Spec Value Hunter Comment - April 16, 2012: Decar resource confirms expectations and signals game on
On April 16, 2012 First Point Minerals Corp published an initial 43-101 resource estimate for the Baptiste nickel deposit on the Decar project in central British Columbia in which iron producer Cliffs Natural Resources Inc can earn up to 75% by producing a bankable feasibility study. The outcome is consistent with my expectations, confirming observations that the nickel mineralization is consistent and homogenous over a large area, which bodes well for the interpretation of drill results later this year from First Point's 100% owned Klow and Wale projects. First Point was recommended a Good Relative Spec Value Buy at $0.41 on December 30, 2011, and with this major milestone of a substantial nickel resource now achieved, I can confirm that First Point remains a Good Relative Spec Value Buy at $0.62. I have constructed a speculative discounted cash flow model for a 60,000 tpd mining scenario described below which supports a price target in the $1.50-$2.00 range based on the Decar project alone. I cannot convert the recommendation to a Good Absolute Spec Value Buy because there are several uncertainties which will not be resolved until Cliffs produces a PEA, though judging by the aggressive manner in which Cliffs is advancing this unusual nickel project I suspect they will have a positive resolution. The key issues the PEA must resolve are 1) the optimal makeup of the concentrates Cliffs intends to ship directly to steelmakers, 2) what percentage of the contained nickel value the steelmakers will be willing to pay, along with possible credits for the iron (magnetite) that makes up the bulk of the concentrate, and, 3) the capital and operating costs for a gravity-magnetic separation based flow-sheet. Also, given the size of the resource, the PEA may reveal the feasibility of doubling the scale of a Decar mining operation from the 50,000 tpd scenario initially contemplated by First Point management when they presented the project to Cliffs in 2009. In this regard Cliffs is engaged in advanced negotiations with the Tl'azt'en First Nation in whose traditional territory north of Fort St James the project falls, as is evident in the map below. Because Cliffs is a substantial operating company the Tl'azt'en First Nation leaders wasted no time rolling up their sleeves after Cliffs optioned the project in late 2009; the indication is that Tl'azt'en is focused on maximizing the economic interest of their members rather than obstructing mine development, which makes sense because Decar has the makings of a mine that will operate more than 50 years with a benign impact on the local environment other than visual surface disturbance. Concrete evidence that affected First Nations people are on side with the development of Decar will be an important near term milestone.
The resource was reported at six cutoff grades ranging from 0.02% to 0.12% recoverable nickel with 0.06% chosen by Caracle Creek International Consulting Inc as the base case inferred resource. At a 0.06% cutoff the Baptiste deposit has an inferred resource of 1,197,000,000 tonnes of 0.113% nickel while at a 0.12% cutoff the resource is 486,770,000 tonnes of 0.135% nickel. The base case model encompasses a 2.3 km long curved body 350-600 metres wide with a vertical depth of 350 metres. Caracle Creek had categorized a good portion of the resource as indicated, but Roscoe Postle, which is working on the preliminary economic assessment (PEA) hoped for by the end of 2012 and expected no later than March 2013, demurred. So Cliffs is preparing a 50 man camp for a 16,500 m 49 hole infill drilling program for 2012 designed to upgrade the resource into the indicated category. Although most of the holes were drilled 300 metres at a 50 degree angle for a vertical depth of 250 metres, Caracle Creek was able to extend the resource estimate to a 350 metre depth because Cliffs drilled several strategically located deep vertical 600 m holes which revealed nickel mineralization consistent with that of the shallower holes. It is thus plausible to conclude that the geologic resource is likely double the reported amount. The 2012 program will include six vertical 600 metre holes.
|Base Case Resource Estimates|
|Project Resource Estimate - Decar - Base Case Scenario|
|Apr 16, 2012||NI 43-101||Jason Baker, P.Eng, Caracle Creek intl Consulting Inc||Cutoff: 0.06% recoverable Ni |
|Note: Grade was assayed with the Davis tube method which recovers only the magnetic forms of nickel, not the nickel in olivine.|
|Metal||Grade||Recovery||Contained Metal||% of GMV|
|Inferred Mineral Resources||1,197,000,000||$20/t||Nickel||0.113%||100.0%||2,981,964,166 lb||100%|
|All Categories Spot||1,197,000,000||$20/t||Nickel||0.113%||2,981,964,166 lb||100%|
|All Categories LTA||1,197,000,000||$23/t||Nickel||0.113%||2,981,964,166 lb||100%|
|Spot Gross Metal Value||Market Cap as % of Net GMV||Spot Prices Used|
|LTA Gross Metal Value||Market Cap as % of Net GMV||LTA Prices Used|
|$27,463,889,973||0.9%||3 Year Average: Nickel $9.21/lb|
|Alternative Resource Estimate Scenarios|
|Project Resource Estimate - Decar - Higher Grade Scenario|
|Apr 16, 2012||NI 43-101||Jason Baker, P.Eng, Caracle Creek intl Consulting Inc||Cutoff: 0.12% recoverable Ni |
|Note: Resource for higher cutoff supports a 25 year mine life at 50,000 tpd, while base case 0.06% resource supports 30 years at 100,000 tpd.|
|Metal||Grade||Recovery||Contained Metal||% of GMV|
|Inferred Mineral Resources||486,770,000||$24/t||Nickel||0.135%||100.0%||1,448,729,820 lb||100%|
|All Categories Spot||486,770,000||$24/t||Nickel||0.135%||1,448,729,820 lb||100%|
|All Categories LTA||486,770,000||$27/t||Nickel||0.135%||1,448,729,820 lb||100%|
|Spot Gross Metal Value||Market Cap as % of Net GMV||Spot Prices Used|
|LTA Gross Metal Value||Market Cap as % of Net GMV||LTA Prices Used|
|$13,342,801,639||1.9%||3 Year Average: Nickel $9.21/lb|
It must be emphasized that the grade is defined by the Davis Tube method which "assays" the grade recoverable through magnetic separation methods. A Davis Tube derived recoverable nickel grade is different from the total nickel grade delivered by a fire assay which includes nickel sulphides and nickel tied up in the lattice of refractory minerals such as olivine, a common constituent of ultramafic bodies which typically grade 0.25% total nickel. Furthermore, the Davis Tube represents the commercially recoverable grade, leaving behind the portion of very fine grained awaruite minerals (nickel-iron alloy). A metallurgical study last year yielded an 80% recovery from a one tonne sample with a nickel-iron alloy based head grade of 0.14% nickel. In attempting a cash flow model one can thus apply close to a 100% recovery to the reported deposit grade.
The obvious question for Spec Value Hunters now that we have an initial resource is what Decar potentially is worth at different nickel prices? I've noticed that some enthusiastic fans of First Point have expressed awe through Bullboard posts about the $24 billion in situ value of the Baptiste resource, but that is not what defines the economic value of a mine. The value of a mine is defined by the discounted cash flow model which projects the cash flow for each year of the life of a mine and discounts those cash flows to a present value using a suitable discount rate such as 10%, higher if there are major risks or uncertainties, or 5% if gold is part of the payable output. The problem with Decar is that there is no comparable nickel mine from which we can borrow capital and operating costs. In fact, all commercial nickel mines process sulphide or laterite grades in excess of 2% nickel, more than 20 times the grade of the Decar base case resource. The Decar nickel, however, is made up of neither sulphide nor laterite mineralization; it is an unusual nickel-iron alloy called awaruite which one can call a "natural stainless steel". Ultramafic bodies such as Baptiste are boring black colored rocks that lack the reddish color created when sulphides get oxidized by weathering. Such deposits are metamorphic freaks of nature that are quite rare as First Point has discovered after years of looking for similar deposits. But when they exist, they are very large and consistently mineralized, which opens the way for simple large scale, low cost mining operations without the environmental issues associated with the acid-generating waste rock dumps of sulphide mines. The initial Decar resource estimate is an extraordinarily important milestone because it demonstrates the large scale of this type of low grade mineralization whose profitable exploitation requires large economies of scale. It was the application of economies of scale to copper porphyry deposits during the fifties which turned these geochemical anomalies into the primary source of copper supply today. First Point is an exceptionally exciting junior because it is trying to do for nickel what was done for copper more than fifty years ago.
Disclosure rules prohibit First Point and Cliffs from showing us the arithmetic that underlies the aggressive advancement of the Decar project, but nothing prevents us onlookers from engaging in the same sort of "back-of-the-napkin" modeling insiders are doing behind the scenes. For guidance with regard to capital and operating costs I have looked at the low grade Mt Milligan copper-gold deposit in central British Columbia for which Terrane Metals Corp produced a feasibility study in 2009 before being bought out by Thompson Creek Mining in October 2010 at a price that valued the project at $368 million. Terrane proposed to put Mt Milligan into production as a 60,000 tpd open pit mine with a flotation circuit that would produce a 26%-27% copper-gold concentrate that would be transported to Asia for smelting. The capital cost was estimated at $900 million with a $270 million sustaining cost over the 23 year mine life. Mining cost was $1.30 per tonne material moved, processing was $3.90 per tonne ore, and G&A and plant service was $0.72 per tonne. Adjusting for Mt Milligan's life-of-mine 0.5:1 strip ratio the operating cost worked out to $6.95 per tonne, or $7.50 per tonne if we annualize the LOM sustaining capital as an operating cost.
Although Cliffs is apparently investigating throughput rates as high as 100,000 tpd, at which the base case resource would support a 30 year mine life, I have decided to focus on the resource defined by the highest cutoff grade, 0.12% recoverable nickel, which results in an ore grade of 0.135% nickel. When a cutoff grade ranges from 0.02% to 0.12% nickel one has to wonder if the simple geometry of the deposit at the lowest cutoff grade mutates into a complex body at the higher cutoff with a soaring strip ratio (waste to ore) that boosts the mining cost. According to First Point's Ron Britten there is little vertical variation in grade within the Baptiste deposit, with grade zoning in a lateral direction from west to east. Subject to confirmation by the block models at the different cutoff grades in the technical report when it gets filed, I have assumed that the 486,770,000 inferred tonnes at 0.135% exist at surface as a continuous body with a 0.5:1 strip ratio (the deposit averages 10 metres of overburden). This resource conveniently maps to that of Mt Milligan, generating a 23 year mine life at 60,000 tpd with a 365 day year.
Although a grinding-gravity-magnetic separation plant at 60,000 tpd may be cheaper than a grinding-flotation plant, I have assumed all the Mt Milligan capital and operating cost parameters except that I have reduced the $3.90/t processing cost to $3.00/t on the assumption that the Decar plant will have a lower reagent consumption and maintenance cost. Including the sustaining cost the operating cost in my model works out to $6.21 per tonne ore rather than $7.50 per tonne for Mt Milligan. I have assumed 100% recovery of the nickel grade on the assumption that the Davis Tube defined resource grade reflects the commercially recoverable grade.
Greater uncertainty resides in my assumptions about transportation cost and the percentage of the concentrate's contained metal that will be payable at market prices. A metallurgical study released in 2011 indicated that Cliffs was able to reduce a one tonne sample of ore grading 0.14% awaruite nickel into a ferro-nickel concentrate that was 4.2% of the original mass. This concentrate graded 2.6% nickel, 52% iron, and 2.2% chromite, with the remaining mass consisting of the oxygen in the magnetite molecule and magnesium oxide. Cliffs' plan is to market this concentrate as a direct shipping product to the steelmaking industry, which would feed the concentrate into its furnaces at the appropriate measure. The Mt Milligan feasibility study estimated that it would cost $163 to ship a tonne of copper-gold concentrate from the mine site to a smelter in Asia. The concentrate had to be trucked 89 km to a railhead in Fort St James at a cost of $20.16 per wmt, railed to Vancouver at $55.93 per wmt, and shipped to Asia at $46 per wmt, with port handling and loading charges adding $40.92 per wmt. Because Decar is located only 5 km from the railway, I have assumed construction of a rail spur that eliminates trucking and reloading costs. I have assumed a $50 per tonne concentrate transportation cost, which may be too low given that we do not know the destination market. More critical to this equation is the amount of concentrate that will have to be shipped from Decar. First Point management indicates that further metallurgical studies suggest the concentrate's nickel content can be upgraded from 2.6% to 15% with the sort of gravity separation methods in which Cliffs has expertise, and that the resulting direct shipping concentrate would be only 1% of the original mass. If this is true then it would only cost about $11 million annually to transport the Decar concentrates to market at a $50/t concentrate cost. The PEA will tell us the actual mass pull, somewhere between 1%-4%, and the average transport to market cost, somewhere between $50-$100/t concentrate. My assumptions are biased to the optimistic side.
Much murkier is the question as to what a steelmaker will pay for the Decar ferro-nickel concentrates. Cliffs is in the business of supplying coking coal and iron pellets to the steelmaking industry, and with its McFauld's Lake chromite development project, aims to also supply chromium. Its involvement with First Point is part of its goal to become a turnkey supplier of key inputs for the North American stainless steelmaking industry. Thanks to its existing relationships with steelmakers Cliffs is in a strong position to figure out exactly what sort of product mix the steelmakers desire and for which they would be willing to pay top dollar. Will the steelmakers pay anything for the iron they receive when they buy Decar ferro-nickel concentrates? Will they insist on a discount from the spot value of the contained nickel as compensation for taking on the iron that comes with it? Cliffs is engaged in a marketing study to determine what product mix will generate the highest revenue with the lowest processing cost. We will not know the result until the PEA is published. I have assumed Cliffs will get zero value for everything in the concentrate except the nickel, for which it will get only 90% of the spot value, equivalent to a 10% smelter retention rate. So what does a discounted cash flow model constructed with these parameters and run at different nickel prices look like?
Conclusion: My sensitivity analysis for my speculative cash flow model shows that at a 10% discount rate the project has an after-tax net present value of $1,237,000,000 at the current nickel price of $8.14/lb with a 31.4% internal rate of return. Adjusting for First Point's net 25% interest if Cliffs goes to 75% by delivering a bankable feasibility study, and the 102.7 million shares it has fully diluted, this after tax NPV works out to $3.01 per share, which is pretty impressive. The 10% discount rate based after-tax NPV drops to zero at a nickel price of about $4.50/lb, but soars to $2.5 billion or $6.12 per share at $12 nickel. The nickel market is expected to be in surplus during the next few years as major new laterite projects come on stream, but largely unknown is what the real operating cost of these new mines will be. At $12/lb nickel a virtual unlimited supply of low quality laterite feed comes on stream from Indonesia and the Philippines in the form of nickel-pig-iron that gets fed into surplus Chinese blast furnace capacity. Indonesia has threatened to introduce an export tax in an effort to force the construction of nickel refining capacity within Indonesia, but no such new capacity will be developed before 2015. The Indonesian export tax would raise the threshold at which it becomes feasible to mine and smelt nickel-pig-iron, currently estimated at $8-$9/lb, which should raise the bar at which nickel-pig-iron comes on stream. At this point it is prudent to assume that the long term range for nickel prices will be $6-$10/lb. At $6/lb nickel my Decar DCF model as an IRR of 19% and an after-tax NPV of $520 million or $1.27 per share, while at $10/lb nickel the IRR is 42% while the after-tax NPV is $1.9 billion or $4.51 per share. Based on this valuation range I believe it is reasonable to expect a price target for First Point in the $1.50-$2.00 range by this time next year based on Decar alone and the assumption that the Roscoe Postle PEA will deliver numbers similar to those produced by my speculative DCF model based on the Mt Milligan feasibility study.
This is not the sort of homerun price target many Spec Value Hunters may be hoping for, but I must remind everybody that this target assumes that Decar is unique, and that First Point's drilling programs on the 100% owned Klow and Wale projects in British Columbia this summer will fail to demonstrate that awaruite mineralized bodies of similar grade and size are present at Klow or Wale. Skeptics overwhelmed by the market's current glass half-empty obsession may think this is the inevitable outcome, but I would warn that the market mood does not change the fact that First Point management has pioneered an entirely new approach to assessing the viability of a hitherto ignored style of nickel deposit, and that the work done so far by Cliffs, along with its body language, signals that a revolution in the nickel mining sector is underway and that First Point will be the primary beneficiary because of its lead in sourcing potentially similar nickel systems elsewhere in the world while the nickel industry stays fixated on sulphide and laterite systems. A $5-$10 price target is conceivable if First Point clones the Decar success at Klow or Wale, with a very rapid achievement of such a valuation once the Decar PEA has validated the assumptions I have deployed in my speculative cash flow model. First Point has budgeted $3 million of its $7 million working capital for exploration drilling this year, starting with Klow in late May and continuing with Wale during the summer. Each of the Klow and Wale projects have implied project values of only $63 million compared to the $255 million implied by Decar. The stock would have to undergo a fourfold price increase to match the Decar valuation. In the current market climate this cannot happen without long Davis Tube intersections from Klow or Wale grading 0.1%-0.2% recoverable nickel, which results will not be available until Q3 of 2012. Patience is in order, but I feel strongly it will be well rewarded.
*JK owns shares in First Point Minerals Corp