Source: Brian Sylvester of The Metals Report (2/19/13)
Last year's drop in iron ore prices made for a once-bitten, twice-shy market, but Colin Healey of Haywood Securities now sees upside opportunity in junior developers. But there's a catch: Iron ore projects often have big price tags, and investors need to be confident that a company can cover its costs. In this interview with The Metals Report, Healey discusses junior developers that look fit to reach the finish line and explains why partnerships are not financial cure-alls in the space.
The Metals Report: Colin, iron prices hit 15-month highs in early January. Iron CFR North China prices are now hovering just below $150 per dry metric ton (/dry Mt). Do you see further upward momentum in iron prices in 2013?
Colin Healey: It's still somewhat touch and go. If we see an average 2013 price hold up where it is today, we'd be happy. Most analysts, including myself, have a declining price forecast for iron ore going forward through 2014, '15 and '16. Our model implies CFR China prices of about $150 for the remainder of 2013, so if we maintain support in that range we'll be pleased.
The latest data that we have for China, the largest consumer and importer of iron ore, show a continuing decline in inventories through December. The price rebound in the last couple of months likely has more to do with restocking of inventories than consumption growth. But we'll know more when we see the World Steel Association data later this month.
TMR: In a recent Haywood Securities report, you tracked the stock prices of selected iron producers and iron developers over the previous two months. So far, the prices of all but one iron producer have increased, whereas about half of the iron developers saw their share prices drop over the same period. What's behind that?
CH: What you're seeing right now for the developers is the market realizing just how difficult it can be to bring a development play from a resource definition and technical/economic study through all the challenges of financing the project to production. Very large capex is involved with a lot of these names. Projects generally require a partner. And those partners have demonstrated a lot of negotiating power in the deals, especially in the Labrador Trough.
Look at Labrador Iron Mines Holdings Ltd. (LIM:TSX), which is un-partnered and struggling to make margin in its initial production period. It is currently subject to high fees imposed by the firm handling and marketing the ore, and would definitely benefit from a partner or offtake agreement that brings improved payment terms and could add liquidity.
The key takeaway is that there is a glut of resource, as we've seen several multibillion-tonne maiden resources out of the Labrador Trough in the past 12 months. The market is starting to realize that developing the resource may be the easy part and demonstrating a clear a path to production is the difficult part.
TMR: The 12-month charts of the iron ore developers all look alike. Share prices started 2012 high and then trended steadily lower throughout the year with a few price spikes along the way. Have these juniors found their bottom?
CH: Throughout 2012 until September, the CFR China price steadily declined, bottoming out at less than $90/dry Mt. The iron ore names properly responded to the decline in iron ore price, but they haven't responded to the same degree with the rebound to greater than $150/dry Mt. That has a lot to do with the market becoming more familiar with iron ore price volatility. Although the difference between the high and low in 2012 was actually less than the differences in each of the previous three years, the market is applying a bigger risk premium to the juniors to account for this volatility, and that's on top of financing and capex risk. Junior developers with established resources are likely close to the bottom, and commodity price stability would help keep that bottom intact. But if the volatility comes back in to the iron ore price and there's a downward trend, iron ore developers could test even lower lows.
TMR: Most retail investors in the iron ore developer space lost their shirts last year. Why should they come back? How are they going to make money?
CH: There's no question that there have been huge declines for investors of all types in the iron ore developer space in the past year, with the commodity suffering significant declines. And the majority of the stock performance over the past year in the developers has to do with the commodity price. At the current price, many developers have the potential to generate substantial margins, although only a few of them have actually made the transition to production over the last 24 months. Investors should come back into the space because the response in the stocks to the downside, thanks to the downward trend in the iron ore price, was not equal to the response in the stocks to the upward recovery in the iron ore price. The stocks are still lagging the commodity, creating some opportunity.
TMR: How long before the stocks catch up?
CH: Stocks are going to be much more tempered in their response to the iron ore price. Given the rapid decline in 2012, there's more of a wait-and-see approach to investing in these equities, and ultimately demand for these equities is what drives the stock price up. An extended period of support at iron ore prices CFR China of above $135-140/dry Mt will start to bring people back into these equities.
TMR: Alderon Iron Ore Corp. (ADV:TSX; AXX:NYSE.MKT) recently published a feasibility study for its flagship Kami project in western Labrador. Why didn't the market respond more strongly to the study's findings, given that mine life doubled from 15 to 30 years and operating costs went down?
CH: In our report on the feasibility study of the Kami iron ore project, we called the study neutral. Capex grew about 27% to almost $1.3 billion ($1.3B) with the feasibility study. It's true that mine life did double compared to the 2011 preliminary economic assessment (PEA), but in my view, this was widely anticipated. The market's tempered response to the feasibility study can be largely attributed to the fact that the results were generally in line with expectations.
TMR: You said that the capex goes to $1.3B. How much of that does Alderon need to raise in order to build that plant and what's the path to get there?
CH: We assume that Alderon's strategic partner, Hebei Iron & Steel Co. Ltd. (000709:CH), will effectively contribute $250 million ($250M), equal to 25% of a capped $1B in project capex. We assume that Alderon will contribute all of the $120M received from the completion of the sale of 25% of the Kami project to Heibei, but part of this (25%, or $30M) is attributable to Heibei's $250M effective total. In straight numbers, that totals $340M. The total project capex estimated in the feasibility study was $1.273B, leaving $933M that Alderon has to finance. Hebei could potentially assist in the fundraising. It's the world's second-largest steel producer, and China's largest. It was a huge win for Alderon to bring this partner in, but it still has to be recognized that the deal was quite favorable to Hebei. The $120M that it paid Alderon is going right back into the project, after all, and Heibei will receive discounts on a portion of production as well.
TMR: Do you think Alderon will reach production?
CH: Yes. The whole basis for our $3.60 price target is the assumption that the company will reach production and that it will be able to manage the financing challenges.
TMR: Production is slated for Q4/15. Is Alderon on target?
CH: It looks that way. The plan is to begin construction in November 2013, although it does have some final permitting it needs to achieve in the September-October timeframe.
TMR: Another company under coverage is New Millennium Iron Corp. (NML:TSX), and it has Tata Steel Ltd. (TTST:LSE; TATLY:OTC) as its strategic partner in the DSO iron project. Further investment from Tata will be based on a definitive feasibility study underway on New Millennium's Taconite project. That study is due roughly halfway through 2013. What are you expecting?
CH: The feasibility study being jointly carried out by New Millennium and Tata Steel on the Taconite project is what's going to form the basis for Tata's investment decision on the projects. New Millennium and Tata have provided good color to the market on the scope of the study, which we expect will contemplate a 22-million ton per annum (Mtpa) concentrate operation feeding a 17-Mtpa pelletizing operation.
The agreement between the two parties, following a positive feasibility study and investment decision from Tata, would see Tata arrange for capital financing of up to about $4.85B, beyond which the two parties would be responsible for their respective proportional share. The bottom line is that the possibility is there for New Millennium to be involved in up to 40% of the Taconite project.
We expect a positive outcome for the study and a positive investment decision from Tata, and we believe there is as high probability of New Millennium and Tata bringing in a third party or parties to spread the funding costs. We also note the potential for the initial capital to come in above the $4.985B amount that Tata would arrange for financing. In a nutshell, we see the possibility or the potential for the joint venture structure to change.
TMR: An update on operations at New Millennium's DSO project stated that New Millennium plans to increase production to as much as 6 Mtpa of iron concentrate by 2015. How would that change the economics of the project?
CH: There's no doubt the Tata Steel/New Millennium JV took the decision to target 6 Mtpa of output at the DSO project to maximize the economics of the project. When this concept was originally introduced in October of last year, we looked at the plan and took the conservative view that 5 Mtpa was achievable.
Our $3.40 current target on New Millennium implies significant upside. There's a definite need to remain conservative in approaching valuations for any developer transitioning into a producer. The potential for the JV to reach its expanded production target represents a positive for New Millennium, in our view. It would allow the company to spread overhead and fix costs over additional tons with the potential to improve economics.
TMR: You cover Champion Iron Mines Ltd. (CHM:TSX), which recently published results of a preliminary feasibility study on its Consolidated Fire Lake North project where you placed a revised target of $1.20 on the stock, and maintained your speculative buy rating. In light of subsequent news that CN Rail has suspended its feasibility study work on an estimated $5B, 800-km railway line that in concept would connect many of the projects in the Labrador Trough to the Port of Sept-Iles, how does this affect your view on the company?
CH: When Champion published the preliminary feasibility study on the project, it included a 310-km independent rail solution at a cost of ~$1.33B in the economics. At that time we elected to take the conservative approach of including the full capital burden of this standalone solution in our model, in addition to the $1.39B in estimated capex for development of the project. We prefer this approach rather than to make assumptions about a shared rail solution where the funding requirements and development timing are not clear. Champion was one of the mining companies that was financially participating in the CN-lead study of the rail line, and a positive outcome for that study could have provided options for rail transport for Champion beyond the independent solution outlined in the prefeasibility study. I think that the prefeasibility study demonstrates the potential for the project to be economic even if the company has to develop its own rail.
More important to the company, in our view, is demonstrating a viable path to maintaining its development timeline in light of the news and identifying non-dilutive sources of funding the large capex involved in bringing the project into production. This could theoretically be done through introduction of a strategic partner investing in the common equity of the company and/or investment at the project level, and might also include offtake agreement(s), any of which could provide support for financing of upfront capital to develop the project. We feel that if Champion could deliver some combination thereof, it would help shed some overhang on the stock.
TMR: Another junior developer trying to work out financing is Labrador Iron Mines. Is there a strong likelihood that at least one of these developers isn't going to get the financing it needs to further develop its project?
CH: There's definitely a risk of that. Any time a company is repeatedly relying on equity markets for financing, the appetite for that stock will diminish. Labrador Iron Mines told the market that it needed three things to restart production for seasonal startup in late March 2013. It needed $40M in working capital financing. It wanted to be confident in an iron ore price above $110/dry Mt CFR China. It also said it needed to be confident that it can achieve cash costs of $65 per ton or less. With iron ore prices at around $150/dry Mt CFR China, that isn't a major concern for Labrador Iron Mines right now. With regard to the $65 per ton cash costs, Labrador looks like it will get there if it can ramp up production.
The biggest concern for the company right now is the fact that it recently completed a ~$20.4M financing at $1.05 a unit, with 24M units. That isn't what it told the market it needed for working capital going into production. The market is concerned that it has yet to put into place all the financing it needs to recommence production in March or April.
Labrador Iron Mines didn't raise the amount that it reportedly needs because the company is continuing to pursue a favorable offtake agreement or some other kind of arrangement, which would provide the additional funding. What we really need to see from Labrador Iron Mines in the very short term is an announcement about the offtake agreement, which it is telling the market it's close to, that provides the funding upfront to recommence production.
TMR: You recently dropped coverage of Northland Resources Inc. (NAU:TSX; NPK:FSE). What was the basis for that decision?
CH: Northland came out with a press release Jan. 24 telling the market that it was in the process of contemplating a $250M equity financing and a $125M bond tap. As proposed, that would have raised $375M. That amount was meant to partially address another piece of that press release, which was a $425M capex funding shortfall. Northland identified the shortfall through a thorough bottom-up review of its budget for the project. The stock went from $1.07 to $0.12 in a matter of days.
Northland pushed on with this proposed financing package and recently announced it was unable to complete it. It's a company in initial production that had $37M in the bank in December and that is now trying to ship its first boatload of ore with a $425M shortfall on its project. At the current stock price, just to fund the $250M equity component, there's over 380% dilution represented in the stock. We don't believe that there's enough information available to even estimate how many shares would be outstanding, never mind put a value or assess the risk to the common shareholder given the failure of the company to raise the money it needed.
TMR: If you were to say which one of the companies you cover that you're most excited about, which would it be?
CH: In the iron ore space, New Millenium is the company we see as having the most potential to be successful with its plan.
TMR: If you were contemplating one of these companies receiving a takeover bid, which is the most likely candidate?
CH: You could look at Champion, which is unmarried at this point. It's almost at the feasibility study level with its Fire Lake North project, so it's well advanced. It is also trading at near 52-week lows, making it a candidate to be picked up. Labrador Iron Mines is in production and has yet to introduce a major partner or offtake agreement, and could also be a candidate for those interested in the production.
TMR: Thanks for the insights, Colin.
Colin Healey joined Haywood in 2008 as a mining associate focusing on the uranium, iron ore and coal sectors. Immediately prior to his arrival at Haywood, Healey worked at a major Canadian bank as an analyst structuring debt financing across a wide variety of industries. Prior to joining the finance industry seven years ago, he worked for eight years as quality manager in an ISO 17025-accredited laboratory that performed extensive assay and analysis work for major mining and precious metals refining companies. He holds a Master of Business Administration from the Schulich School of Business at York University, majoring in finance and investments, as well as a Bachelor of Commerce degree majoring in computer information systems and a technical diploma in mechanical engineering.
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1) Brian Sylvester of The Metals Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Metals Report: Alderon Iron Ore Corp. and New Millennium Iron Corp. Interviews are edited for clarity.
3) Colin Healey: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
4) Haywood Securities Inc. or one of its subsidiaries has managed or co-managed or participated as selling group in a public offering of securities for Champion Minerals Inc. and Labrador Iron Mines Holdings Ltd. in the past 12 months.
5) Haywood Securities, Inc. or one of its subsidiaries has received compensation for investment banking services from Champion Minerals Inc., New Millennium Iron Corp. and Labrador Iron Mines Holdings Ltd. in the past 24 months.
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