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CIBC kicks off coverage of Frontier Rare Earths with $7.30 target price

CIBC has initiated coverage on Frontier Rare Earths (TSX:FRO) with a Sector Outperform- Speculative rating, and a target price of C$7.30 based on the company’s promising rare earth exploration projects in South Africa.

Frontier is a Luxembourg headquartered, mineral exploration and development company that is exclusively focused on rare earth elements. Its primary asset is the Zandkopsdrift rare earth deposit in the Namaqualand region of the Northern Cape Province. Zandkopsdrift is believed to be one of highest grade and largest known rare earth resources outside of China, large enough to support annual production of up to 20,000 tons of rare earth oxide; this rivals the largest non-Chinese projects currently under development.

Rare earth demand is driven, in large part, by two fast-growing sectors, energy and high technology. In the energy sector, neodymium, praseodymium, and dysprosium are used in the manufacturing of rechargeable batteries, hybrid/electric cars, and wind turbines. Cerium and lanthanum are used in fluid cracking catalysts and catalytic converters. In the high tech sector, elements like europium and yttrium are used in flat panel displays, lasers, radar, and weapon guidance systems. Neodymium, praseodymium, yttrium, europium and terbium have substitutes but they are not as effective and other elements have none at all in specific applications. Due to their unique attributes, new applications are constantly being developed for rare earths.

CIBC is bullish on Frontier in part due to the current uncertain atmosphere surrounding rare earth supplies, leading to skyrocking prices for the 17 metals. While demand is expected to continue growing steadily, China, which produces 97% of the world’s rare earths, has cut exports by more than half of 2004 levels to 30,000 tons in 2010. Meanwhile, projects outside China are only now ramping up production. As a result, prices outside of China have risen 706% on average since January 2009.

This tight market has created opportunities for those who are able to quickly begin production. This is reflected in the nearly $4 billion valuation assigned to Colorado-based Molycorp, which has already begun mining operations at its Mountain Pass project in California and the circa $3 billion valuation of Lynas who are expecting to have production from their Mount Weld rare earth deposit come on stream in H2 2011. Rare metal oxide production by Molycorp from newly mined ore will not begin until 2012 when facilities come on line, current production is from old stockpiles. As Molycorp and, Lynas, continue their growth, merger and acquisitions may become an important strategy, with Frontier making a nice target.

It is important to note that a typical deposit often requires an average of 10 years to move from discovery to production- and that’s assuming success. Frontier has the advantage of being an early mover: it intends to begin producing rare earths in 2015, ahead of many other projects. The company’s major deposit is also favorably weighted in elements having the tightest supply and therefore the highest prices. CIBC considers these the “bullish” metals and calls the Zandokopsdrift composition “world class.”

Rare earth processing is a multi-step operation, beginning with exploration, mining and production of RE concentrate, oxide separation, upgrading to rare earth metals, converting metals to into alloy powders, then finally component manufacturing. Each step adds increasing value to the product, but few miners have the ability to complete the entire process. Frontier plans to sell separated RE oxides. A separated oxide such as neodymium fetches $150/kg while a mixed rare earth concentrate only garners $38/kg. 

Frontier acquired the prospecting rights for Zandkopsdrift in 2006, and in October 2010 completed a NI 43-101 compliant report which estimated a total resource at Zandkopsdrift of approximately 43 million tonnes (56% in the indicated category and the balance inferred) and total contained TREO (total rare earth oxides) of nearly 1.0 million tonnesThere is good scope for resource expansion as the Zandkopsdrift deposit remains open both laterally and at depth. The main host rare earth bearing mineral at the deposit is monazite , similar to other rare earth deposits being developed, including Lynas’s Mount Weld in Australia. Zandkopsdrift contains elevated levels of valuable heavy rare earths,particularly europium, terbium and dysprosium and also the important light rare earths of dysprosium and praesodymium. It also contains radioactive elements of  thorium (225ppm) and uranium (65ppm), which occur in low both absolute and relative concentrations and should reduce potential environmental implications.

Rare earths are not uniformly located in the deposit; it can be divided into three zones. Zone A contains inferred total rare earth oxides (TREO) of an average grade of 2.5%, Zone B (450,000 tonnes TREO) is at an average grade3.6%, and Zone C is at an average grade of 4.7%. The analysts believe it can be mined using an open-pit plan and estimate up to$700 million may be required to develop the project, which will include a milling operation capable of processing 2,800 tpd - 3,000 tpd, a hydrometallurgical plant to “crack” the ore, and a separation plant to convert the concentrate into finished oxide products.

The project's proximity to good infrastructure is an important consideration due to the immense amount of raw materials required to produce rare earth oxides. As an example, in order to generate 10,000 tons of finished oxides, Avalon's Nechalacho facility is expected to require 400,000 tons of reagents. Frontier's deposit is located in the Namaqualand region, South Africa’s longest established mining provinces, and is close to highway, rail, and deep sea port transportation as well as relevant mining infrastructure and support services.

Several catalysts are expected this year that may move the stock. Results from a 20,000 meter drill program begun in January will increase understanding of the deposit and possibly increase the size of the resource. Preliminary details on economic parameters of the project should be released by Q4 2011, providing valuable information on capital and operating costs- this is expected to allow CIBC to revise their conservative capex estimates, boosting valuations. Any further changes in RE export quota by China will significantly affect all stocks in the sector.

Frontier trades at a significant discount to its peers, valued at only 0.4 x NAV, compared to 0.6 x NAV for Molycorp and 0.7 x NAV for Avalon. As investor awareness of Frontier builds (the Company only listed on TSX in November 2010) and the company advances the project, the valuation gap should narrow.