Great Western Minerals Group Valuation Actually Is Great (Part II Of IV)

Apr.17.12 | About: Great Western (GWMGF)

Steenkampskraal, GWTI, Exploration Properties

One Company, Two Schools of Thought

The research available on Great Western Minerals (OTCPK:GWMGF) (including our piece from last spring) basically falls into two camps.

In the bullish camp, the general is Jon Hykawy from Byron Capital Markets who, based on the most recent reports available to us, currently has a $3.40/share price target on the company. Mr. Hykawy, while holding a very different perspective on long term rare earth prices than us, has done some of the best research in the sell side analyst community we have seen on the demand side perspective of the rare earth element sector. The Byron thesis on Great Western Minerals is based on two major points. First, the downstream integration through the Less Common Metals alloy & metal-making subsidiary will drive significant margin expansion. The second pillar of the thesis is a very bullish view on the prospects of Great Western Minerals' Steenkampskraal project in South Africa.

In the bearish camp, the most prominent voice is John Kaiser of Kaiser Bottom Fish who is, in our opinion, is one of the most respected and insightful voices on the rare earth sector. In February 2011, Mr. Kaiser made a very compelling argument that the Steenkampskraal mining project in South Africa was not economic and that the Less Common Metals subsidiary was not competitive in an environment where FOB spot prices for rare earth oxides were multiples of the prices inside of China.

Steenkampskraal Viability

Our understanding and reading of Mr. Kaiser's report is that the DCF model only considers Steenkampskraal through the rare earth oxide stage. To be perfectly honest, our view on Steenkampskraal is very much in line with Mr. Kaiser's. The only set of operating and cost parameters that are available for Steenkampskraal is those put forward by Mr. Hykawy of Byron Capital Markets. There is not yet any NI 43-101 compliant resource estimate, and the company has conveyed to us no intention to carry out a feasibility study on Steenkampskraal. But hey, when you can raise $90 million in a mandatory convertible and claim that The Strategist capital expenditure estimate of $100-$150 million is apparently too high, why waste the money on those reports when you can successfully execute a "Serra Pelada" and get sophisticated investors and partners. Frankly, Great Western has successfully pulled off a "Serra Pelada", and we congratulate them.

To be fair and balanced, the GQD joint venture on the separation facility is a ringing endorsement that the NI 43-101 resource estimate on Steenkampskraal will be positive when published later this spring. However, we are not going back down the road of evaluating Steenkampskraal when the historical resource estimate is only 22,350 tonnes in-situ rare earth oxide with an additional 7,050 tonnes of rare earth oxide in the tailings and a pile of rocks. We stand by our view that until we see a compliant resource estimate for Steenkampskraal that it is reckless to assign a positive value to the proposed operation as it could very well be value destructive.

In an update piece in February, Byron Capital Markets reported that one of the step out drilling holes of the recently completed drilling program appeared to intersect nearly six meters of high grade monazite (Another Chance to Visit Steenkampskraal, February 10, 2012, page 2). If this drill hole is indicative of the potential to expand the resource at Steenkampskraal, then obviously there is some promise to this project. The question then becomes, given the vein nature of the deposit, how many tonnes of gangue material will have to be moved to access each tonne of monazite. The current mining plan as we understand it is very labor intensive and low tonnage based. The reality here is that without a feasibility study we cannot analyze the parameters of Steenkampskraal on an operating basis other than through the metrics Byron Capital Markets has used (but as Mr. Kaiser has pointed out, the original source is not known).

As is clear at this point, we remain skeptical on Steenkampskraal. As we have previously put it, one industry insider told us, "That one actually has some promise, but I do not know how you do it with such a high thorium content". We understand the thorium storage issue has been solved by Great Western so it is not such a major issue of concern for us, but we think the comment nicely sums up Steenkampskraal. It is a project that has some promise, and in our opinion is the only project after Mountain Pass and Mt. Weld that might make it into production prior to the end of 2015, but at this juncture there are simply too many questions and not enough answers.

We also have to at least acknowledge that the radiation at Steenkampskraal is particularly high. Kathleen Anne Meehan wrote her doctoral thesis in Biomedical Technology at Cape Technikon on the bats who live in the Steenkampkraal monazite mine and the effects of their exposure to low continuous doses of ionizing radiation (thank you to John Kaiser who mentioned this thesis in his February 2011 analysis). The major take away from this report is that the bats that habituated portions of the mine with high radiation levels did in fact see changes relative to the control group (bats residing in portions of the mine with low levels of radiation) that could lead to cancer. We have footnoted the thesis for those that wish to read it. While bats are not human beings, the author of the thesis recommended that if Steenkampskraal is put back into production that stringent protocols be put into place to protect the miners from excessive doses of radiation.

We do have to therefore be concerned about the ability to retain a highly trained mining work force. Radiation limits could very well force Great Western Minerals to maintain a high man count such that miners do not hit their radiation limits. It is just something we have to take into account.

Because of the proposed underground vein mining plan, we need to see not just an NI 43-101 resource estimate but also some guidance from Great Western on how the mining operation at Steenkampskraal will work in terms of tonnes per day mined, stripping ratio, dilution, cost per tonne, etc (an engineering or bankable feasibility study would ease our fears). Management would not give us estimates on these figures when we pressed them on the April 11th conference call. As we will discuss later on, research analyst assumptions can be quite off base (as we have been informed our Steenkampskraal CAPEX estimates are).

As a result, we are assigning zero value to Steenkampskraal at the current time and continue to view the current project timeline as "wishful thinking". We do not anticipate production coming online until 1H2014 at the earliest.

We will re-consider this stance once we have an NI 43-101 compliant resource estimate in our hands and a better sense of what is there at Steenkampskraal. We were invited to visit Steenkampskraal in February but had to decline due to prior commitments, and because to be perfectly frank we need to see an NI 43-101 to get a better understanding of the property before that trip will be worth our while. We have been told by independent individuals that have visited Steenkampskraal that "you can visibly see the monazite vein go on forever", so the NI 43-101 is something we will be watching for carefully. We understand that after the events of the last few years and given their backgrounds, Great Western management in Saskatoon wants to have a secure supply for LCM. But as it stands right now, we are in "show me" mode on Steenkampskraal.

Exploration Properties

Great Western Minerals has several other exploration projects other than Steenkampskraal. The most prominent of these is the Hoidas Lake property. Before acquiring Steenkampskraal, Hoidas Lake was the original plan for sourcing material to Less Common Metals. The interesting thing here of course is that project progress simply seemed to ground to a halt when the company received a draft PEA that was never published. Our conversation with one individual in the rare earth sector leads us to conclude that the project was found to not be economic however we have not actually seen the results of the PEA for ourselves.

Beyond Hoidas Lake, there are a bunch of early stage projects that have no NI 43-101 resource estimates and we feel should not be assigned any value just how we are assigning zero value to Hoidas Lake. We in fact will go out on a limb and say that Hoidas Lake does not get put into production in the next decade. All investors positive on Hoidas Lake as a project should take a look at the paragraph Mr. Kaiser spent on the project in the piece we referenced previously in this report. We need to see some metallurgy on Hoidas Lake ore and to be perfectly honest, a Preliminary Economic Assessment before we are going to even consider any of this "Hoidas Lake will be the 2nd source after Steenkampskraal" chatter (if this was not a family audience newsletter, we would use more colorful language). And we would encourage Great Western to keep all its development focus on Steenkampskraal other than what is required to maintain its claims at its other properties.

GWTI: Location Actually is Everything

Great Western Minerals has a facility in Troy, Michigan owned by its subsidiary Great Western Technologies. We assign zero value to this facility's existing operations. What it does have is a location in the United States that gives it significant political value. We believe the factory should be re-branded as part of Less Common Metals and integrated with the Less Common Metals facility. GWTI historically has produced the alloy powders that go into NiMH batteries and one industry expert told us that in the past the facility may have taken some of the alloy from Less Common Metals and processed it into powder form for magnet manufacturers (alloy powder being the first step in the alloy to magnet manufacturing process).

We currently assign zero value to the facility. But given the fact that LCM already has all the intellectual property necessary, we could see long term the possibility of the facility either becoming Less Common Metals North America and producing the same products that is currently produced near Liverpool or even as an alloy powder processor. But these possibilities are several years down the line. As one industry expert described the GWTI facility to us, it's not making money, it is lightly staffed, not focused on rare earth products, and its current value to Great Western is political in the event that the United States federal government chooses to promote the re-creation of a rare earth industry and supply chain.

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Disclosure: I am long MCP, OTCPK:GWMGF, CODI, TAS.

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