Thursday, 17 January 2019
Black Rock Mining Ltd (ASX:BKT) has been labelled undervalued in a 68-page special research report by Simon Francis of Orior Capital. The company is developing the Mahenge Graphite Project in south-eastern Tanzania. Black Rock published a definitive feasibility study (DFS) in October 2018, which followed the pre-feasibility study (PFS) completed in April 2017. The following is an extract from the report: Unjustifiably cheap. The project has a post-tax, unlevered NPV10 of US$895m, and an IRR of ~43%, both net of the Tanzanian government’s 16% stake. The NPV is ~7x the initial capex requirement of US$115m. Despite these strong metrics, Black Rock’s market capitalisation is less than 2% of NPV. Assuming total initial capital required of US$140m, 80:20 debt-to-equity funding, equity being issued at A$0.10 to A$0.15 per share, and a fair EV valuation, 12 months from now, of 30-50% of NPV, then Black Rock’s EV could be US$269m to US$448m. This equates to a valuation of A$0.16-0.40 per share, ~4-11x the current share price. Opportunity knocks: In a sample of eight ASX-listed African graphite developers, there is only a US$16m difference in market capitalisation between the largest and smallest. The market is not differentiating between projects, meaning it has so far failed to take advantage of the opportunity in Black Rock. Compelling project, with substantial cash flows: The DFS envisages a three-phase project ultimately producing 240,000 tpa high-grade graphite. When completed, Black Rock is likely to be the 2nd largest miner of natural flake graphite in the world ex-China. Based on DFS figures of a US$1,301/t basket selling price, and US$401/t C1 costs, annual EBITDA will be around US$216m, equating to an EBITDA margin of 69%. The project is expected to generate US$313m in EBITDA over the first three years. This strong cash generation is expected to support a high-level of debt financing, limiting the dilution to existing shareholders. Risk mitigation a key part of the DFS: The DFS was compiled after more than 25,000 man-hours of work. It incorporates the results from a large-scale pilot plant, improvements in the plant design over 15 iterations, a decision to use dry-stacking, development of an ultra-high-grade graphite product, logistics tests on the Tanzania Zambia Railway Authority (TAZARA) railway, customer testing of Mahenge graphite products, and operational readiness work designed to provide a smooth ramp-up, and to address concentrate transportation. Management’s approach has been to reduce as many risks as possible. Significant advantages, both geological…: Mahenge hosts the 2nd largest graphite reserve, and the 4thth largest JORC-compliant graphite resource globally. The resource is biased towards larger flake sizes. Strip ratios are low. Impurities are at a minimum. Black Rock has demonstrated the ability to produce amongst the highest quality products globally, without chemical interference. This means lower capital and operating costs, less environmental impact, and a differentiated high-value product. The use of dry-stacking means there is no need for wet tailings dams, and the risks they impose. There is no need to dispose of used hydrofluoric acid, which can be difficult. …And geographical. Access to key infrastructure is excellent, and provides the Mahenge project with a long-term sustainable cost advantage. This includes the TAZARA railway line, which feeds directly into the port of Dar es Salaam. The port is an internationally vital trade link serving seven countries. It handles 95% of Tanzania’s trade cargoes. There is frequent shipping to key markets in Asia. The Tanzania Electric Supply Co Ltd (TANESCO) will provide grid power. Excellent logistics ensures there is no need for unsafe several hundredkilometre truck journeys, no uncertainty as to available port capacity, no barging and reloading, and no need for expensive diesel generators on site. Phases 1 and 2 are already sold out: Critically, Black Rock spent the past year demonstrating a path to market. A large-scale pilot plant, an order of magnitude larger than the next, enabled delivery of certified samples to customers and laboratories. Feedback has been hugely positive. Three offtake agreements have been signed for a combined 205,000 tpa (in the third year), representing 85% of planned production, and an astonishing ~23% of 2017 global natural graphite demand. Notably, two of the agreements – those with Heilongjiang Bohao and Taihe Soar – are believed to be the two largest offtake agreements signed by any graphite company, either in production or development. The agreements cover a variety of end-use applications including expandable graphite, and energy storage. The agreements will enable Black Rock to establish branding in the energy storage market. The agreements are a testament to Black Rock’s notion that Mahenge graphite has unique properties that make it highly desirable to end-users. Graphite demand growth accelerating: The births of the electric vehicle and energy storage systems markets have transformed the graphite market from a mature one, to one with rapid growth prospects. Both these industries are embryonic in nature, and growing at a terrific pace. There is also huge pent-up demand for expandable graphite for use in the foil and fire retardant segments. Demand for fire retardants is being driven by technological developments and more stringent safety standards in automotive, aerospace, and in building and construction after a number of large fires. Demand for natural flake graphite (excluding amorphous graphite) is expected to more than double over the next decade from ~630,000 tpa in 2017 to ~1.4m tpa in 2027. Even before accounting for any further curtailment in Chinese supply, the world could need the equivalent of three “Mahenges” to meet demand over the next decade. Chinese supply is under pressure: Supplies of large flake graphite from China are dwindling as resources are depleted. Combined with strong growth in the expandable market, China is now short of large flake graphite, and has started importing +50 mesh material from East Africa. Environmental controls, mainly aimed at restricting the use of acids in graphite beneficiation, are being more strictly enforced. Over time, purer graphite sources are likely to attract premium prices. Outlook for prices is excellent: The combination of new industries experiencing peak demand growth, and challenged supply out of China, the world’s largest producer, suggest a strong outlook for graphite prices. Experience from the iron ore and coal markets in the mid-2000s, suggests that increasing Chinese imports (or decreasing exports), may have a significantly positive impact on market prices. As a result, there is an immediate opportunity in large flake graphite, with new suppliers of high-quality materials able to sell into a rapid growth market that is seeing shortages. Not all graphite is created equal; market segmentation is key: The market can be broadly divided into three categories; Large flake: The market for 80 mesh and larger has massive pent-up demand, and is supply constrained. Changes in building regulations and challenged Chinese supply suggest an increasingly tight market with strong price outcomes. There is a step change in pricing above 98% purity and 80 mesh. Battery grade: Typically, 150 to 80 mesh. The market has been demand constrained, though forecasts of exponential growth in the electric vehicle space suggest this will change quickly. High-grades, and spheronizing performance are differentiating factors. ‘Dirty’ concentrates containing impurities such as vanadium and others, will attract lower prices, and are at risk of stricter environmental controls in China. Selling directly to larger battery makers, where qualification can take years, is difficult. Establishing channels is critical. Refractory grade: Generally, smaller flakes and lower grades, used in steel making and other metallurgy. Lower prices, and essentially the market of last resort for a graphite company. (Some high-end applications require premium product). Black Rock has unearthed significant demand for large flake, high-purity graphite. The company has also established channels for the battery sector through offtakes with Heilongjiang Bohao (which supplies the German automotive industry), and Qingdao Fujin Graphite (anodes for consumer electronics). Black Rock’s initial battery tests were conducted at a US-based, ISO-compliant laboratory. Battery cells produced from surface coated, spheronized natural flake from Ulanzi, exceeded 300 cycles, with a 94% recharge rate. The cells also had flatter performance curves than an existing commercial battery, indicating potential for longer battery life. This is a significant result that bodes well for future development. Few new projects are of global scale. The combination of strong demand, and challenged Chinese supply, has motivated a plethora of new projects in East Africa. Most of these are relatively small scale. The obvious hurdle many will face is completing a detailed DFS study that will be necessary to secure funding. Black Rock has set the bar in this regard. Further, many projects seem focused on the electric vehicle revolution. Though exciting, the market is currently small, and qualification periods, as for anything in the automotive sector, are long. Companies focusing on this space will need to find other markets to sustain themselves through this qualification period. It seems likely that over the next few years, supply from East Africa will become dominated by two large producers in Syrah Resources (SYR.AX), and Black Rock, with a number of smaller players serving niche markets. Tanzania: Tanzania’s reset of its legislative code in 2017/18 negatively impacted risk perceptions, and the capacity to raise debt finance from traditional sources, and hit share prices. Yet over the past year, Tanzania has made great strides. Companies report that engagement with the government has been positive, and that projects that contribute positively to Tanzania’s development are being approved. Black Rock expects its mining licenses to be approved in early-2019. The country has a fast-growing economy, benefits from a young and educated workforce, and there is rapid investment in infrastructure. The government’s vision is for Tanzania to be semi-industrialised (manufacturing represents 40% of GDP) by 2025. In summary, the Mahenge graphite project has been thoroughly conceived. It boasts significant and sustainable natural advantages, it stands to benefit Tanzania directly through shared ownership, upgraded infrastructure, and increased employment, and it looks like coming on stream into a period of peak demand growth. Consequently, it also seems likely to reward shareholders. As part of its financing strategy and post the DFS, Orior Capital was commissioned by Black Rock Mining to undertake a review of the business and graphite sector.