Investment thesis
Adriatic Metals PLC (OTCPK:ADMLF)(ADT.ASX)(ADT1.LSE) is a U.K.-headquartered mining company that operates in Bosnia and Herzegovina as well as Serbia.
Richly endowed with mineral resources, the Balkan region, in general, and the Vareš area in Bosnia and Herzegovina, in particular, have been mined as early as the Bronze Age and the Roman times. Fast forward to 1989-1992, the breakup of Yugoslavia and the ensuing civil unrest forced mines to be closed before the depletion of mineral resources. The region received little mineral exploration thereafter, thus preserving it for today's exploration using modern techniques.
The predecessor of Adriatic entered Bosnia early, after a long hiatus of foreign investment. Thanks to the first-mover advantage, it was able to pick up the exceptionally prospective Vareš mining district on the cheap, which Adriatic subsequently expanded considerably. In May 2020, Adriatic further added the Raska mining district in neighboring Serbia to its exploration pipeline through the acquisition of Tethyan Resources.
Since 2017, Adriatic has carried out aggressive exploration programs, which led to the re-discovery of its flagship asset, the ultrahigh-grade Rupice zinc-silver-lead-gold-copper-barite deposit. Findings of a scoping study completed in November 2019 indicate the Vareš project, consisting of Rupice and nearby brownfield Veovača, is highly economical with projected after-tax IRR of 107.4%, making it the most economical pre-development base-metal project in the world.
At an EV/MRE multiple of US$0.025/lb ZnEq, Adriatic trades at a deep discount to its mineral resources, which is set to expand in the mineral resource update scheduled for the next quarter. It trades only at 17% of the NPV-8 of the Vareš project, much lower than analogous mines in production, although the quality aspect of Rupice may have been priced in.
I believe Adriatic stock will rerate upward, as the company expand mineral resources and advances Vareš and Raska through permitting, pre-feasibility study, feasibility study, and financing over the next 1-2 years. Specific near-term catalysts include:
- By the 3Q2020, Adriatic is scheduled to release an update to the July 2019 mineral resource estimate, incorporating successful holes newly drilled outside of the maiden mineral resource area. With expanded mineral resources and new metallurgical test work, which reports materially better metal recovery than used in the scoping study, I expect the pre-feasibility study, also anticipated in the 3Q2020, to revise the NPV-8 substantially higher.
- Also, in the 3Q2020, Adriatic expects the approval of the Exploitation Permit for Veovača, while that for Rupice is anticipated in the 1Q2021.
- Exploration since the 1Q2020 at (1) the Jurasevac-Brestic and Borovica prospects near Rupice; (2) the Orti, Seleste, and Veovača West prospects in the vicinity of Veovača; and (3) in the 12km gap between Rupice and Veovača may generate positive news flow anytime now.
- Furthermore, I believe the acquisition of Tethyan is value-accretive. For less than 7% equity dilution, Adriatic added a past-producing mining district - Raska - with historical mineral resource superior to Veovača. The market will come to appreciate the deal as 2020 draws to an end when the maiden JORC-compliant mineral resource estimate on the Kizevak-Sastavci deposits therein is due.
There is a slew of risk factors associated with Adriatic, e.g., the political uncertainty of the concerned jurisdictions, and share price volatility and thin trading typical of junior mining stocks. However, those who have the stomach for those uncertainties, in my opinion, can sleep well at night, recognizing:
- firstly, Adriatic is fully-funded through the definitive feasibility study, with neither debt nor warrants;
- secondly, Rupice will most certainly be a producing mine in the not so distant future; and
- thirdly, Paul Cronin, the CEO, has proven to be shareholder-friendly and capable of delivering results under budget and with a palpable sense of urgency. After all, he and other insiders have considerable skin in the game through their 19% shareholding in the company.
Assembling asset portfolio & exploration
Adriatic was incorporated by Paul Cronin in February 2017 to facilitate the acquisition of Eastern Mining & Balkan Mining Pty Ltd., including its Vareš project in Bosnia (Fig. 1).
Fig. 1. Location of Rupice and Veovaca in the Vareš project in Bosnia and Herzegovina. Areas prior to and after August 2018 expansion are encircled in red and blue lines, respectively. Source.
2017. Immediately after the deal, Adriatic started confirmatory drilling at the past-producing Veovača and Rupice, a base metal and barite discovery dated back to 1952. The drilling program allowed Adriatic to complete an initial JORC-compliant mineral resource estimate for Veovača. Seven holes Adriatic drilled on Rupice confirmed not only high-grade zinc and lead as formerly known but also impressive grades of silver, gold, and barite. Please note, precious metals in the deposit were previously overlooked because they had little value for the Yugoslavian government.
2018. Just like any other world-class discoveries, Rupice kept emanating surprises as the 2018 drilling program of 15,000m went on. In addition to hitting more intercepts of high-grade precious metals, Adriatic struck extraordinary lengths and grades of multiple metals, e.g.
- Some 64m at 4.6 g/t Au, 537 g/t Ag, 0.9% Cu, 7.7% Pb, 10.8% Zn, and 46% barite, equivalent to 20 g/t AuEq, in drill hole BR-2-18; and
- 66m at 2.1 g/t Au, 158 g/t Ag, 2.3% Cu, 8.6% Pb, 12.8% Zn, and 37% barite, equivalent to 16 g/t AuEq, in hole BR-5-18.
The 2018 drilling further demonstrated Rupice is exceptionally rich in metals, remarkably continuous, and very thick.
Mineralization at Rupice was also found to be open northerly and toward the southeast. Orebody clearly extends beyond the northern boundary of the then-existing exploration concession as shown by the northernmost hole BR-5-18. Hole BR-25-18 suggests the orebody plunges further southeast beyond the known extent (see here; Fig. 2). So, Adriatic applied for an expansion of the concession, with approval received in late 2018 (see here and here; Fig. 1).
Fig. 2. Plan map showing holes drilled prior to end-November 2018, including BR-25-18. Source.
2019. With the Urban Planning Permit and an Exploration Permit over the expanded concession areas in hand by the 1Q2020, Adriatic commenced testing the northern and southeastern extension of Rupice, with great success (see here; Fig. 3).
Fig. 3. Plan map of the Rupice deposit, showing holes BR-01-19 and BR-04-19 in the north and BR-02-19 and BR-03-19 in the south. Source.
By July 2019, a little over two years after it had acquired the Vareš project, Adriatic was able to release the maiden JORC-compliant mineral resource estimate for Rupice, confirming it to be a 9.4 Mt high-grade polymetallic deposit with significant silver and gold credits. The mineral resource estimate for Veovača was also updated with new drill hole data (see here).
Based on the metallurgical test-work on Rupice and Veovaca, Adriatic released the scoping study four months later, revealing the extremely attractive economics of the project.
2020. Adriatic's 20,000m drilling campaign for 2020 was allowed to continue amidst the coronavirus curfew. All metallurgical test work, geochemical domaining, and pre-feasibility study are underway, largely unaffected by the public health crisis.
Adriatic decided to defer the pre-feasibility study to 3Q2020 and definitive feasibility study to 1Q2021 to allow an updated mineral resource estimate (see here). If everything progresses smoothly, the mine construction may start in the 2Q2021, with the first production possibly in the 2Q2022 (see here; Table 1).
Table 1. Adriatic Minerals project flow chart. Source: Laurentian Research based on materials released by the company, including this.
Tethyan Resources acquisition. On May 11, 2020, Adriatic announced the acquisition of Tethyan Resources (TETH: TSX-V) in exchange for 6.9% of Adriatic shares (see here), gaining the Raska mining district in southwestern Serbia. Raska and Vareš are similar in geological characteristics (Fig. 4). Raska includes brownfield Kizevak and Sastavci as well as a cluster of satellite exploration prospects.
The deal may prove very value-accretive to Adriatic shareholders in the next couple of years.
Adriatic will be able to parlay its exploration know-how in Bosnia to the under-explored Raska. A maiden JORC-compliant mineral resource estimate is expected by end-2020, with a scoping study and pre-feasibility study on the lookout in 3Q2021 and 4Q2021, respectively (Table 1).
Fig. 4. Map showing Tethyan Resources' Raska mining district in southwestern Serbia and its relative position to the Vareš project, modified from this source.
Mineral resource estimates & scoping study
Rupice and Veovača, part of the same polymetallic sulfide mineralization system, occur in carbonates overlying alkaline volcanic rocks. They are mainly of carbonate replacement-style with subordinate veining (Fig. 5).
Fig. 5. A N-S cross-section of Rupice along the strike length. Source.
July 2019 mineral resource of Rupice and Veovača. According to the July 2019 mineral resource estimate, Rupice holds 9.4 Mt of indicated (80%) and inferred (20%) resource down to 300m depths, containing 480 Kt Zn, 310 Kt Pb, 52 Kt Cu, 530 Koz Au, 55 Moz Ag, and 2.92 Mt of barite.
The Veovača mineral resource estimate was updated at the same time to 7.4 Mt of indicated (72%) and inferred (28%) resource, containing 106 Kt Zn, 66 Kt Pb, 18 Koz Au, 10 Moz Ag, and 0.984 Mt of barite (Table 2).
Table 2. Mineral resource estimates for Rupice and Veovača as of July 2019. Please note: 1, mineral resources are based on JORC code definitions; 2, a cut-off grade of 0.6% ZnEq has been used; 3, ZnEq was calculated using Zn% * 90% + 0.8 * Pb% * 90% + 0.08 * BaSO4% * 90% + 1.8 * Au(g/t) * 90% + 0.019 * Ag(g/t)* 90% + Cu% * 2.4 * 90%, where 90% is the recovery for all elements and metal prices used were US$2,500/t for Zn, US$2,000/t for Pb, $200/t for BaSO4, $1,400/oz for Au, $15/oz for Ag and $6,000 for Cu; 4, a bulk density was calculated for each model cell using regression formula 2.88143 + BaSO4 * 0.01555 + Pb * 0.02856 + Zn * 0.02012 + Cu * 0.07874 for the barite high-grade domain and 2.76782 + BaSO4 * 0.01779 + Pb * 0.03705 + Zn * 0.02167 + Cu * 0.07119 for the barite low-grade domain, whilst the barite domains were interpreted using 30% BaSO4. Source.
Raska mineral resource. Kizevak, a past-producing open-pit mine, has a strike length of >1,200m, a width of 1-30m, and depth up to 200m. The historical mineral resource estimate suggests 7.6 Mt of resource (Table 3).
Table 3. The historical, JORC-noncompliant mineral resource estimate of the Kizevak and Sastavci deposit. Source.
Some 14 holes drilled by Tethyan in 2018-2019 have intercepts such as:
- 43m at 4.3% Zn, 2.5% Pb, 26.1 g/t Ag, and 0.2 g/t Au for 7.4% ZnEq (Hole KSEDD001, from 193m);
- 12m at 22.0% Zn, 10.5% Pb, 166.5 g/t Ag, and 0.2 g/t Au for 35.1% ZnEq (Hole KSEDD002, from 130m);
- 40m at 4.4% Zn, 2.1% Pb, 26.7 g/t Ag, and 0.3 g/t Au for 7.4% ZnEq (Hole KSEDD003, from 137m).
It is safe to assume grades at Kizevak and Sastavci are similar to or better than Veovača. So, I expect Adriatic to report greater than 7.6 Mt of resources at grades of >6.0% in its effort to produce a JORC-compliant maiden mineral resource estimate by end-2020.
The Vareš scoping study. The July 2019 mineral resource estimates form the basis for the November 2019 scoping study, which envisions
- recovery on average 715,000 tpa for 10 years from the underground mine Rupice,
- followed by 679,000 tpa for 7 years from the open-pit Veovača,
- with a central processing plant at Veovača, where the old mill is, to produce three concentrates (lead/copper, zinc, and barite).
The scoping study implies Vareš will be extremely economical, with an after-tax IRR of 107.4%, and an 8-month payback from the post-construction start of ore processing (Fig. 6).
Fig. 6. The result of the scoping study on the Vareš project. The assumed metal prices are US$17.2/oz Ag, US$1,440/oz Au, US$2,500/t Zn, US$2,000/t Pb, US$6,500/t Cu, US$155/t Sb, and US$6,500/t barite CIF. Source.
Permitting
As of May 25, 2020, the Federal Ministry of Environment and Tourism has issued the Veovača Environmental Permit for the Veovača mine, plant, and tailings facility. The receipt of the Environmental Permit allows Adriatic to apply for an Urban Planning Permit from the Federal Ministry of Spatial Planning, which has been lodged. Then, the company will apply for the Exploitation Permit from the Federal Ministry for Energy, Mining & Industry. There will be a public hearing in Vareš as part of the application (see here). The Veovača Exploitation Permit is expected in the 3Q2020 (Table 4).
Table 4. Milestones in the Vareš and Raska projects. Source.
Given the ongoing public health crisis and considering Adriatic is the only one of the two mining exploration programs in Bosnia, I am really impressed with the punctuality of the permitting process, which in my view reflects positively of the country as an emerging mining jurisdiction. Cronin commented,
"We are grateful to the Ministry for expediting the issue of the Environmental Permit and are pleased that yet another step in the procedure for exploitation permission has been completed".
It is worth pointing out that once the Rupice Exploitation Permit is received by 1Q2021, the tenure over the Vares project will be extended to 2048. I assume the potential acquirers of Adriatic must be watching this key permitting milestone closely.
Valuation
Drivers of share price movement. As I discussed previously, further share price appreciation is predicated on (1) the Vareš project being advanced toward production, (2) Adriatic being acquired by a major, and/or (3) a zinc bull market, since much of the superior economics of the project has been priced in. Specifically, in the event of those favorable conditions, Adriatic will be able to capture a P/NPV multiple of approximately 0.45X, which corresponds to an EV/MRE of 0.017-0.025X (Fig. 7).
Fig. 7. A variation diagram showing the relationship between after-tax IRR and P/NPV for a select group of pre-production zinc miners, including special situations Trilogy Metals (TMQ), Discovery Metals (DSVMF), Salazar Resources (OTCQB:SRLZF), and Aquila Resources (OTCQB:AQARF). Source: Laurentian Research.
By end-2020. Supposing Adriatic will be able to expand the mineral resource by 25% in the next update as I expect, the Vareš project will contain 7,413 Mlb ZnEq of mineral resource. At the current EV/MRE of 0.025X, Adriatic is supposed to capture a market cap of US$202 million or US$0.99 per share.
By the end of 2020, Adriatic is expected to release the maiden mineral resource estimate for the Raska project. I expect the mineral resource there to be in the neighborhood of 5,070 Mlb ZnEq. At the average pre-PEA EV/MRE of 0.0031X, the market cap of Adriatic is supposed to increase to US$218 million or US$1.00 per share, after taking the dilutive effect of the Tethyan acquisition into consideration.
An analogous transaction: Sasa.
In November 2017, Central Asia Metals (CAML.LSE) acquired Lynx Resources Ltd., obtaining a 100% ownership of the Sasa underground zinc-lead-silver mine in North Macedonia, formerly part of Yugoslavia as are Bosnia and Serbia. Sasa had produced from 1965 to 2002, sharing a history similar to Veovača in Bosnia and Kizevak in Serbia (see here). Lynx resumed production at Sasa in 2010 and has been producing since then. Sasa reportedly contained 3,372 Mlb ZnEq of indicated and inferred mineral resource at the time of the transaction (see here). Central Asia Metals paid 340 million Euro (US$404 million), at an implied EV/MRE of 0.120X (see here). At the EV/MRE multiple for the Sasa transaction,
- Adriatic will be worth US$906 million or US$4.14 per post-Tethyan-acquisition share if the Vareš project produces by 2Q2022 as planned and is sold.
- Once the Raska project is brought on stream as expected in 2023-2024, Adriatic can be sold for US$1,496 million or US$6.91 per post-Tethyan-acquisition share.
Risks
The previously discussed upside represents the cumulative effect of the outcomes of a series of project execution steps under ideal conditions. The actual outcome will have to consider how effectively and at what pace Adriatic management de-risks the project.
Jurisdictional and permitting risk. To investors, Bosnia and Serbia are unfamiliar mining jurisdictions. Many investors are skeptical of these Balkan countries when it comes to their political stability, protection of foreign investments, fiscal regimes, and permitting processes.
We must not forget Serbia and Bosnia are currently candidates for accession into the European Union, which indicates their commitment to the rule of law and transparent governance. In Serbia, mining majors, including Rio Tinto (RIO), Freeport-McMoRan (FCX), and Chinese Zijin Mining (OTCPK:ZIJMF), have operated successfully for a number of years. In relatively under-explored Bosnia, as one of the only two mining investors, Adriatic gets a lot of public support from the local government, which seems to sincerely want Adriatic to succeed and emerge as a taxpayer. The government agencies handled the permitting applications of Adriatic in a timely manner, even in a crucial time of coronavirus pandemic. Adriatic was recognized last year as one of the best foreign investors in the country. Additionally, I believe Miloš Bošnjakovic, executive director of and seller of the original Vareš project to Adriatic, is playing an instrumental role in smoothening things out and pulling strings wherever necessary in the country.
Infrastructure. Both Bosnia and Serbia had a long history of mining prior to the Balkan civil war (1991 to 2001). There remains a well-developed infrastructure dating from the Yugoslavian years. The past-producing Veovača has access to roads, railroad, power, water, old plant site and tailings facility, and skilled labor (Fig. 1). So does the Raska project in Serbia. Both projects have access to seaports on the Adriatic coast. There are multiple smelters for lead-zinc and for copper in the region (Fig. 8).
Fig. 8. Lead-zinc smelters and copper smelters in the Balkans. Source.
Subsurface uncertainty. Even though Rupice shows remarkable thickness and continuity, the mineralized body may pinch out toward the north and the southwest (Fig. 5). Adriatic is yet to drill test a number of prospects discovered via trench sampling, soil geochemistry, and geophysical surveys. Actual drilling may disappoint.
Financing. In the 1Q2020, Adriatic spent GBP 306,000 on salaries and GBP 561,000 on administration expenses. With the acquisition of Tethyan Resources, it has over 32 on the payroll; it also has the added cost of running a Serbian office. So, I estimate the cash burn will be GBP 4 million per year on the overhead. The company spent on average GBP 1.1 million on exploration in each of the last four quarters. Now with the newly-acquired Raska project, the annual exploration budget may rise to GBP 5 million. Combined, I reckon it will probably take roughly GBP 9 million per year to run the operations (Fig. 9).
Fig. 9. Costs by quarter. Source: Laurentian Research based on Adriatic financial filings.
Adriatic has so far relied on equity capital raises to fund its operations. Although the company had A$23.8 million cash in hand and is fully-funded through 1Q2021 when it is scheduled to complete the definitive feasibility study, it will probably need to raise equity capital again in early 2021.
As the Vareš project is further de-risked, I believe another non-dilutive option emerges for Adriatic, i.e., to sell net smelter royalties or metal streams to royalty firms. Hypothetically, Adriatic may sell a 2% NSR on the Vareš project for roughly US$80 million, which can be used to fund its expanded exploration program and both the pre-feasibility and feasibility studies.
Metallurgical risk. Polymetallic with no less than six metals, metallurgy is a major concern for the Vareš project. The preliminary metallurgical test work released in September 2019 reached the following encouraging finding:
- Expected payability-adjusted recoveries from all concentrates were 92.6% for Ag, 66.7% for Au, 81.7% for Zn, 90.4% for Pb, 82.7% for Cu, and 71.7% for BaSO4, with all Rupice concentrates exceeding the current specifications at a range of European and Chinese smelters, and in the case of barite, exceeding the API specification.
According to the early result from the second test work released in January 2020,
- A copper concentrate (grading 25.1% Cu, containing 9,550 g/t Ag and 20.9 g/t Au, and >95% payable as compared to the previously-assumed 30% payable) can be produced through froth flotation, in addition to the previously-announced lead, zinc, and barite concentrates. This is expected to have a positive effect on the aggregate revenues generated from concentrate sales.
- Levels of some deleterious elements are now lower than in the previous test work, with no material smelter penalties expected. Antimony would either attract no penalty or be payable at certain smelters because it can be concentrated to a sufficiently high grade.
More detailed metallurgical optimization will eventually support a definitive feasibility study.
It is worth noting that the saleability of the barite concentrate - voluminous for the Vareš project - opens up the possibility of hauling de-watered tailings, in return trips of haul trucks, from the Vareš mill back to the Rupice paste-fill plant and back-filling cement paste-fill into underground stope voids, thus minimizing the footprint of the Vareš mines.
The management. CEO Paul Cronin has a financial background in the mining sector. With extraordinary prescience, he bought the Vareš project. He worked energetically to ensure the delivery of results on schedule and under budget. Miloš Bošnjakovic, a dual national of Australia and Bosnia and both a mining entrepreneur and a lawyer, seems to be responsible for communicating with the local communities and governments and ensuring Adriatic to operate smoothly in the country.
As the company embarked on the pre-feasibility and feasibility studies, Adriatic brought ex-Anglo-American Graham Hill in as COO. Hill, to be Sarajevo-based, has a track record of shepherding multiple exploration projects from exploration to commercial production in challenging jurisdictions (see here).
The acquisition of Tethyan Resources may also make it possible for Adriatic management to consult shrewd businessman Richard Warke of the Augusta Group of Companies, who is associated with a number of zinc miners, e.g., Titan Mining (TNMCF) and Arizona Mining, which discovered the giant Hermosa-Taylor zinc-lead-copper deposit in Arizona and sold it to South32 (OTCPK:SOUHY) for C$2.1 billion.
The insiders hold 19% of Adriatic shares, which gives them considerable skin in the game and alignment of interest with shareholders.
Potential exit via acquisition. It is generally expected Adriatic will probably sell the Vareš project at some point to a larger mining company for mine construction. The presence of acquisitive Sandfire Resources (OTCPK:SFRRF) as a 16% shareholder speaks to that possibility. The announcement in May 2020 of the acquisition of Tethyan Resources appears to point to a different path going forward, namely, to build a Balkan-focused base metal miner. At any rate, a deal as small as the acquisition of Tethyan Resources should not discourage any aspiring acquirers.
Adriatic on OTC. Adriatic is listed on ASX under 'ADT' and on LSE under 'ADT1', with adequate liquidity on both exchanges, with a market cap of approximately A$242 million or US$158. However, investors should be aware that no firm is making a market in Adriatic on OTC Link; all prices there reflect unsolicited customer orders, and investors may need to pay a high premium buying or have a difficult time selling the stock.
Near-term catalysts
The next 12 months are studded with catalysts which may drive the share price higher:
- 3Q2020: The Veovača Exploitation Permit;
- 3Q2020: Resource update for Rupice and completion of the pre-feasibility study for the Vareš project;
- 4Q2020: Drilling results from Kizevak in Serbia and the release of the maiden JORC-compliant mineral resource estimate for Kizevak;
- 1Q2021: Completion of the definitive feasibility study for the Vareš project, which may seriously pique the interest of potential acquirers;
- 1Q2021: Completion of the Environmental & Social Impact Assessment (i.e., ESIA);
- 1Q2021: The Rupice Exploitation Permit;
- 1Q2021: First drill results from Jurasevac-Brestic, Borovica; Orti and Veovača West; and Sastavci (Serbia).
Investor takeaways
Adriatic is an exciting polymetallic miner thanks to the Rupice deposit now famous for its exceptionally high-grade, remarkable thickness, and continuity. The Vareš project, which lumps Rupice together with the nearby, past-producing Veovača mine, is found to have extraordinary economics, partly due to its access to excellent infrastructure.
Adriatic checks numerous other boxes as well. The jurisdiction, though under-appreciated, is actually quite mining-friendly and punctual in permitting. All in all, Rupice seems set to be a mine in the not too distant future although it may not be Adriatic that will build the mine. Furthermore, there is still a lot of exploration upside, both in the satellite prospects in the vicinity of Rupice and Veovača and in the newly-acquired Raska district in Serbia. The management, 19%-shareholding, is not only capable of delivering results on time and under budget but also shareholder-friendly.
However, the stock is still very undervalued relative to the expanding mineral resources and advancement of the project. Given the numerous catalysts in the next 12 months, I believe the risk-reward profile is decidedly tilted in the favor of shareholders.
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