DEC 08, 2014 ASX-ARU TARGET A$0.35 ARAFURA RESOURCES LTD. //Rare Earths INITIATING COVERAGE Magnet Materials Matter Magnet Materials Matter – Arafura’s Nolans Project can produce an industry leading amount of neodymium and praseodymium, to be used by rare earth magnet makers whose products are destined for the automotive, alternative energy and aerospace industries. Stable Location – Australia is as good and as stable a mining jurisdiction as one could find. Decades of Production – Nolans has a 40+ year mine life, at planned 20,000 tpa equivalent TREO production rate. Economically Viable – Our worst-case REO price deck suggests that Arafura can generate slim but positive cash flows in any rare earth market, and this with current estimated production costs. If programs with Chinese partners bear fruit and operating costs can be driven lower, then Arafura will reap additional rewards. Known Minerals – The minerals in the Nolans deposit are rare-earth bearing phosphates and silicates, which makes their processing a low-risk affair. Societal Acceptance – The region around the proposed mine is mining country. The project should not suffer from protests regarding its operation in the area. Positive Recommendation – Using our recently published base-case REO price deck, we are initiating coverage on Arafura with a AU$0.35 target price. We believe that every rare earths investor should hold Arafura, as it is one of a very few strategic-grade projects outside of China. Jon Hykawy, PhD President [email protected]Tom Chudnovsky Managing Partner [email protected]S T O R M C R O W New Old Rang Posive N/A Target A$0.35 N/A Shares O/S FD ~451.7M Recent Price AUS$0.05 Market Cap AUS$22.5M Net Cash ~AUS$20M See the end of report for important disclosures
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DEC 08, 2014 ASX-ARU
TARGET A$0.35
ARAFURA RESOURCES LTD.
//Rare Earths
INITIATING COVERAGE Magnet Materials Matter
Magnet Materials Matter – Arafura’s Nolans Project can produce an
industry leading amount of neodymium and praseodymium, to be used by
rare earth magnet makers whose products are destined for the automotive,
alternative energy and aerospace industries.
Stable Location – Australia is as good and as stable a mining jurisdiction as
one could find.
Decades of Production – Nolans has a 40+ year mine life, at planned 20,000
gadolinium (SEG) mixed oxides and all heavier rare earths as a mixed
oxide (HREOs).
3. We ascribe no value to the final potentially saleable product from the
project, cerium carbonate. The only likely market for this product is in
China, and given that domestic Chinese production of all cerium
chemicals is likely sufficient for some time to come, we will be
conservative and not attribute revenue to this product.
4. We assume that the values of lanthanum and cerium oxides are as given
by our pricing model.
5. We assume the value of didymium oxide is given entirely by the price of
neodymium oxide in our pricing model, as recent prices for
praseodymium oxide are likely skewed higher by purchases made for the
ceramics market for small quantities of pure praseodymium oxide.
Magnet use does not require separated praseodymium oxide.
6. We assume the value of SEG oxide is its value as separated and purified
REOs less 20%.
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7. We assume the value of HREO from Nolans Bore is its value as separated
and purified REOs less 15%.
8. We believe that the above discounts are reasonable for mixed
concentrates in this form. We have analyzed historical pricing of
separated rare earths produced from ionic clays and the price paid for
ionic clay mixed concentrate, all quoted by Asian Metal. These data show
a 28% discount for a mixed concentrate that still contains large amounts
of lanthanum, cerium and didymium oxides. We believe it correct that a
purer concentrate can command a higher price, as there is simply less
refining to do.
9. We assume operating costs of AU$15.67 per kg, as per Arafura’s
September 2014 Nolans Development Report, and assume operating
costs in their entirety are borne by the project starting in 2019.
10. We assume capital costs of AU$1.41 billion, as per Arafura’s September
2014 report. Capital costs are split 60% debt, 40% equity. Debt carries a
10 year term, with interest rates of 6%.
11. The project takes two years to ramp to full production, with production
of 5,000 tonnes of TREO in 2019 and 9,000 tonnes of TREO in 2020.
Annual production of 20,000 tpa equivalent is achieved in 2021.
12. We apply a 8x terminal multiple to the project in 2026, owing to decades
of remaining production. It would be incorrect to assign zero value to the
remaining production levels.
13. Our DCF analysis assumes a discount rate of 19%. We believe that
venture capital discount rates of 20% or higher are excessive, given the
lack of technical and market risk, and we believe our chosen rate properly
reflects the capital risk of the project.
14. We assume, as have Arafura management, an AU$ to US$ exchange curve
sourced from Access Economics, a leading Australian forecaster. The
curve predicts an exchange rate of 0.838 in 2016, when the bulk of capex
is shown to be injected to the project. We assume rates in 2019 and later
are the average of the curve, at 0.855, as we do believe that China and
the global appetite for commodities will improve, and the AU$ will
strengthen compared to the US$. The current exchange rate is roughly
0.84.
So, with these assumptions we obtain the following cash flow model
through 2025:
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Exhibit 5: Arafura Cash Flow Model
Source: Stormcrow
Our analysis suggests a target price of AU$0.35 per share, rounded down, with
the stock trading in the AU$0.05 range of late.
Note, too, that we have applied our “pessimistic” rare earth price deck to the
same model. The result is slim but positive cash flows once full production
rates are achieved in 2021. From our analysis, it appears that Arafura is one
of very few projects that can weather the storm of the worst pricing that the
rare earth market is likely to be able to produce. It is also clear to us that such
pricing cannot last for very long, as it is likely to kill a number of the
hypothetical producers that are necessary to create sufficiently large supplies
outside of China to drive down pricing to these levels. For our pessimistic REO
price deck, please see our report The Rare Earth Market Keeps Changing,
published in November 2014.
Management Team
Gavin Lockyer, Managing Director Qualifications: BBus, CA Appointed: 23 July 2013 (current position) Mr. Lockyer graduated with a Bachelor of Business degree in Accounting and Finance from Western Australia in 1987, and has subsequently become a
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member of both the Institute of Chartered Accountants and the Finance & Treasury Association of Australia. He joined Arafura in 2006 as CFO and Company Secretary after having served as Financial Controller with the Tethyan Copper Company Limited. Mr. Lockyer previously held a number of senior finance and treasury positions in global mining companies Newcrest and Newmont following an international investment banking career with BankWest and ANZ in Australia, and Bankers Trust and Deutsche Bank in London.
Peter Sherrington, Chief Financial Officer & Company Secretary Qualifications: BBus, CA Appointed: 24 July 2013 (current position) Mr. Sherrington holds a Bachelor of Business in Accounting and Finance, and is a member of the Institute of Chartered Accountants. He commenced employment with Arafura in 2008 as Commercial Manager and was appointed CFO in July 2013. He has in excess of 20 years experience in professional and corporate roles in Perth. Prior to working with Arafura he held senior finance and commercial positions with a number of ASX and unlisted entities. He has also worked in accounting public practice for 10 years in the areas of business services and corporate advisory.
Richard Brescianini, General Manager Exploration & Development Qualifications: BSc (Hons) Appointed: 18 March 2007 Mr. Brescianini is a graduate in Geology and Geophysics, and has extensive private and public sector experience in the minerals industry, in a career that spans over 20 years. From 1987 to 1999, he worked with BHP Minerals on base and precious metals exploration programs throughout Australasia and North America, contributing to significant economic discoveries at Eloise (copper-gold) and Cannington (silver-lead-zinc). Mr. Brescianini led the Northern Territory Government’s Geological Survey as its Director from 2003 to 2007, and was responsible for major geoscience initiatives and investment attraction strategies. Prior to that, he was the Survey’s Chief Geophysicist.
Neil Graham, General Manager Operations & Technology Qualifications: BSc (Hons) Chemical Engineering, C.Eng. Appointed: 1 September 2010 Mr. Graham has more than 25 years of international experience in the chemical industry, encompassing design, construction, and commissioning of both start-up and brownfield installations, in addition to substantial
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operations management experience of facilities in several different countries. He is a chartered engineer who commenced his professional career at BP prior to joining ICI, where he was involved in major project design and implementation roles. He developed the Asian market presence of Rittershaus & Blecher and subsequently completed several technical and site manager roles with Huntsman Pigments before becoming the Group Sulphate Manufacturing Director. More recently, Mr. Graham was responsible for Orica’s largest and most complex facility, worldwide, at Gladstone, Queensland, producing ammonium nitrate, sodium cyanide and chloralkali products. He joined Arafura Resources in September 2010.
Brian Fowler, General Manager NT & Sustainability Appointed: 24 July 2013 (current position) Mr. Fowler has worked for over 40 years in private sector mineral companies, developing a range of commodities, including rare earths, base metals and gold. He has significant experience in a number of disciplines including environmental management, safety management, community engagement, project permitting and approvals, and land access. He has worked at various mining operations and in exploration throughout Australasia. In these roles, Mr. Fowler has been involved in taking projects from discovery, through production, to mine closure, rehabilitation and compliance management. Prior to joining Arafura in 2007, Mr. Fowler worked with Newmont Australia and Normandy Mining in a variety of senior management roles. He is a member of the Northern Territory Mining Board, Management Board of the Northern Territory Minerals Council of Australia, and a member of Work Health & Safety Advisory Council of the Northern Territory.
Conclusions – Magnet Materials Matter
We will reiterate our opening thought. Most financial investors have chosen
to ignore rare earth companies at present. We believe this is a mistake,
because REEs are a critical material with long-term value. Investors that are
interested in the space strategically, those that have to remain interested in
the REE industry, are not likely to let a good opportunity go to waste.
We believe that Arafura remains one of the best opportunities in the rare
earth market. Arafura represents a low-risk, prospectively very long-lived
producer of low-cost critical rare earths. Financially, it can suffer the very
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worst that the rare earth market can throw at it, and generate strong profits
in a base-case market. It remains one of the very few companies in the space
that can make those claims, joining Molycorp, Lynas, Rare Element Resources
(RES-US) and Quest Rare Metals (QRM-TSX). This does not imply that all of
these companies will survive to reach production, but they stand a far better
chance in this market than most of their so-called peers.
We are initiating coverage on Arafura Resources with a positive
recommendation and a target price of AU$0.35. Arafura has every
characteristic of a project that will be supported by strategic investors,
including end-users. The Nolans Bore deposit is located in mining-friendly
Australia, and can produce for many decades. Arafura can produce industry-
leading levels of neodymium and praseodymium, to be turned into magnets
and used in the automotive, alternative energy and aerospace industries. The
project is economically viable, even if REE prices approach worst-case levels.
And the company has few, if any, remaining technical or social acceptability
hurdles. We believe that Arafura is a name that every interested rare earths
investor must own.
Keywords
Important Disclosures
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Industry Rare Earths, Critical Materials, Critical Metals, Mining, Industrial Minerals
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