SVH Tracker - March 23, 2016: Recommendation Strategy for First Point Minerals Corp
First Point Minerals Corp was continued as a Good Relative Spec Value Buy at $0.05 on December 31, 2015 based on the junior's 100% ownership of a large, low grade nickel deposit in British Columbia called Decar whose grade is 10% of the lowest grade existing laterite and sulphide mines. Given that nickel prices are suffering from refined nickel warehouse stocks representing a half year's worth of consumption, while the Philippines continues to grow its supply of laterite ore shipped directly to China for conversion into nickel pig iron at a time when China's growth slowdown and shift away from investment spending is reducing stainless steel demand, it would seem very odd to recommend a junior with such a low grade nickel deposit that is definitely not feasible at nickel prices below $6/lb. This story, which I have been covering since late 2009, has an unusual twist that could make it one of the first major nickel deposits that get considered for development in 3-5 years when the nickel supply glut has turned into a deficit. I expect 2016 to be a dead year for First Point to get anything done that improves the outlook for Decar, but see it as an ideal period for Spec Value Hunters to accumulate a cheap position as a long term bet on higher nickel prices, and on management's ability to demonstrate that the development economics are considerably better than outlined in a PEA delivered by a former partner that requires a $9.39/lb nickel price for feasibility. First Point had about $1.1 million working capital left as of September 30, 2015, but much of that will disappear via severance packages for the departing CEO and Exploration VP. Peter Bradshaw remains as chairman and former CFO Martin Turenne has become the new CEO. First Point needs to spend about $3 million to update the PEA through a better product marketing strategy than envisioned by Cliffs which requires some metallurgical work, optimize the mining plan to exclude barren dykes, and create a better starter pit by drilling off a high grade extension. However, with nickel prices stuck in the doghouse, a nickel stock price that discourages equity financing for this junior with 117.8 million shares fully diluted, and a resource sector still coming to terms with the end of the China super-cycle, First Point has little choice but to hibernate during 2016 while it shows the story to potential future partners. The upside surprise for Spec Value Hunters would be a strong deal that leaves First Point with a deal equivalent to or superior to the one it had with Cliffs, a minimum net 25% interest carried through a bankable feasibility study. Currently the market is assigning a value of only $6 million to Decar, or $24 million if a 25% net farmout deal were negotiated. Decar's low grade nature makes it necessary to be operated as a bulk tonnage open-pit mine with a scale entailing a CAPEX in excess of $1 billion. The future for Decar is either as a very big mine or none at all. For such a project to proceed it will need an after-tax NPV approaching $1 billion. If First Point nets 25% it would command a stock price of $2 per share, about 40 times the current price in the absence of further equity dilution. The location in central British Columbia with nearby infrastructure offers a safe jurisdiction that can ship concentrates to North American, European or Asian steelmakers. The marketing challenge is to find steelmakers willing to accept this concentrate as a direct feedstock for their stainless steel mills; it would be a non-dirty version of nickel pig iron. Any deal done during 2016 while nickel languishes would require the partner to be bullish about nickel long term and focused on security of supply for 2 billion lbs of payable nickel over a 24 year mine life (average 39,000 tonnes annually representing 1.5% of 2015 global supply of 2.53 million tonnes); such a deal with timing would imply a serious long term development commitment and cause First Point's stock price to rise into the $0.20-$0.30 range from where it would gradually increase another 5-10 times over the next few years as the project is aggressively marched through the feasibility demonstration stages by the partner. This strategic aspect of Decar justifies keeping First Point Minerals Corp as part of the 2016 SVH Portfolio rather than shunting it to the 2016 Bottom-Fish Edition.
What makes Decar interesting is that its host rock is a simple, homogenous ultramafic rock whose metamorphic history created a natural stainless steel alloy that occurs as grains of a mineral called awaruite. The paltry 0.12% grade is not a conventional fire assay that measures all the nickel content, including the nickel hopelessly trapped in the olivine lattice, but rather a Davis Tube assay which only measures the amount of nickel recoverable through magnetic separation down to a minimum grain size. The coarseness and consistency of the awaruite grains are critical to the bulk tonnage economics of this deposit type. The concept developed by First Point management was that these very large deposits could be developed as relatively low cost mines with minimal reagent consumption, and energy costs limited to crushing, grinding and gravity-magnetic separation. A key requirement was the absence of sulphides so that the voluminous waste rock and tailings would be environmentally benign, an important hurdle for permitting in secure western jurisdictions. Since 2009 First Point has engaged in a worldwide review of potential similar deposits, and while it found a few candidates in British Columbia and Yukon which proved not as good as Decar, other regions with similar ultramafic settings disappointed management. The good news was that deposits like Decar are very rare, and First Point does not need to worry about a supply glut arising from an abundance of similar deposits owned by others.
The "awaruite" concept attracted the attention of Cliffs Natural Resources Inc which optioned the project in late 2009 through a deal that enabled it to earn up to 75% by delivering a bankable feasibility study. It twinned with management's goal of establishing itself as a supplier to the North American stainless steel industry of key stainless steel inputs (iron, chromium, nickel) from North American sources. Cliffs spent $22 million to deliver a PEA in February 2013, earning 60%, and elected to proceed with a PFS. But Cliffs' plans were derailed when the iron ore producer came under attack from a hedge fund that ousted Cliffs management in mid 2014 abolished the strategic goal and went to work liquidating non-core assets. First Point secured a deal on September 8, 2015 to acquire Cliffs' Decar interest for US $4.75 million, which it funded by granting a 1% NSR to a third party in exchange for a five year fully secured USD $5 million loan (see SVH Tracker: September 10, 2015 for an analysis of the deal). Cliffs also sold its 14,353,190 share block at $0.0515 to a group of friendly investors rounded up by First Point management, thus removing an onerous overhang from the market. The loan comes due in November 2020, which gives First Point plenty of time to boost its valuation through a positive revision of the PEA or by securing a long term development partner.
Cliffs delivered a PEA on Mar 22, 2013 that proposed a 114,000 tpd open-pit mine that would produce 39,000 tonnes of nickel annually over a 24 year mine life with a CAPEX of $1.4 billion and OPEX of $6.91/t (USD figures). At a base case price of $9.39/lb nickel Decar generated an after-tax NPV (at 8%) of $579 million and IRR of 13% from a resource of 925 million tonnes at 0.12% nickel, below the hurdle thresholds generally required for mine development. The PEA was conservative in that its ore schedule consisted of life-of-mine average grade, a hefty 25% payability discount for the nickel content, and a high contingency cost for what is a fairly simple flow-sheet of crushing-grinding and gravity-magnetic separation. Management thinks that a mapping program aimed at outlining the barren dykes within the Baptiste deposit could allow diversion of this material to the waste dump and thus avoid the 8% dilution assumed by the PEA. A drill program planned for the higher grade Southeast Extension of the Baptiste Zone could translate into a better starter pit location. With regard to the 75% payability assumed by Cliffs (applied after an 82% processing recovery), management thinks that additional metallurgical work on 10-20 tonnes of material from existing core could lead to a better nickel concentrate grade that improves payability into the 85%-90% range. The concentrate resulting from the testwork could also be sent to potential end-users as sample material. This work about cost about $2-$3 million which First Point does not currently have and is reluctant to raise at the SVH recommended stock price. The plan, however, offers a good bang for initial dollars spent by a big company willing to do a deal while nickel prices continue to stink. A revised PEA based on these changes will not make Decar feasible at nickel below $4/lb; the goal is to make it feasible in the $6-$8/lb range.
I constructed an after-tax sensitivity DCF model based on the PEA except for using the current 1.35 CAD:USD exchange rate instead of the near parity assumed by the PEA. Because capital and operating costs were all sourced in Canada as Canadian dollar denominated costs, they are unlikely to have changed. If anything, they will have decreased somewhat in absolute terms in light of the resource sector bear market. Initial CAD CapEx of $1,384,000,000, sustaining CapEx of $763,000,000, and an OpEx of $6.90 per tonne milled become in USD terms respectively $1,025,000,000, $565,185,000 and $5.11 per tonne. The NPV graph above shows how the after-tax NPV varies at 5% and 10% discount rates at different nickel prices with the currency adjusted costs. The chart shows that Decar is very feasible at the $9.50/lb nickel price, and even interesting in the $6-$8/lb range. The challenge for First Point is to demonstrate that Decar is very interesting in the $6-$8/lb range, and then wait for nickel to rise back into that range. At $8/lb Decar with the currency adjusted PEA assumptions has an after-tax NPV range of USD $700 million to $1.9 billion (10% to 5% discount rate) and an IRR of 21%. That translates into a $5.92 to $11.74 per share target based on 100% net interest and 118 million fully diluted shares. If First Point does a 25% net farmout deal, the target prices become $1.48-$2.94 per share.
First Point and a partner have a very good chance of achieving mining plan improvements that make Decar robust in the $6-$8/lb nickel price range. But will nickel achieve long term price stability in this range? Wood McKenzie's nickel specialist Andrew Mitchell gave perhaps the gloomiest of all the commodity talks during the Sunday afternoon session at PDAC on March 6, 2016. He pointed out that warehouse stocks exceed 1 million tonnes (LME plus China warehouses and in stockpiled nickel pig iron), about 40% of the 2,530,000 tonnes the USGS has estimated for 2015 global mine supply. Mitchell pointed out that this is half of global consumption, which suggests a monstrous surplus of about 500,000 tonnes. Where did that surplus come from when nickel touched $25/lb in 2007 as warehouse stocks dropped towards zero? The answer lies with a Chinese innovation that enabled Chinese steelmakers to feed a crude product called "nickel pig iron" into their furnaces to make a stainless steel acceptable to Chinese standards. Where did the Chinese get their nickel pig iron? It came from lower grade laterite deposits in Indonesia and the Philippines that were not suitable for HPAL operations such as those operated in New Caledonia and Australia. This ore was strip mined and direct shipped as raw ore to China where it was fed initially into legacy blast furnaces and then later into new furnaces optimized for nickel pig iron production. The nickel pig iron innovation saved China's bacon.
Indonesia's output went from 157,000 tonnes in 2006 to a peak of 440,000 tonnes in 2013. Since then Indonesian output has dropped to 170,000 tonnes after the government in 2014 imposed a ban on the export of raw ore. The Chinese have since build smelters in Indonesia to handle this laterite ore representing 260,000 tonnes of capacity, but it is not clear when these smelters will be turned on, in part because of Indonesia's stretched energy grid. The Philippines went from 65,000 tonnes in 2006 to an all time annual high for any nation of 530,000 tonnes in 2015. Predictions that the Philippines will encounter environmental opposition or run out of ore have not become reality. The conventional laterite and sulphide nickel producers have refrained from cutting back production on the assumption that the nickel pig iron related supply surge is peaking and will in fact soon subside. The elephant in the nickel room is the relentless supply growth of nickel pig iron destined laterite ore, a situation that will worsen if Indonesia gives up on its export ban. Mitchell estimated that 60%-70% of the nickel production industry is cash negative at current nickel prices below $4/lb. He indicated that no additional nickel output is needed until 2021, and that based on demand projections, if no new supply is mobilized, the annual deficit will reach 475,000 tonnes by 2030 and support a $9.50-$10.00/lb nickel price. At the start of his talk Mitchell pointed out that the nickel pig iron revolution was created by the supply squeeze in 2007 that in turn was caused by the clash between short term planning and the long term investment nature of nickel production. He did not offer any ideas on how long the NPI destined laterite supply from the Philippines and Indonesia can last before decline sets in, but he did warn that the assumption that nickel pig iron is a high cost source of nickel is false. The nickel industry is engaged in a game of chicken between the conventional nickel laterite and sulphide producers, and the nickel pig iron destined laterite producers; who will cut supplies first? First Point's awaruite based Decar nickel project does not have a depletion problem as may be the case with Filipino and Indonesian NPI ore, and it does not have the energy price sensitive cost structure that characterizes conventional laterite and sulphide nickel supply. No matter who wins this game of chicken, Decar stands to benefit, which is a good reason Spec Value Hunters should accumulate First Point before a potential strategic partner figures out what First Point management is talking about. The nasty nickel warehouse chart and general ignorance about the nature of Decar are the reasons First Point is such a cheap security of supply bet on nickel. The main nickel producers are not going to rush to mobilize new supply when that mountain starts to decline and nickel prices inch higher. But somebody is going to grab Decar and fast-track its development for 2021 and beyond when the battle between nickel pig iron and refined nickel is over.
*JK owns shares in First Point Minerals Corp