Is The Current Iron Ore Price Just A Bump In The (Iron) Road?

| About: Iron Road (IRNRF)
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Summary

Iron Road has increased its throughput in the feasibility study, but this also increased the initial capex to $4.5B.

You can't blame the management for this, as the feasibility study was completed before the iron ore price crashed.

At the current iron ore price the project still has a positive NPV of close to $2B, but I'm worried about the chances to finance this project.

As such, I think there are better companies in the iron ore space right now, and I'm not sure it'll be easy to find $4.5B.

Introduction

After writing about Atlas Iron (OTC:ATLGF) and Fortescue Metals (OTCPK:FSUMF), I thought it was a good idea to have a look at Iron Road (OTCPK:IRNRF) again to see if I had to reduce my expectations after the crash (yes, I dare to call it a crash) in the iron ore price earlier this year. I will mainly focus on the viability of the project with special attention for the payback period, as I think that will be the most important thing for this high-capex iron ore project in Australia.

Source: company presentation

As this is an Australian company, I recalculated Australian Dollars into US Dollars wherever necessary using an exchange rate of 1.065. As there's better liquidity on the Australian Stock Exchange where the company is listed with IRD as its ticker symbol, I'd strongly recommend you to trade in Iron Road through the facilities of the ASX.

As always, all images in this article were taken from the company's website, presentation and other public materials. All calculations are my own and are no official company guidances.

The Project

Iron Road is pretty much a one trick pony as it is focusing all its efforts on the Central Eyre Iron Project in Southern Australia. The project is pretty large and would support an initial mine life of 25 years, producing in excess of 21 million tonnes of iron ore concentrate at an average grade of 67% Fe.

Source: company presentation

According to the company, it's the largest magnetite project in the country, but as the average grade is just 16% Fe, a very high throughput will be needed to make the project work, as a saleable product should have a minimum iron content of 56-58% Fe to be considered viable. This means that Iron Road will have to construct a megalomanous processing facility in order to get to an output of 21.5 million tonnes of end product per year. Approximately 140 million tonnes of ore will have to be moved each year, that's 380,000 tonnes a day which is just huge.

The project will be very important for the development of the region, as the South Australian government has declared the infrastructure works (to construct a port and railway to the port) a 'major development' project. And it's easy to understand why. As Iron Road expects its port to have a capacity of 70 million tonnes per year, 46-48.5 million tonnes of that capacity would be available for other companies, thus opening up an export terminal for other iron ore plays in the region. Needless to say that once the infrastructure in South Australia gets better (a large port), more exploration and development activities will take place, and that could be something the local government is encouraging. Additionally, Iron Road's port at Port Hardy would be the only port able to service capesize vessels on a 2500 mile coast line between Port Esperance and Port Kembla. This is another advantage, as there are huge economies of scale if a company can ship its ore in a capesize vessel because those are larger than for instance Panamax-sized ships.

Source: company presentation

There's one slight problem though. All of the company's studies were based on a much higher iron ore price. The feasibility study was for instance based on a long term iron ore benchmark price of $112/t, which has since then dropped to $98/t. As the company hasn't provided some kind of sensitivity analysis, the investors are left in the dark whether or not the project is still interesting right now.

Was there any progress in the past six months?

Absolutely, the company hasn't been sitting on its hands in the past quarters, and significant steps to move the project ahead were taken. Most importantly, a definitive feasibility study was released which should increase the confidence in the viability of the project, as feasibility studies are usually stricter than scoping studies or pre-feasibility studies.

Source: company presentation

As I expected in my previous article, the envisaged output of the Central Eyre Iron Project was increased from 12.7 million tonnes to 21.5 million tonnes per year, as upscaling the project would increase the benefits from economies of scale. The feasibility study also confirmed the CEIP will produce a premium quality iron ore at an average grade of 67% Fe. This will prove to be very important for the project as first of all, a higher iron content commands a premium price. I expect the CEIP end product to receive a premium of $15/t (I think the company's $18/t is a tad optimistic, but I hope they are right and I'm wrong) over the benchmark price, which is based on an end product containing 62% Fe. Secondly, because the product has a higher grade, it should also increase the operational efficiencies of the steel mill the ore will be used in. This means that Iron Road shouldn't have a lot of difficulties to market its iron ore as its high-quality ore could be used to be blent with lower quality ore.

However, the biggest problem might be the price tag, as Iron Road's expanded operation will carry a $4B price tag. Not only would it be very difficult to raise that kind of money for an iron ore project in the current investment climate, it might actually kill the entire project, as an additional $0.5B will be needed for pre-stripping activities. Unfortunately the company hasn't been giving any more details about the modular expansion it talked about last winter. As I think it will be very difficult to finance a $4.5B project, I think a modular approach might be a better strategy to reduce the up-front cost, and increase the throughput through reinvesting the operating cash flow in additional modules. That's why I'm very surprised to see that the company is actually looking to upscale the project even further to 24 million tonnes per year instead of the currently planned 21.5M tonnes.

Additionally, it's not very clear whether or not the sustaining capital expenditures are included in the 'total capital costs'. If the sustaining capex is included, then the economics will be a bit better than what's currently expected. However, if you need to deduct further sustaining capital expenses, I wouldn't too keen to invest in the Central Eyre project right now. So some clarification from the management will be needed.

Should I revise my expectations because of the lower iron ore price?

As you probably know, the iron ore price has crashed and is currently trading at less than $100 per dry metric tonne, at $98/t. This already causes a first issue with the feasibility study. As the Feasibility study used a benchmark price of $112/t (which was perfectly valid at the time the FS was published), the economics will look much worse if you'd apply the current iron ore price of $98/t.

Let's now add the premium for Iron Road's high-quality ore of $15/t and your sales price FOB is $113/t. However, this is the price for dry metric tonnes, so you'd need to apply a discounting factor to find the price for wet metric tonnes. As the moisture content in iron ore is usually 7-9%, I will use an 8% discount for a sales price of $104/wmt. The next step would be to deduct the shipping cost to Asia, and unfortunately the Central Eyre project is located on the 'wrong' side of Australia and the shipping costs will very likely be double the costs from for instance Port Hedland on Australia's north shore. So if I deduct a $17 shipping cost, the FOB revenue is $87/t.

Let's now look at the cost basis. The C1 Cash cost was expected at $45/t but this was excluding royalties. If you throw in the royalties, I'd expect the cost FOB to be approximately $50/t (note: I deducted the shipping costs from the revenue, and have not deducted the sustaining capex which I will treat differently). According to Coffey, the sustaining capex and closure costs for the mine could be as high as $2.3B, but as these numbers were only used to base the ore reserves on, I think Coffey might have been over-cautious, given the fact their assumption of a $5.2B capex is 'just' $4.5B. So I'll round the number down to $2B which works out to be $80M per year, or about $5 per tonne.

The corporate tax rate in Australia is 30%, and I will use a higher discount rate of 8% compared to the previously used 6%. I do this because the iron ore price has been more volatile than I originally expected and I wanted to build in additional safeguards. So let's see what that gives over the 25 year mine life, assuming an interest rate of 6% on the debt, and the free cash flow being applied to reduce the debt.

Cash Flow

Corporate Tax Rate (30%)

After-tax cash flow

Discount rate (8%)

NPV 8%

-4,500,000,000.00

-

-4,500,000,000.00

 

-4,500,000,000.00

510,000,000.00

0.0%

510,000,000.00

1.00

510,000,000.00

540,000,000.00

0.0%

540,000,000.00

1.08

500,000,000.00

570,000,000.00

0.0%

570,000,000.00

1.17

488,683,127.57

600,000,000.00

0.0%

600,000,000.00

1.26

476,299,344.61

630,000,000.00

0.0%

630,000,000.00

1.36

463,068,807.26

665,000,000.00

0.0%

665,000,000.00

1.47

452,587,826.03

670,000,000.00

0.0%

670,000,000.00

1.59

422,213,650.01

670,000,000.00

0.0%

670,000,000.00

1.71

390,938,564.83

670,000,000.00

0.0%

670,000,000.00

1.85

361,980,152.62

670,000,000.00

30.0%

469,000,000.00

2.00

234,616,765.58

670,000,000.00

30.0%

469,000,000.00

2.16

217,237,745.91

670,000,000.00

30.0%

469,000,000.00

2.33

201,146,061.03

670,000,000.00

30.0%

469,000,000.00

2.52

186,246,352.80

670,000,000.00

30.0%

469,000,000.00

2.72

172,450,326.67

670,000,000.00

30.0%

469,000,000.00

2.94

159,676,228.40

670,000,000.00

30.0%

469,000,000.00

3.17

147,848,359.63

670,000,000.00

30.0%

469,000,000.00

3.43

136,896,629.29

670,000,000.00

30.0%

469,000,000.00

3.70

126,756,138.23

670,000,000.00

30.0%

469,000,000.00

4.00

117,366,794.66

670,000,000.00

30.0%

469,000,000.00

4.32

108,672,958.01

670,000,000.00

30.0%

469,000,000.00

4.66

100,623,109.27

670,000,000.00

30.0%

469,000,000.00

5.03

93,169,545.62

670,000,000.00

30.0%

469,000,000.00

5.44

86,268,097.80

670,000,000.00

30.0%

469,000,000.00

5.87

79,877,868.33

670,000,000.00

30.0%

469,000,000.00

6.34

73,960,989.20

       

1,808,585,443.36

So the NPV of $1.8B is still great, meaning the project still has its merits, but my biggest issue is the payback period which will be closer to 8 years. Additionally, don't focus too much on the $1.8B NPV. If Iron Road would have to fund $1.5B through raising equity at the current share price, a massive amount of new shares would have to be created which would reduce any upside from the NPV/share perspective.

Investment thesis

I'm quite disappointed to see the modular expansion approach has been removed from the company's plans, and even though I acknowledge Iron Road's product will be a superior product compared to the benchmark, I have my doubts about getting a $4.5B project financed in the current investment climate, which isn't really favorable towards iron ore. Add the $2B in sustaining capex, and the Central Eyre project will be difficult to realize in the current depressed iron ore price environment.

Does that mean this is a bad company with a bad project? Not at all. The leverage to the iron ore price will be high (an increase of $5/t of the iron ore price will increase Iron Road's annual revenues by more than $100M) and the NPV is definitely positive, but my main problem is the ability to finance a project of this size, as I can assure you there isn't a lot of appetite for $4B+ projects right after the iron ore price plummeted.

It will be very interesting to see what Iron Road's next steps will be, as I'm convinced the economics could be enhanced by fine-tuning the operational side a bit more, and I hope this will be sufficient to make the project more attractive at a low, double digit iron ore price. I'm not giving up on the Central Eyre Iron Project, but a lot of things will have to change to make it attractive at the current iron ore price.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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