Graphite One - Their Price Assumptions Don't Add Up

Summary

• Graphite One has been able to raise more capital just recently and the project has been defined as high priority by the USG.
• Graphite itself is also going to be, we assume at least, in higher demand as a result of the electric vehicle and lithium battery boom.
• However, the price assumptions being made by Graphite One look extreme on the upside. I don't think the project adds up.

We should be interested in this

The Graphite One (OTCQX:GPHOF) share price has leapt, this is something we should be interested in:

(Graphite One stock price from Seeking Alpha)

Standard warning

This is about a junior miner - broadly speaking a junior miner is someone not producing anything as yet - and it's also a microcap. Two reasons to be very wary, very careful, about any investment in anything like this. 

Fortunately, we also have Tolstoy's words about unhappy families to guide us - each are unhappy in their own way. The corollary of that being that for a family to be happy it must have avoided all those different - all of them - ways of being unhappy. 

So with small companies, junior miners, microcaps, if we're to be in favour of them we need to rule out, or at least explain around, all of the ways they can go wrong. If we're going to decide to be against them, or just sit it out, we just need to find the one way we think they're going wrong and that's enough.

Price assumptions

With Graphite One my reason to sit it out is simply that I don't believe their price assumption of the final product. This is not to say that I insist they won't succeed, it's just to say that this isn't where I'd put money. There might well be fun with the stock price as a result of speculation but the risk attached to their price assumption seems grossly excessive to me.

Things in favour

It's entirely true that the current design of lithium batteries for electric vehicles requires the use of graphite. Given that we expect EVs to take ever more of the auto market, at least for the next decade or more we expect those to be using roughly today's design of lithium batteries, then yes, there will be more graphite used.

Graphite One has been able to get their project defined as  "high priority status". This isn't as exciting as it might seem, it really just streamlines the approach to the bureaucracy for permits and licences. Gives the company something close to a one-stop shop we might say. Still, given that at this stage a junior miner's life is the process of wading through the bureaucracy to gain licences and permits that is a help. 

They've also been able to raise some cash just recently. CAD $10 million which will keep them going for a bit. It's the combination of those two which has, I think, boosted the stock just recently.

If I was going to be bullish I'd say more about these points but I'm not so there's little need. 

Here's the problem

As Graphite One themselves say their price assumption is:

The PEA estimates the CSG price (as of November 2016), to be $6,200 per tonne

They then explore the implications of higher prices for their profits and thus net present value. CSG is, by the way, coated spherical graphite, the specific product used in the batteries.

That, alone, is enough for me to not believe the projections. Here's a more recent price estimate:

Prices stabilised at the relatively low level of US$2,500-2,600/t between September 2019 and March 2020.

That's before Covid. Yes, that's spherical graphite, not coated, but the price difference is in no manner that large. That's also from Roskill who are monitoring the actual market price rather than making projections of what it might be.

We can also check this other ways. USGS carries a graphite price here. That's $1,400 for 2020 for flake graphite delivered US customs - before the process to turn it into spherical. But we can also look at what the usual costs are to do that:

Production of spherical graphite is an attractive goal for mine developers since the added value, downstream product can achieve much higher returns than basic concentrate. The average value of spherical graphite exported from China is typically 3-4 times higher than small- to medium-sized flake concentrate (the preferred flake size for this industry), at around US$3,000/t in early 2019.

We can also back check that with the inside China (that is, not the USGS import price into the US) price for flake:

Prices for graphite flake 94pc fob China ($/t, -100 mesh) were assessed by Argus at $680-780/t on 8 January 2019. To put this in context, during the exploration boom days of 2011-12, reported prices for graphite fines reached over $1,300/t with large flake selling for up to $3,000/t in early 2012.

So, yes, the spherical is selling for three times -ish the local flake price which is what we think it should be. But the spherical is selling in the $2,200 range (Covid affected) or $2,600 (pre-Covid) one.

Graphite One is running their income projections on the basis of a $6,200 price.

No, I don't believe it.

Sure, the market is expanding

Yes, I agree, EVs are coming, lithium batteries are the thing, more graphite will be used. And yet:

Mozambique entered the graphite market in 2017. The country went from having no graphite exports to around 23,000t with the start-up of Syrah Resources’ Balama mine. Syrah is aiming to become the world’s largest producer outside China. The company is targeting an increase in production at Balama to 350,000 t/yr. After a slowdown in exploration activity in recent years, several junior mining companies continue to raise capital and progress new projects to feasibility study and beyond in Australia, Madagascar, Canada, Tanzania and Namibia, to name a few. As with so many other commodity markets, depressed prices in recent years have impacted the level of financing, and junior mining companies overall remain poorly funded.

Syrah, by the way, intends to finish that raw flake into spherical inside the US as well.

As I've said before and will no doubt have to say again. Prices do not rise just because demand does. It is the combination of demand and supply that determines price. It has, historically, been common for excitement about a particular mineral or element to lead to the funding of more new supply than the new demand requires. Thus the rather unwelcome sight of higher demand leading to lower prices.

We are not short of new mines hoping to enter the graphite market.

My view

As with that Tolstoy line, we only need to find one part of the plan that doesn't look quite right for us to be able to pass on to other opportunities. 

Here it's that assumption about the price of the output. It's not as outrageous as the Niocorp one (where they assumed they could sell three times current world consumption at triple current world price) and it is, I agree, within the bounds of possibility. I also agree that if they start making 45,000 tonnes a year or so then there will be a market for that sort of volume. 

I just don't think it's a likely price and I think it's a horrible one to base financial projections upon. "We're forecasting our income on three times the current world price" is not, to me, a sound basis for projection.

The investor view

Given the fun and games being had with stocks in this sector currently - really, who knows where the fever is going to hit next? - it's entirely possible that there could be some excitement here. But as anything other than a speculation on market sentiment I don't buy the story.

There are better places to put money into. If this does succeed it will be by happenstance, not by planning or forethought.