of the Arctos anthracite coal project to the British Columbia Government, which he attributed to being linked to the loss of the Revenue Silver Mine. He failed to recognize that this project was stalled by an unresolved First Nations issue and that Fortune was also facing another issue of having to finance the next phase of scheduled expenditures under its obligations with its joint venture partner POSCO (NYSE:PKX). The Company was able to settle both of these issues pursuant to the sale while also monetizing a coal asset for $18.3 million at a time of extremely low coal prices, and in an environment in which some of the largest coal companies in North America such as Peabody Energy, Arch Coal, Patriot Coal, Alpha Natural, and Walter Energy were heading for bankruptcy. The sale was also completed a few months following the announcement that Grande Cache Coal changed hands for $2.00, after being acquired in 2011 for more than $1 billion. Itinerant also did not point out that Fortune retains a 10-year option to repurchase the coal licenses at the same price they were sold for at its election. The transaction also provided cash when the capital markets were effectively closed and allowed Fortune and POSCO to be paid while we wait for the British Columbia government to negotiate a land use settlement with the First Nation. This transaction was received as an elegant solution to a difficult situation by many investors.
Itinerant was also critical of the Company's sale of its Hemlo used milling equipment assets that had been purchased earlier for use at the NICO development. He did not recognize that these assets were monetized because they were redundant and no longer needed as part of the development plan due to optimizations that demonstrated that the project could reduce capital and operating costs with the purchase of new equipment. The sale of the Hemlo used equipment was also accomplished in a difficult market, saving storage costs, and provided cash, eliminating the need to raise capital from a dilutive equity raise.
The Itinerant article was incorrect in its statement that the Company was unable to complete a $1 million private placement earlier this year. Fortune did complete the second half of this financing to strengthen the balance sheet and is judiciously managing expenditures with prudent capital raises as the share price increases and as we advance NICO toward development.
Itinerant was critical of the 2014 NICO feasibility study results and conducted his own analysis of project economics are current metal prices. However, Itinerant failed to recognize that this study was based on a project financing structure that we were advancing at the time under a Memorandum of Understanding (MOU) with China CAMC Engineering Co., Ltd. (an international Engineering Procurement and Construction (EPC) company) and its Canadian controlled subsidiary, Procon Group. This transaction was at an advanced stage of due-diligence for a debt and project equity transaction after Procon had already purchased a 19.9% interest in the Company. Significant fees payable to CAMCE/Procon were built into this study to reflect the project financing structure. However, the feasibility study generated an attractive levered pre-tax NPV (7%) of $254 million and IRR of 15.6% at base case commodity price assumptions that were lower than historical average prices for cobalt and lower gold prices than the previous year. Sensitivities were therefore done at higher cobalt prices, reflecting longer-term average cobalt prices of US$19/lb cobalt and generated a $383 million NPV and 19.4% IRR at static gold and bismuth prices. If the gold price also increased to US1,500/oz (the price during the prior year), it would have generated more than $400 million in NPV and a more than 20% IRR. Itinerant also fails to recognize to point out the metal cyclicity sensitivity the Company did in the feasibility study to emulate the six-year trailing metal price histories for the recoverable metals on project economics. This resulted in an improvement to the levered pre-tax IRR to 23.6%, (after-tax IRR of 23.2%), and 7% discounted pre-tax NPV to C$543 million (after-tax 7% NPV of C$505 million).
Itinerant conducted his own analysis of NICO economics using current metal prices, which are near historic lows for cobalt, and are also lower for gold and when many producers of nickel copper and cobalt are losing money on a cash basis. His analysis also did not include the premiums typically paid for chemical products, he did not adjust for the change in the US$ to C$ exchange rate from 88 cents to 76 cents that mitigates some of the metal price declines, and did not adjust for the significantly lower energy costs today (US$100/barrel oil at the time of the feasibility study to below US$50/barrel currently). He also did not account for lower engineering and construction costs at the present time due to less competition for labor and materials from oil sands developments. Additionally, Itinerant incorrectly assumed that the costs for royalties, concentrate transport, corporate overheads, and marketing costs were not included in the study when in fact they were.
As noted by Itinerant, NICO's vertical integration is likely necessary because concentrates from the mine would not receive fair value from smelters on the open market because of the metals contained. However, he does not recognize the significant advantages of the process metallurgy planned by the Company, which is ideally suited for this combination of metals. These include a very high concentration ratio during flotation, an ability to conduct and efficient separation into gold-bearing cobalt and bismuth concentrates after re-grinding and an efficient secondary flotation process, very high metal recoveries from downstream acid leach processing, high recoveries for gold which would otherwise include refractory gold, and conversion of the contained arsenic to a stable ferric arsenate that can be safely landfilled - all conducted at a proposed company-owned facility that captures the revenues from value-added processing for the benefit of the Company. Once established, the refinery also creates the opportunity for toll processing of concentrates from other mines around the world and potentially diversify production into metals recycling.
Finally, Itinerant's comment that "the native Tlicho people are a battlesome lot when it comes to mining on their lands" is a mischaracterization. The Tlicho people are supportive of mining and have reaped significant benefits from diamond mining in the Northwest Territories. They are also supportive of the NICO project, and the Tlicho government approved the NICO environmental assessment.
Fortune has successfully advanced NICO through the challenges of a difficult resource "Bear" market, delivering the important milestones to NICO since our initial production of battery-grade cobalt chemicals in 2012 and include:
- Completed Front-End Engineering and Design (FEED) studies
- Acquired the land for the refinery in Saskatchewan
- Secured Procon's strategic investment
- Received Environmental Assessment approval from the Tlicho, Northwest Territories and Federal governments for the mine and mill in the Northwest Territories
- Received Environmental Assessment approval for the refinery in Saskatchewan
- Produced an updated Feasibility Study along with increased reserves
- Secured the Land Use Permit and Water License approvals for construction and operation of the NICO mine
- Delivered a high purity cobalt chemical sample for testing by a potential off-take party
Fortune Minerals is now well positioned to become a reliable North American source of battery-grade cobalt chemicals with supply chain custody and transparency. NICO is also a potential new source of bismuth metal and chemicals in a market that is dominated by Chinese production and will have significant gold production to provide a highly liquid counter-cyclical hedge.
Please feel free to contact Fortune Minerals at 1-877-552-7726 or by email at email@example.com with any questions on the Company.
CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION
This commentary contains forward-looking information. This forward-looking information includes, or may be based upon, estimates, forecasts, and statements as to management's expectations with respect to, among other things, the size and quality of the Company's mineral resources, progress in permitting and development of mineral properties, timing and cost for placing the Company's mineral projects into production, costs of production, amount and quality of metal products recoverable from the Company's mineral resources, anticipated revenues, earnings and cash flows from the Company's mineral projects, demand and market outlook for metals and coal and future metal and coal prices. Forward-looking information is based on the opinions and estimates of management at the date the information is given, and is subject to a variety of risks and uncertainties and other factors that could cause actual events or results to differ materially from those projected in the forward-looking information. These factors include the inherent risks involved in the exploration and development of mineral properties, uncertainties with respect to the receipt or timing of required permits and regulatory approvals, the uncertainties involved in interpreting drilling results and other geological data, fluctuating metal and coal prices, the possibility of project cost overruns or unanticipated costs and expenses, the possibility that production from the Company's mineral projects may be less than anticipated, uncertainties relating to the availability and costs of financing needed in the future, uncertainties related to metal recoveries and other factors. Mineral resources that are not mineral reserves do not have demonstrated economic viability. Inferred mineral resources are considered too speculative geologically to have economic considerations applied to them that would enable them to be categorized as mineral reserves. There is no certainty that mineral resources will be converted into mineral reserves. Readers are cautioned to not place undue reliance on forward-looking information because it is possible that predictions, forecasts, projections and other forms of forward-looking information will not be achieved by the Company. The forward-looking information contained herein is made as of the date hereof and the Company assumes no responsibility to update them or revise it to reflect new events or circumstances, except as required by law.
The disclosure of scientific and technical information contained in this commentary has been approved by Robin Goad, M.Sc., P.Geo., President and CEO of Fortune, who is a "Qualified Person" under National Instrument 43-101. The technical report on the feasibility study referred to above, entitled "Technical Report on the Feasibility Study for the NICO-Gold-Cobalt-Bismuth-Copper Project, Northwest Territories, Canada", dated April 2, 2014 and prepared by Micon International Limited, has been filed on SEDAR and is available under the Company's profile at www.sedar.com.
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