Spec Value Hunter Comment - March 21, 2012: Recommendation Strategy for Tasman Metals Ltd
Tasman Metals Ltd was recommended a Good Relative Spec Value Buy at $1.58 on December 30, 2011 on the premise that the company would deliver a preliminary economic assessment (PEA) which confirms its 100% owned Norra Karr deposit as a world class solution to Europe's long term rare earth supply needs. Tasman has now achieved this milestone and joined the ranks of serious rare earth supply contenders racing to deliver non-Chinese rare earth supply for 2016 and beyond. After trading as high as $6 in Q2 of 2011 the stock has suffered as the market waited for a PEA initially expected in October 2011. That wait is now over, and although the market has had a lukewarm reaction to the publication of robust PEA's by other juniors, the heavy rare earth nature of Tasman's Norra Karr deposit and its strategic location in Europe promise a much better market reception during Q2 of 2012. Matamec and its Kipawa PEA could be offered as a counterexample, but the smaller size and lower grade of Kipawa coupled with an astonishingly bad deal the company struck with Toyota last December prior to revealing its PEA to the market, rule out Matamec as a valid comparison. I have run Tasman's PEA parameters through a discounted cash flow model at various basket prices and come to the conclusion that management has been very conservative in its choice of a rare earth price deck. My own after-tax NPV per share target works out to $17.58 using the base case price deck, which suggests an ultimate buyout target of $8-$9 if Tasman can minimize the dilution needed to fund delivery of a prefeasibility study (PFS) during the next 12-18 months which does not overly boost capital and operating costs without sacrificing recoveries. I am setting a short term target of $4 which implies a project value of $260 million that is comparable with that of other world class rare earth supply contenders with better than 20% heavy rare earth output potential. Accordingly I am elevating the Good Relative Spec Value Buy to a Good Absolute Spec Value Buy at $2.27 with a short term target of $4 by the end of Q2 2012. Key to this target will be evidence that European end-users are prepared to roll up their sleeves and secure some sort of supporting relationship with Tasman that rules out the company slipping into the grasp of Chinese entities seeking a long term option on heavy rare earth supply. An alternative scenario would involve a move by Molycorp and Neo Material after their merger has been consummated to secure a European feed of heavy rare earth dominated concentrates for their Silmet facility in Estonia. Much will depend in the short term on whether German end-users are content to wait patiently until the cows come home (ie government brain farts like investing $4 billion in Kazakhstan or recycling failed renewable energy technologies), or succumb to the urge to send out some cowboys to round up what they need. My understanding from Tasman management is that the German end-users are very much on top of the Norra Karr story, and, given the fact that there is nothing else in Europe on the scale of Norra Karr with its simplicity of full spectrum rare earth supply potential without undue reliance on cerium and lanthanum for commercial viability, I am inclined to bet on decisive action. As the chart below shows, Norra Karr rare earth supply would be just a sliver in the overall supply pipeline, but it would be a completely "Made in Europe" supply of rare earths no non-European would be in a position to disrupt. Furthermore, if you were a European watching President Obama raising a big WTO stick to bash a Chinese hornet's nest, or wondering if American red heifer seekers will succeed in getting an Israeli stick poked into an even worse hornet's nest called Iran, and needed a secure supply of rare earths, what would you do?
On March 21, 2012 Tasman published a PEA for a 4,110 tpd open pit mining operation designed to produce annually a mixed rare earth concentrate containing nearly 7,000 tonnes of rare earth oxides of which 50.3% belong to the heavy rare earth group for which China, currently providing 95% of the world's rare earth output, will be in short supply of within 10 years. Tasman's mining plan envisions reaching full production within three years of startup and operating for at least 40 years, with somewhat higher grade material being mined after the first 20 years. An "in pit" indicated and inferred resource of 58.1 million tonnes of 0.59% TREO and 1.7% ZrO2 forms the basis of the PEA. The rare earth elements report primarily to a single mineral, eudialyte, which is uniformly distributed within an unweathered deposit whose grade improves with depth. The global resource is substantially larger than the "in pit" resource and would allow Norra Karr to produce rare earths at the proposed mining rate of about 1.5 million tonnes ore per year for a hundred years.
|Project Resource Estimate - Norra Karr - "In Pit"|
|Mar 21, 2012||NI 43-101||Geofrrey Reed, Pincock Allen & Holt,/Minarco-Mineconsult||Cutoff: 0.285% TREO |
|Note: Basket Price used domestic spot $64/kg as of Mar 20/11 & $3.77/kg ZrO2, FOB spot was $155/kg, FOB 3Y $104/kg, DOM 3Y $54/kg, Toyota-Kipawa $68/kg, Tasman PEA $54/kg.|
|Metal||Grade||Recovery||Contained Metal||% of GMV|
|Indicated Resources||41,600,000||$429/t||Rare-Earth-Metals||0.570%||100.0%||237,120,000 kg||85%|
|Inferred Mineral Resources||16,500,000||$474/t||Rare-Earth-Metals||0.640%||100.0%||105,600,000 kg||86%|
|All Categories Spot||58,100,000||$442/t||Rare-Earth-Metals||0.590%||342,720,000 kg||85%|
|Spot Gross Metal Value||Market Cap as % of Net GMV||Spot Prices Used|
|$25,657,576,849||0.6%||Rare-Earth-Metals $64.00/kg, Zirconium $1.71/lb|
The company emphasizes that grade, mineral grain size and the heavy percentage vary only slightly across the deposit in a concentric manner. These are very important considerations because the commercial viability of a rare earth deposit hinges on the consistency of the ore feed to a chemical plant built according to an optimal flowsheet. The PEA is a major milestone for Tasman in that it signals that the company's metallurgical engineers have overcome the recovery problem associated with processing rare earth bearing eudialyte, though this breakthrough has already been presaged by Matamec Explorations Inc whose eudialyte dominated Kipawa deposit in Quebec became the subject of a tentative financing and offtake deal involving Toyota last December.
Using a price deck that is similar to the one Toyota recommended for the Kipawa PEA, except that dysprosium and terbium prices are 31% and 35% lower than "projected" by Toyota, Tasman has come up with a base case basket price of $51/kg which generates a pre-tax net present value of $1,464,000,000 using a 10% discount rate. The internal rate of return is 49.6% thanks to a low capital cost of $290 million compared to $315 million for Matamec's similar sized operation. Tasman's"life-of-mine" average operating cost is $48/tonne compared to $59/tonne for the Kipawa PEA. Norra Karr assumes an 80% recovery for TREO and 60% for zirconium oxide compared to 81% recovery for the Kipawa PEA which does not attempt to recover zirconium. Because the basket price is based on separated rare earth prices, and because the flowsheet produces only a mixed oxide concentrate, Tasman has applied a 38% discount to its basket price compared to 30% applied by Matamec in its PEA, and 40% applied by Rare Element in its recent Bear Lodge PFS.
As in the case of Toyota-Matamec, the price deck excludes the obscure rare earths holmium, erbium, thulium, ytterbium and lutetium for which neither Asian-Metals nor Metal-Pages provide price quotes. When I add the prices Avalon used in its PFS, which was prior to the jump in rare earth prices in July 2010, the Tasman basket price increases to $54/kg, compared to $68/kg using the Toyota price deck with the obscure rare earth prices included.
Assuming a 100% interest and 64,920,089 Tasman shares fully diluted, the PEA pre-tax NPV works out to $22.59 per share in the base case PEA scenario. I have constructed a discounted cash flow model based on the Tasman PEA parameters supplemented by a 28% Swedish tax rate that kicks in after payback, which generates an after-tax NPV of $1,139,000,000 or $17.58 per share and an IRR of 58.5% at a 10% discount rate. It is significant that the modified base case basket price of $54/kg is equivalent to the basket price using three year trailing average domestic prices as of March 20, 2012 (Metal-Pages prices). Assuming CAPEX and OPEX are reasonable figures (they have a 35% error margin in a PEA), this DCF based valuation qualifies as very conservative.
Note that in the Matamec DCF chart below the price target using the domestic 3 year trailing average basket price that applies to Kipawa's distribution, $50/kg, generates an after-tax NPV target of only $0.65 per share. When you look at the TREO supply potential profile for 2016 above, and see that Kipawa will produce 5,200 tonnes of TREO annually compared to 7,000 tonnes from Norra Karr, one has to wonder why Tasman seems to have so much upside compared to Matamec, something that does aggrieve me as a shareholder of Matamec. The difference is due to Matamec having more than double Tasman's fully diluted shares, netting only 49% after Toyota pays $17.5 million towards a feasibility study, a grade that is 27% lower than Norra Karr, a heavy proportion that is only 36% compared to 50%, a mine life of only 13 years compared to 40 years, and no zirconium by-product revenue which adds $55 million annually to Tasman's bottom-line if it can get the PEA's assumed price of $3.77/kg ZrO2. (See my January 30, 2012 Matamec Index Member Comment for an analysis of the Kipawa PEA.)
The location of Norra Karr in southern Sweden within 0.5 km of a paved highway and 25 km from a railway avoids the infrastructure development obstacles faced by other major heavy rare earth dominated deposits. The low thorium (7 ppm) and uranium (14 ppm) levels in the ore which are close to background levels are unlikely to create disposal problems. Given the strong interest European end users have shown in Norra Karr, in particular German manufacturers who are loathe to shift production of their advanced technologies to China, and who are cognizant of Germany's policy decision to promote renewable energy, development of Norra Karr along the lines envisioned by the PEA makes not just strategic sense, but economic sense if the PEA cost structure holds up reasonably well as Tasman pushes the project through a prefeasibility study during the next year.
Conclusion: There has been much hand wringing of late about the glut of light rare earths that will flood the market when Mountain Pass and Mt Weld come fully on stream in 2013, and unless this glut unleashes new offsetting demand from end-users no longer worried about becoming roadkill in China's geopolitical machinations, one has to be concerned about the viability of additional major non-Chinese rare earth projects that are predominantly light rare earths. Every other week there is a new significant 43-101 resource estimate for a light rare earth deposit. One analyst frequently quoted as a rare earth expert is predicting $1/kg for cerium in 2016 and beyond, which will not help the economics of cerium dominated output from a certain bat cave in South Africa, nor the revival of monazite sand production. When assessing the viability of a rare earth prospect you have to look at the supply distribution of the mine, as in the chart above for Norra Karr once it is generating 7,000 tonnes of rare earth oxides annually. Norra Karr's light rare earth contribution will be a fraction of global supply, and because it is likely to be controlled by European end-users at the end of the day, it will find a home in Europe. Norra Karr's vulnerability lies with yttrium, but look at the yttrium supply profile chart below. Most of the existing supply comes from the threatened ion adsorption clay deposits in China. Perhaps this will be supplemented by African clay deposits controlled by high-flying OTC BB companies as Byron's rare earth expert believes, but the biggest yttrium supply threat comes from heavy rare earth peers such as Avalon and Quest, both of which will likely serve non-European markets if and when they come on stream. It is a mistake to assume that rare earth supply will feed into a global market. Rare earths are regarded as "critical metals" not because they are essential in the sense that oxygen is to life, but, because they are minor though poorly substitutable inputs to vastly more valuable applications, end-users will do what it takes to secure their supply. And that is a reason why Obama's WTO protests will accomplish nothing more than spawn a scramble by end-users to secure their rare earth needs, sort of like Warren Buffet's International Metalworking Companies is doing with regard to tungsten, another metal in which China is the dominant supplier. It took Tasman longer than expected to deliver a PEA, but the timing is ideal for Tasman to take the limelight while others such as Quest and Avalon iron the devils out of the details of their flowsheets. Eudialyte has historically been a no-go rare earth mineral, but both Matamec and Tasman, courtesy of the late metallurgist Les Heymann, have cracked the code. Tasman, however, has the most immediate upside potential.
*JK owns shares in Tasman Metals Ltd