Ivanhoe's Platreef Project: Rich Man's Gold

| About: Ivanhoe Mines (IVPAF)

Summary

The Platreef project is world-class and has very attractive projected returns based on my calculations.

Current calculations and valuations provided by Ivanhoe use metal prices materially higher than current prices.

I have recalculated the net present value, internal rate of return, and payback period for each of the three phases of the project using current metal prices.

I provide detailed up-to-date information on the project as well as a project valuation conclusion.

Company Overview

Ivanhoe Mines Ltd. (OTCQX:IVPAF) is a mineral exploration and development company founded and guided by mining legend Robert Friedland. The company is headquartered in Vancouver, Canada, and trades on the Toronto Stock Exchange since October, 2013, under IVN. Ivanhoe Mining Ltd. adopted its name in 2013 from Ivanplats Limited to better represent its projects' commodities.

The company is developing three world-class projects in Sub-Saharan Africa: The Platreef Project for platinum group metals and nickel, the Kamoa-Kakula Project for copper, and the Kipushi Project for zinc. Ivanhoe has no operating revenue but has a healthy balance sheet that will keep it afloat until production. Currently, the company has a price-to-book ratio of 1.3 and a market cap of US$1.39 billion.

The Platreef Project (64% ownership)

Located in South Africa, the Platreef Project is expected to be the largest platinum group metals (PGM) mine in the world. I have recently written about the appealing prospects of the platinum industry. The project's platinum-to-palladium ratio is approximately 1:1, which is much higher than other PGM deposits in the Northern Limb of the Bushveld Complex, the world's largest region for PGMs. This ratio tells us that the project will yield a higher proportion of the more valuable platinum than competing producers, leading to a higher margin.

Indicated and Inferred Resources, factoring in Ivanhoe's 64% ownership, total approximately $77,053 billion U.S. dollars at current market prices. See table for metals allocation.

Mineral Resources (US Dollars)

Metal

Indicated Mineral Resources (2% base cut-off grade)

Inferred Mineral Resources (2% base cut-off grade)

Current Price (millions)

Total Value

(millions)

Ivanhoe's 64% share (millions)

Platinum

18.66 Moz

23.17 Moz

$920.90/oz

$38,521

$24,654

Palladium

18.94 Moz

23.78 Moz

$748.10/oz

$31,959

$20,454

Rhodium

1.23 Moz

1.56 Moz

$775.00/oz

$2,162

$1,384

Gold

3.12 Moz

4.26 Moz

$1,194.90/oz

$8,818

$5,644

Copper

1,226 Mlbs

1,775 Mlbs

$2.69/lb

$8,073

$5,167

Nickel

2,438 Mlbs

3,440 Mlbs

$5.25/lb

$30,860

$19,750

Total

n/a

n/a

n/a

120,393

$77,053

Click to enlarge

Platinum's and palladium's main source of demand is in automobile catalysts. Global vehicle sales have seen their growth rate slow down in recent years, but total sales continue to grow each year, supporting demand. My previous article on platinum reveals a dangerous depletion of above-ground stocks, which, due to numerous annual deficits, will put upward pressure on its price as supplies dwindle.

Palladium is also in a deficit and has been for the last few years (source 15). The fundamentals for these two metals indicate price appreciation which would increase the value of the Platreef Project.

The Platreef Project will be developed in phases to establish an operating platform early on to support further expansion. An initial rate of four million tonnes per annum (Mtpa) will be produced in the first phase in late 2019. This will double to 8.0 Mtpa in the second phase by 2024. The third and last phase, to be reached by 2028, will produce 12 Mtpa which would rank the Platreef Project as one of the largest PGM mines in the world. Each phase has a thirty-year life. The total project, therefore, has a mining life of 38 years until 2058, as the phases overlap.

The project is also anticipated to be the lowest cost producer of PGMs in Africa. Africa accounts for 70% platinum mining supply and over a third of palladium mining supply.

South Africa's mining industry is prone to labor disputes. Platinum producers in the region have seen strikes and violence in recent years. However, Ivanhoe has recently negotiated a one-year deal with the National Union of Mineworkers. Stipulated wage increases have been determined to avoid any work stoppages or labour disruption. This is encouraging but a longer deal would be better. In any case, Ivanhoe claims relations and negotiations are cordial.

Other Key Highlights:

  • The deposit is at a relatively shallow depth of 800-1200m
  • Highest concentration of base metals among Africa's PGM producers
  • Expected to rank at the bottom of the cash-cost curve yielding better margins
  • Mineral thickness allows for high productivity and cost efficient mechanized mining methods
  • High safety standards for all employees
  • High positive involvement of surrounding communities
  • Excellent exploration potential for unexplored areas outside of Indicated and Inferred Resource areas.

Project Finance

A mining project can be evaluated using its Net Present Value, its Internal Rate of Return, and its Payback Period. Ivanhoe provides these calculations but with commodity prices that are materially higher than current prices; therefore, these provided calculations have little value. I have recalculated them for a more relevant valuation that reflects current prices.

Since prices change, I have added two rows of potential contribution margins in the payback period calculation: one row is bearish, the other bullish. These additional rows will show the sensitivity the project has to changing prices and provide a range to the project's valuation.

Payback Period

Information and figures provided by the 2016 Resource Technical Report and my calculations. All dollar figures in US$

Payback Period - Phase 1 Starting in 2019

Economic State

Initial Investment

Total Annual Contribution Margin

Payback Period in Years

Bear (-30%)

$1,525 million

$196,666,610

7.75

Current

$1,525 million

$280,952,300

5.42

Bull (+30%

$1,525 million

$365,237,990

4.17

Click to enlarge

Calculations for Phase 1 Payback Period

Metal

Current Price

Per Unit

Average Cost per Unit Over Life of Mine

Contribution Margin per Unit

Estimated Units Sold Annually Over Life of Mine

Annual Contribution Margin

Platinum

$920.90/oz

$367/oz

$553.90/oz

203 Koz

$112,441,700

Palladium

$748.10/oz

$367/oz

$381.10/oz

212 Koz

$80,793,200

Rhodium

$775.00/oz

$367/oz

$408.00/oz

14 Koz

$5,712,000

Gold

$1,194.90/oz

$367/oz

$827.90.oz

26 Koz

$21,525,400

Copper

$2.69/lb

$1.4/lb

$1.29/lb

12 Mlb

$15,480,000

Nickel

$5.25/lb

$3.00/lb

$2.25/lb

20 Mlb

$45,000,000

Total

$280,952,300

Click to enlarge

Payback Period - Phase 2 Starting in 2024

Economic State

Initial Investment

Total Annual Contribution Margin

Payback Period in Years

Bear

$1,719 million

$357,000,000

4.81

Current

$1,719 million

$510,000,000

3.37

Bull

$1,719 million

$663,000,000

2.59

Click to enlarge

Calculations for Phase 2 Payback Period

Metal

Current Price

Per Unit

Average Cost per Unit

Contribution Margin per Unit

Estimated Units Sold Annually

Annual Contribution Margin

Platinum

$920.90/oz

$341/oz

$579.90/oz

348 Koz

$201,805,200

Palladium

$748.10/oz

$341/oz

$407.10/oz

364 Koz

$148,184,400

Rhodium

$775.00/oz

$341/oz

$434.00/oz

25 Koz

$10,850,000

Gold

$1,194.90/oz

$341/oz

$853.90/oz

49 Koz

$41,841,100

Copper

$2.69/lb

$1.5/lb

$1.19/lb

23 Mlb

$27,370,000

Nickel

$5.25/lb

$3.2/lb

$2.05

39 Mlb

$79,950,000

Total

$510,000,700

Click to enlarge

Payback Period - Phase 3 Starting in 2028

Economic State

Initial Investment

Total Annual Contribution Margin

Payback Period in Years

Bear

$1,769 million

$467,908,000

3.78

Current

$1,769 million

$668,440,000

2.64

Bull

$1,769 million

$868,972,000

2.03

Click to enlarge

Calculations for Phase 3 Payback Period

Metal

Current Price

Per Unit

Average Cost per Unit

Contribution Margin per Unit

Estimated Units Sold Annually

Annual Contribution Margin

Platinum

$920.90/oz

$371/oz

$549.90/oz

495 Koz

$272,200,500

Palladium

$748.10/oz

$371/oz

$377.10/oz

510 Koz

$192,321,000

Rhodium

$775.00/oz

$371/oz

$404.00/oz

35 Koz

$14,140,000

Gold

$1,194.90/oz

$371/oz

$823.90/oz

69 Koz

$56,849,100

Copper

$2.69/lb

$1.6/lb

$1.09/lb

32 Mlb

$34,880,000

Nickel

$5.25/lb

$3.4/lb

$1.85/lb

53 Mlb

$98,050,000

Total

$668,440,600

Click to enlarge

Net Present Value of Platreef Project - All dollar figures in US$

Phase

Present Value of Net Cash Flows (millions)

Initial Investment (millions)

Net Present Value (millions)

Internal Rate of Return (Pre-tax)

Phase 1

$2,511

$1,525

$986

17.72%

Phase 2

$3,350

$1,719

$1,631

29.5%

Phase 3

$3,227

$1,769

$1,458

37.72%

Total

$9,088

$5,013

$4,075

Click to enlarge

Net Present Value Calculations

Phase

Project Dates

Total Annual Contribution Margin

Present Value of Total Annual Contribution Margin (Annuity) Discounted to Project Start Date at 8%

Present Value of Total Annual Contribution Margin Discounted from Project Start Date to Current Date at 8%

Phase 1

2020-2050

$280,952,300

$3,163 million

$2,511 million

Phase 2

2024-2054

$510,000,700

$5,741 million

$3,350 million

Phase 3

2028-2058

$668,440,600

$7,525 million

$3,227 million

Click to enlarge

Results of Project Financial Analysis

The Platreef Project's average payback period for all three phases, at current commodity prices, is three years and nine months, which represents 12.5% of the mine's life. This is a rapid payback considering each phase is expected to produce for thirty years. The average payback period in a bear market is five years and five months which is still only 17.6% of the mine's life. In the case of a bull market, the average payback period is two years and eleven months which is 9.77% of the mine's life.

The project's payback period is very attractive across a range of metal prices. I also believe there is significantly more upside to the value of its holdings. The current supply deficits of platinum and palladium and the expected nickel deficit will cause prices to rise as demand exceeds supply. As prices rise, the payback period will diminish.

Looking at the Net Present Value (NPV) of the Platreef Project's phases at current prices, we can see that it is positive and indeed considerable so. Phase 1's NPV of $986 million represents a 39% gross margin on the present value of its net cash flows. This is an impressive margin. Phase 2's NPV of $1,631 million yields a gross margin of 48.7% on the present value of its net cash flows. Phase 3's NPV of $1,458 million yields a 45% gross margin over its net cash flows.

These impressive margins are a function of the project's low production costs, its conservative discount rate, and current prices. Again, given the reasons mentioned above, I believe there is more upside to the price of the Platreef Project's metal holdings. Moreover, there are still potential mineral reserves in unexplored areas surrounding the project on Ivanhoe land which would add to the total value of the project.

The total NPV of the project is $4,075 million. Factoring in Ivanhoe's 64% share of the Platreef Project yields a project value of $2,608 million. This valuation is much higher than Ivanhoe's current market cap of $1.885 million. More importantly, the project's value exceeds Ivanhoe's total assets of $1,006 by $1,602 million, suggesting the company is extremely undervalued. In addition, Ivanhoe owns significant stakes in two other world-class mining projects which further suggests the company is undervalued.

Lastly, each phase's internal rate of return (IRR) exceeds its discount rate, making the phases profitable pursuits. In fact, the average IRR across the phases is 28.31%, which is far in excess of the discount rate used by Ivanhoe of 8%. This excess over its discount rate is encouraging as it creates a buffer to the project's profitability.

Conclusion

Across all three of its phases, using current metal prices, the Platreef Project has a very short payback period averaging three years and nine months, attractive net present values, high gross margins on the present value of its net cash flows, and high internal rates of return averaging 28.31%.

Ivanhoe's share of the project's net present value is $2,608 million, which is far in excess of its total assets suggesting the company is a bargain. This is before evaluating its two other projects into the equation.

Though this project looks attractive, I am not saying that Ivanhoe's share price can only go up. Ivanhoe could see some turbulence in its share price in the event of an economic crash. Platinum, palladium, and nickel are industrial metals so an economic crash would temporarily repress their prices; however, these are common and necessary metals and demand will return once the economic cycle enters its recovery stage. In the meantime, platinum, palladium, and nickel are experiencing supply deficits and will see upward price pressure as demand exceeds supply. This will increase the value of the project's holdings.

Ivanhoe will have to raise an estimated $1,525 million for the initial investment of the first project. This is a considerable amount of money given the company's market cap of $1.885 million and total assets of $1,006 million. These funds could be sourced from selling ownership of the project, which would negatively affect my calculations above. The funds could also be sourced partially from debt, as Ivanhoe has little debt and significant assets, share dilution, or revenue from its other projects. A combination of these sources could and would most likely be used.

The Platreef Project, based on my calculations, is undervalued and exceptional. It will make Ivanhoe Mines Ltd. a major producer of PGMs and provide an attractive profit over 38 years and across a range of metal prices.

I will be publishing articles on Ivanhoe's two other major projects in the next few weeks, the Kamoa-Kakula Copper Project and Kipushi Zinc Project. I will also write an analysis of the company's financial health in an effort to provide a clear and thorough picture of a promising company.

I hope you found this information and analysis helpful.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IVPAF over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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