Getting back on track at the TGO

Alkane Resources 15 May 2017 Update
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Alkane Resources

Getting back on track at the TGO

Re-initiation of coverage

Metals & mining

15 May 2017

Price

A$0.26

Market cap

A$130m

A$/US$0.75

Net cash (A$m) at 31 March 2017

20.8

Shares in issue

505.2m

Free float

51%

Code

ALK

Primary exchange

ASX

Secondary exchange

OTCQX

Share price performance

%

1m

3m

12m

Abs

(3.8)

(29.2)

27.5

Rel (local)

(2.2)

(30.4)

17.8

52-week high/low

A$0.6

A$0.2

Business description

Alkane Resources is a multi-commodity explorer and developer, with projects in the central west region of New South Wales in Australia. It owns the Tomingley Gold Operation (TGO) and the Dubbo Project (DP) rare metal, zirconium chemicals and rare earths projects (both 100%). TGO entered production in January 2014 and DP is planned for first production during 2019.

Next events

Q417 quarterly cash flow

July 2017

Analysts

Tom Hayes

+44 (0)20 3077 5725

Charles Gibson

+44 (0)20 3077 5724

Alkane Resources is a research client of Edison Investment Research Limited

After a testing H117 at the Tomingley Gold Operation (TGO) due to high levels of rainfall that affected gold production, Alkane’s third quarter results show a return to profitable operations, with net cash flow from operations of A$6.5m reducing after delayed December 2016 payments to a net A$2.0m at quarter’s end. As weather conditions improved in NSW, Q317 gold production recorded a q-o-q increase of 59%, with 18,721ozs Au produced at AISC costs of A$1,201/oz. Sales of 16,303ozs Au at an average realised gold price of A$1,694/oz resulted.

Year
end

Revenue (A$m)

PBT*
(A$m)

EPS*
(c)

DPS
(c)

P/E
(x)

Yield
(%)

06/15

101.8

0.1

1.0

0.0

26.0

N/A

06/16

109.6

11.0

2.2

0.0

11.8

N/A

06/17e

98.0

(17.7)

(1.5)

0.0

N/A

N/A

06/18e

104.3

(16.2)

(1.2)

0.0

N/A

N/A

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

TGO exploration eyes further UG resources

Following a review of the underground (UG) resource and proposed mine plan for the TGO, Alkane has stated that it will revise its overall plan for the transition to UG mining. Previously, we assumed c 84koz would be recovered from an UG operation at Wyoming One from FY18 to FY24, supplementing ounces derived from ongoing surface mining. For now, we keep this Wyoming One UG mining schedule intact until official guidance is announced, but advise that the amount and, more importantly, the schedule for ore extraction, is likely to change as exploratory drilling completes and, so far, very favourable assay results are incorporated into a new resource and mine plan. Concerning Alkane’s broader exploration focus, drilling completed over a number of non-TGO exploration targets has so far revealed promising stratigraphic and lithological signals which, in some instances, are the same as some of the largest gold mines in the region.

DP – product prices stable or rising

Our DP valuation uses pricing forecasts for 2020 as detailed in its definitive feasibility study (DFS). We have reviewed current pricing trends across the Dubbo Project’s (DP) product suite and see these forecasts as intact, see page 6 onwards.

Valuation: Fluctuates heavily on share price level

We have incorporated TGO FY17 production guidance of 53-58koz (we assume 57koz, see page 5), rolled forward our valuation to FY18 and have moved our DP funding assumptions from FY17 to FY18 to allow for DP financing negotiations to complete. Applying a lower share price for notional future funding has the automatic effect of reducing our valuation to A$0.61/share for the TGO and DP combined (previously A$0.78). However, with all other pricing, project development and mine schedule assumptions unchanged, we see considerable scope for upside as DP catalysts emerge in the form of commercial offtake and financing, see pages 9 and 10 for details.

Investment summary

Company description: Rising DP prices could release financing

The longstanding investment case for Alkane Resources is tied to the development of the Dubbo Project (DP), a strategic project in that it carries a multitude of key speciality metals outside of the dominant supplier, China. These metals feed not only into a wide range of green technologies and electric vehicles, but also into defence technologies that do not wish to be subjected to Chinese export controls, in whatever form they take. Alongside the DP, the ongoing mining of gold at the TGO has seen a rebound in gold production after an H117 affected by rain.

Valuation: Share price reaction to DP catalysts key

We have valued Alkane’s shares on the basis of its revised DP project scope (see our December note Staged DZP plan de-risks financing and off-take), as well as our interpretation for mining the TGO until FY24. The TGO valuation uses our in-house gold price deck, and the DP uses prices as per its Front End Engineering Design (FEED) study announced in August 2015. The latter, in general, reflect current REE pricing levels, with zirconium product pricing rebounding from multi-year lows. Hafnium prices could rise as supply disruption results from Toshiba’s Westinghouse bankruptcy and ferro-niobium prices remain stable, as ever, due to the oligopoly present over supply. Our base case valuation, fully diluted for our DP financing assumptions, is A$0.84/share using a 10% discount rate.

Exhibit 1: Base case, TGO-only and DP scenario valuations

Previously

FY18

TGO only, without any dilution, financing, costs or revenues associated with the DP.

0.37

0.26

Base case - TGO and DP fully developed

0.78

0.61

The following valuation scenarios include TGO production

Post stage one capex with stage two developed

0.93

0.66

Post stage one without stage two developed

0.43

0.35

Post stage two capex

1.31

0.86

Source: Edison Investment Research

Financials

Alkane had A$20.8m cash at end March 2017 and we now estimate net cash of A$9.4m at end FY17, which factors in an earlier repayment of its debt, than under our previous assumptions. To this could be added A$8.2m for the company’s gold held as bullion on hand.

Sensitivities: DP shovel-ready, TGO operationally sound

We consider that Alkane’s share price over the course of 2016, and ytd, reflects both newsflow concerning the DP, as well as the market’s assessment of the TGO’s profitability and performance. Sensitivities to Alkane’s valuation therefore range from operational performance at a working gold mine to the pre-development catalysts involved with developing the multi-commodity speciality metal DP project into a working mine. The performance of the TGO was only affected in H117 due to heavy rainfall of roughly four times the average for the time of year. Third-quarter gold production, which came in at 18.7koz, or c75koz on an annualised basis, indicates that Alkane is more than able to generate the gold ounces required to meet its annual production targets. The main sensitivity to the DP is that of finalising offtake agreements to secure revenue, a finalisation of bankable studies on the phased two-stage development plan and DP financing.

Moving on all fronts

As Alkane continues to progress its flagship DP, with financing to follow a finalisation of bankable studies into the project’s revised modular design (by its consultant Outotec, due later in 2017), exploration has become a focus for the TGO. This is not only to replenish depleted reserves, but also to gain greater confidence in planning for building out a UG mining phase at Wyoming and possibly also either at Caloma or Caloma Two. Caloma Two is situated only c 0.5km laterally from Wyoming One, making lateral UG development from one to the other very possible. The following overview of exploration activities continues to demonstrate the highly prospective (for gold and copper, in particular) land packages Alkane maintains in New South Wales, Australia. We also provide a brief summary of the current level of DP product prices. These include the rare earth group of elements, chemical zirconia and zirconium basic carbonate, as well as hafnium and ferro-niobium. All but a few of the rare earths are being sold, and there have been material price increases in rare earths used in magnets.

Exploration activities – both at TGO and its environs

Exploration activities during Q317 have focused on areas surrounding the existing TGO mining operation, in particular the area underneath the Wyoming One and Caloma open pits. This focus will allow Alkane to form stringent underground mining plans for these orebodies. We already value an UG mining phase at the TGO, and have done so since the company first suggested it had plans for an UG phase at Tomingley when the surface operations and mine schedules were being devised as part of the DFS back in 2013. Whereas Alkane has guided that its underground mining inventory may reduce on removal by its engineers of an ore-grade crown pillar at the base of the Wyoming One pit accounting for c 20koz, we understand from management that this will in fact be extracted, but likely towards the end of the mine’s life. This could occur when deeper-level workings cease and a retreat through the upper levels allows for the removal of certain ore-grade rock left in place for structural support.

Coupled with exploration at the TGO, the company continues to explore the areas surrounding the mine. The geology of the TGO, as well as that of the surrounding area, is that of a 60km-long trend of complexly folded and faulted Ordovician-aged volcanics, intrusives and sediments. Alkane states that much of the belt is covered by younger, transported sand and clay sediments, which mask basement geology and mineralisation – the term for such hidden mineralisation is ‘blind’.

TGO – similar to early Wyoming exploration signatures

Drilling undertaken during H117 adjacent to or below the Wyoming One and Caloma open pits was designed to prove greater continuity between known ore-grade drill intercepts. For a very good and thorough overview of these results, the company’s 20 January 2017 announcement is well worth reading. The following two views of drill hole traces below the Wyoming One pit are taken from this announcement and clearly indicate the typical vein hosted at the TGO (as shown by the pale green areas in Exhibit 2 below).

Exhibit 2: View of drilling beneath Caloma (LHS) and Wyoming One, pale green is orebody, brown is pit outline

Source: Alkane Resources

Regional exploration

The exploration targets drilled by Alkane in the surrounding areas to the TGO have so far returned gold and copper grades that encourage further investigation. 16,277m of air core drilling to the top of fresh rock have been completed so far, broadly spaced and testing an area just south of the TGO to the Cemetery exploration target located just north of Alkane’s past-producing gold heap leach operation, approximately 12km away. Air core drilling is used as a cheaper, early-stage drilling method, and is commonly used to screen exploration targets devised either from field reconnaissance works or desk top studies using remote sensing data. It is usually not included in resource estimation calculations due to the lack of sample support it provides. Side-wall contamination of the returned air core cuttings can take place which can arterially extend or reduce the area of influence of a particular assay data point.

Exhibit 3: Drilling locations and selected assay data for early-stage indications of a Wyoming One-type deposit

Source: Alkane Resources

Operational TGO data – subtle seasonality appears

The following chart displays all grade and tonnage data, by quarter, for the TGO mine from start of mining in Q214 to the current quarter. While H117 was adversely affected in terms of ore tonnes milled and grade mined (due to the above average heavy rainfall across the period), the third and fourth quarters tend to experience relatively high levels of waste tonnes mined, along with a commensurate decrease of ore tonnes moved due to finite haulage capacity. This pattern now appears to be roughly consistent should be noted in terms of earnings potential from the mine.

Exhibit 4: TGO grade and tonnage performance by quarter, Q214-Q417e

Source: Alkane Resources and Edison Investment Research

This seasonality in TGO’s operational data suggests that as the Australian autumn sets in, so it also favours a return of more stable mining conditions during the latter half of the financial year, followed by a final quarter of production that is guided by the company’s requirement to meet its stated production target. Such management can include the processing of existing lower-grade stockpiles, blended with higher-grade ore (if appropriate) or the amount of gold held as bullion on hand.

Unit cost breakdown – main mining costs were steadily falling

In terms of unit costs over the course of FY17, the following trends are seen, as represented by Exhibits 5 and 6. Despite the unseasonal weather experienced through H117, in fact on a unit cost basis the main costs incurred from mining were all steadily decreasing through FY17.

Following discussions with management, we are now more positive on the company’s cost performance and expect costs to stay at the same level as Q3 to support a FY17 AISC cost level below A$1,500/oz. Actual gold production was obviously affected, but the strength of Q3 gold production as the TGO mine recovered shows that, importantly, the actual operational performance of mining and processing equipment was relatively unaffected by the adverse weather conditions in H117.

Exhibit 5: C1 cash cost breakdown over FY17

Exhibit 6: AISC cost breakdown by quarter over FY17

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 5: C1 cash cost breakdown over FY17

Source: Edison Investment Research

Exhibit 6: AISC cost breakdown by quarter over FY17

Source: Edison Investment Research

Exhibit 7: FY17 TGO quarterly operational and selected financial data

Production

Q117

Q217

Q317

Q417e

FY17e

Waste mined

BCM

1,533,279

-1,533,279

2,165,717

1,550,000

3,715,717

Implied strip ratio

Tonnes

18.3

15.4

23.0

12.4

6.4

Ore mined

g/t

221,139

-221,139

249,109

330,000

579,109

Ore grade

Tonnes

1.51

1.39

2.42

2.00

9.42

Ore milled

g/t

231,797

279,338

281,654

330,000

1,122,789

Head grade

%

1.50

1.48

2.36

2.00

1.78

Recovery

Ounces

90.1%

90.4%

91.1%

91.0%

90.7%

Gold recovered

A$/oz

10,435

11,756

18,721

19,310

60,222

Gold sold

A$oz

10,000

12,519

16,303

19,310

58,132

Gold revenue

A$/m

16.3

21.2

27.6

32.2

97.5

Implied realised gold price/ actual

A$/oz

1,627

1,694

1,694

1,668

1,681

Cost of sales

A$m

19.2

21.2

22.5

23.2

86.1

AISC operating cost

A$/oz

2,139

1,803

1,201

1,201

1,469

Gross Margin

%

-11.6%

6.1%

58.3%

55.9%

29.7%

 

3,150

3,150

4,986

4,986

4,986

Stockpiles and bullion on hand

 

Ore for immediate milling

Tonnes

3,150

3,150

4,986

4,986

4,986

Bullion on hand

Ounces

5.12

5.34

8.20

8.32

8.32

Value of bullion on hand (based on implied gold price above)

A$m

661,645

709,148

620,271

620,271

620,271

 

Stockpile grade

g/t Au

0.80

0.79

0.75

0.75

0.75

Contained gold in stockpiles

oz

17,201

18,195

15,126

15,126

15,126

Value of stockpiled gold ounces at quarter's average price

A$m

28.0

30.8

25.6

25.6

25.6

 

Detailed cost summary

 

Mining

A$/oz

1,188

1,029

721

721

855

Processing

A$/oz

505

450

269

269

343

Site support

A$/oz

148

118

80

80

98

C1 site cash costs

A$/oz

1,841

1,597

1,070

1,070

1,296

Royalties

A$/oz

35

40

51

51

46

Sustaining capital

A$/oz

130

37

8

8

35

Rehabilitation

A$/oz

68

72

38

38

49

Corporate

A$/oz

65

57

34

34

44

AISC

A$/oz

2,139

1,803

1,201

1,201

1,469

Source: Alkane Resources and Edison Investment Research

Alkane’s Dubbo Project – prices on the rise

Alkane’s longstanding flagship project is now called the Dubbo Project (DP). Previously, it was known as the Dubbo Zirconium Project (DZP). The new simplified name omits zirconium which, although forming a major component of future DP revenue streams, does not describe the multi-commodity nature of the project. The DP will extract and sell 12 of the 15 lanthanide group elements. Lanthanum and cerium will not be sold due to current oversupply/low prices, and will, instead be stockpiled. Also, thulium will not be sold. The DP will also produce a highly pure form of chemical zirconia (free of the element hafnium, which itself will form a distinct revenue stream to service the growth in demand seen particularly in the aerospace sector) and zirconium basic carbonate, as it is the preferred feedstock material for use in a range of downstream industrial applications. The DP will also produce ferro-niobium, with this output already subject to a binding offtake agreement with German company, Treibacher Industrie.

Alkane’s initial scope for the DP has changed materially over the course of our coverage of the company (which dates back to 2010). Putting the recent material change of project scope to one side (see our December 2016 note Staged DP plan de-risks financing and off-take , which should be read in conjunction with this note and carries a complete review of our DP + TGO valuation), the company’s R&D into DP products has been assessing and meeting potential end-user requirements since 2008. Indeed, Alkane’s continued use of its pilot plant facility at ANSTO, just outside central Sydney, NSW, has provided the company with a crucial tool to tailor the DP’s products to meet the ever changing landscape of specialist metal applications alongside the development of the DP’s front-end design. The use of the ANSTO pilot plant facility has allowed Alkane to develop its product suite at minimal cost. Alkane spent A$2.5m on building the plant in 2007 and has spent c A$30m operating it. This compares very favourably to works being undertaken elsewhere in the sector. For example, Northern Minerals’ recent announcement (8 April 2017) states that it intends to build a A$56m plant to recover only 148 tonnes of neodymium over a three-year period, and from this work to prove a working flow sheet design. Note that Alkane has been refining its proven flow sheet design for over seven years to recover 15 speciality metals, including 12 of 15 lanthanide metals. In addition, its long use of the ANSTO facility is not due to any abnormal difficulties in processing DP ore material. Rare earth development is notoriously difficult and to develop a working process flow sheet is a long-winded process.

The DP’s enrichment in magnet metals used for electric cars

The level of attention paid to the lithium space over the course of 2016, intimately linked to the electric vehicle space, brought about a considerable increase in the value of this market over 2016. However, the metals used in the production of electric vehicles and the myriad of other green technologies go far beyond just that of lithium and graphite. Of the various metals used in electric vehicles, the following are the key technology metals required in the manufacturing processes behind renewable energy storage and generation in particular:

Rare earth metals praseodymium, neodymium and holmium for use in magnets and various electronic components.

Lithium in either carbonate or hydroxide form, for use in battery anodes

The upgraded form of graphite called coated spherical purified graphite (CSPG) for use in battery cathodes.

Cobalt metal used as cobalt-oxide in the anode material of lithium-cobalt-oxide batteries.

Based on DP Phase 1 product output tonnages at 500ktpa ore throughput, and applying our assumption of product prices in 2020 (as guided by Alkane and its consultants due to the opaque nature of these product markets), we generate 2020 revenue estimates as shown in the following exhibit. Note that the DP is enriched with the aforementioned ‘magnet’ metals, with all of the main three (Nd+Pr+Dy) accounting for 73% of DP REE revenues (excluding Hf), and 22% of total DP revenues (including hafnium, zirconium basic carbonate, chemical zirconia and ferro-niobium).

Exhibit 8: DP pricing assumptions and Phase 1 tonnages produced (ie based on 0.5Mtpa throughput)

Product

Units

Anticipated 2020 product price (US$/kg)

Refined output
(tonnes pa)

Anticipated 2020 revenue (US$m)

Comments

Atomic number

 

LREE

57

Lanthanum oxide

La2O3

2.25

685

1.5

Not sold due to oversupply

58

Cerium oxide

CeO2

2.25

1,125

2.5

Not sold due to oversupply

59

Praseodymium oxide

Pr6O11

68.5

119

8.1

60

Neodymium oxide

Nd2O3

47.5

461

21.9

61

Samarium oxide

Sm2O3

3.0

56

0.2

62

Europium oxide

Eu2O3

280.0

2

0.4

63

Gadolinium oxide

Gd2O3

17.5

54

0.9

 

HREE

64

Terbium oxide

Tb4O7

600.0

7

4.2

 

65

Dysprosium oxide

Dy2O3

285.0

61

17.4

66

Holmium oxide

Ho2O3

39.5

11

0.4

67

Erbium oxide

Er2O3

40.5

38

1.5

68

Thulium oxide

Tm2O3

0

3

0.0

Not sold

69

Ytterbium oxide

Yb2O3

30

31

0.9

70

Lutetium oxide

Lu2O3

985

2

1.5

71

Yttrium oxide

Y2O3

7.0

516

3.6

 

 

 

 

 

0.0

ZBC (zirconium basic carbonate)

100% ZrO2

5.5

2,000

11.0

Chemical zirconia

99.5% ZrO2

12.5

6,178

77.2

0.0

Hafnium oxide (95% HfO2)

Hf Metal

1,100

25

27.5

0.0

Ferro-niobium (65% Nb)

Nb Metal

37.5

984

36.9

 

 

Grand total (US$m)

 

 

 

218

 

 

 

Grand total (A$m)

 

 

 

287

 

Source: Alkane Resources and Edison Investment Research

Rising DP basket prices

Alkane stated in its Q317 quarterly report that the rare earths that go into making magnets are undergoing material price increases, of 5-7% since the start of 2017. Indeed, this is supported by our view of SteelHome prices recorded over the same period (source: SteelHome/Bloomberg), as shown in the following six exhibits. These indicate only neodymium, in particular, experiencing a meaningful price increase of 11% ytd. This rare earth element is the most important in terms of volumes mined (Nd represents 34% of traded DP rare earth element tonnes produced, and 10% of Phase 1 DP revenues based on a US$47.5/kg price assumption). Phase 1 dysprosium production is 87% lower than the tonnes of neodymium produced. Based on the 2020 assumption for dysprosium given in Exhibit 8, of US$285/g, it accounts for 8% of estimated 2020 DP revenues. The current SteelHome dysprosium price is US$234/kg, 18% below the 2020 forecast price we use to value the DP. Due to the bilateral nature of trading REEs, SteelHome prices may not truly reflect the prices fetched in the overall global REE market.

When comparing these six REE prices to our DP pricing assumptions given in Exhibit 8 above (estimated levels expected in 2020, the year of first steady-state production for Phase 1 at the DP under our assumptions), the majority are at the price level used in the DP’s August 2015 FEED study.

We include three other rare earth price charts for europium, terbium and ytterbium for reference and note that these six prices are the only available for the lanthanide group of elements on the Bloomberg platform.

Exhibit 9: Dysprosium metal prices (US$/kg)

Exhibit 10: Europium metal prices (US$/kg)

Source: Bloomberg

Source: Bloomberg

Exhibit 11: Neodymium prices (US$/kg)

Exhibit 12: Praseodymium metal prices (US$/kg)

Source: Bloomberg

Source: Bloomberg

Exhibit 13: Terbium prices (US$/kg)

Exhibit 14: Ytterbium prices (US$/kg)

Source: Bloomberg

Source: Bloomberg

Exhibit 9: Dysprosium metal prices (US$/kg)

Source: Bloomberg

Exhibit 11: Neodymium prices (US$/kg)

Source: Bloomberg

Exhibit 13: Terbium prices (US$/kg)

Source: Bloomberg

Exhibit 10: Europium metal prices (US$/kg)

Source: Bloomberg

Exhibit 12: Praseodymium metal prices (US$/kg)

Source: Bloomberg

Exhibit 14: Ytterbium prices (US$/kg)

Source: Bloomberg

Zircon

A surge in demand for zircon based products in 2011 resulted from concerns about supply shortfalls, creating an almost bubble-like demand situation that carried through into 2012. The result of this intense period of buying led to the creation of vast stockpiles which, when coupled with decreasing Chinese demand through the downturn years of 2012-16, depressed zirconium prices to multi-year lows (one major market driver was the construction industry as zircon is used in the manufacture of tiles, which are a major type of floor surfacing and wall finishing in Asia). As these stockpiles have now dissipated into the marketplace and along with increased Chinese demand experienced over 2016 and ytd, the commodity is now experiencing price increases across its various product types (ie ZOC, ZBS and the Dubbo Project’s own ZBC), which Alkane states are similar to the 5-7% increases seen in the REE group.

Letters of intent signed over 60% of Phase 1 DP output

The marketing of the DP’s zirconia-based output has been plagued in recent years by the aforementioned depressed nature of the zircon market, which now appears to be recovering. Potentially as a result of this recovery, Alkane’s marketing agent, Minchem, has secured six non-binding letters of intent (LOIs) covering 60% of planned Phase 1 output from the DP (ie 8,150tpa, or 8,178tpa under our assumptions, with the difference due to rounding during the calculation of finished product tonnages from raw ore at the grades and recovery numbers given in the DP’s DFS).

Westinghouse bankruptcy to stifle hafnium & hafnium-free zirconia supply

Hafnium is an important, although relatively recent addition to the DP’s product suite. Hafnium is constrained by supply; and its ability to enhance the physical properties of alloys has led to increased R&D and demand in the high-growth civil aerospace industry. One important recent development that may affect the supply of this metal is the bankruptcy of Toshiba’s Westinghouse atomic unit. The closure of this business, due in large part to cost overruns in reactor construction and increased health and safety regulation post-Fukushima, may well constrain upstream supply of speciality metals produced by Westinghouse used in the nuclear industry, of which hafnium and hafnium-free zirconia are two such materials.

Industry feedback has been especially positive for DP hafnium output as it is not tied to the vagaries of the nuclear industry. This is because growth in the extremely small (c 50tpa) hafnium market is to be largely linked to high-tech material usage, such as alloys used in the aerospace and industrial gas turbine industries. Current hafnium production is linked to production of neutron transparent zirconium metals used in nuclear fuel rod casings (hafnium absorbs c 600x the amount of neutrons that zircon absorbs and therefore needs to be refined out of zirconium metal – a process Alkane has successfully completed). As such, the depressed levels of activity in the nuclear industry currently, coupled with the Westinghouse bankruptcy, and uncertainty persisting from the Fukushima disaster of 2011, plus the increasing growth in the renewable energy economy, mean that stable hafnium output from nuclear industry sources cannot be depended on. Further, hafnium production volumes from the nuclear industry are unlikely to meet demand from other industrial sectors.

Valuation: More dilution due to Alkane share price fall

The following exhibit is based on the two-stage development concept for the DP. It also includes our value for the TGO, although we highlight that the potential future revenues and profits occurring from the DP (starting in FY18 under our assumptions) dwarf the relatively small cash generation levels that result from gold mining.

Exhibit 15: Edison’s estimate of theoretical EPS, diluted EPS, DPS and dividend discount flow (DDF)

Source: Edison Investment Research

As can be seen above, earnings are depressed through to FY22 as production from the DP ramps up and the project’s capital expenditure dominates. Even though maximum gold production of 68koz from the TGO occurs (as per our assumptions) in FY19e, earnings are depressed as a result of the A$7m in capex required to develop an underground mining phase at Wyoming, with an additional A$13m in TGO UG capex capitalised as the reserve base is expected to grow as mining commences. A slight rise in earnings is seen over FY20 and FY21 as first DP profits materialise, but reduces again as stage 2 capex is spent over FY22. The following year (FY23) sees the first full year of mining at the maximum 1Mtpa ore throughput rate.

Note that our current UG mining assumptions for the TGO may change as the company finalises new resource estimates and these are subsequently used to potentially revise the mine schedule.

Breakdowns of discounted earning valuations for the following periods of our valuation horizon are given in Exhibit 16 below.

Exhibit 16: Base case, TGO-only and DP scenario valuations

Previously

FY18

TGO only, without any dilution, financing, costs or revenues associated with the DZP.

0.37

0.26

Base case - TGO and DZP fully developed

0.78

0.61

The following valuation scenarios include TGO production

Post stage one capex with stage 2 developed

0.93

0.66

Post stage one without stage 2 developed

0.43

0.35

Post stage 2 capex

1.31

0.86

Source: Edison Investment Research

Sensitivity to share price

Other than commodity prices, the most notable effect on our valuation stems from our assumption for the price at which Alkane raises capital. Following Edison’s practice we apply the current share price to future potential equity issuance. However, we note that likely positive upcoming DP catalysts will alter this calculation as good news feeds into the share price. Exhibit 17 provides our total valuation (TGO+DP) given a range of share prices at which an equity portion of the DP’s financing might be raised:

Exhibit 17: Sensitivity to price at which DP financing raised

Equity raise price

0.20

0.26

0.30

0.40

0.50

0.60

NPV10 (TGO + DP) A$/share

0.50

0.61

0.68

0.82

0.96

1.067

Source: Edison Investment Research

Illustrative premium rating valuation – A$2.20 possible

Mining companies, once they are firmly into profitable stable production, are usually awarded valuations at a multiple to their NPV. Simply put, once the DP reaches steady-state stable production and its products are sold into a stable price environment, if we assume that Alkane pays out all its free cash in the form of dividends, we can impute a share price valuation. If we assume a 5% dividend yield (a relatively conservative assumption of long-term mining stock yield levels), Alkane’s maiden theoretical dividend of A$0.11 in FY24 (the first year we estimate that the dividend could be paid) could imply a potential A$2.20/share Alkane valuation.

Financials

Alkane had A$20.8m cash at end March 2017 and we estimate that Alkane will finish with net cash of A$9.4m at end FY17. To this should be added A$8.2m for the company’s gold held in inventory as bullion on hand.

Our end FY17 net cash figure is after a cash outflow of A$46.1m relating largely to TGO expenditures, and net financing inflows of 3.6m. From our discussions with management we do not expect bullion-on-hand to increase further from its end H117 amount. Our estimate includes an earlier repayment of the company’s bank debt. Previously we had repayment of Alkane’s working capital loan facility equally over four years, from FY18 through to FY22. From Alkane’s Q3 cash flow report, debt repayments ytd total A$6.7m. We now assume that all debt is repaid by end FY17, amounting to a small debt repayment of A$0.9m in Q417.

Note: Alkane has a hedge book with Macquarie bank. At the beginning of FY17 this book had a starting balance of 63,900oz Au. We have factored these sales and revenues into our cash flow forecasts for the TGO. The remaining 31,000/oz are to be paid in full by end FY18, unless the book is replenished by agreement with Macquarie bank.

Our financing assumptions for the DZP

Alkane’s financing team (led by Sumitomo Mitsui Banking Corporation) is pursuing the US$0.5bn initial capex required to bring the DP into Phase 1 production. Alkane’s plan is to sell a small stake in its wholly owned subsidiary containing the DP. Alkane is also pursuing Export Credit Agency (ECA) funding, which may provide hundreds of millions of Australian dollars in the form of loans at very low interest rates. These two financing routes would be joined with more conventional debt and equity financing to satisfy the requirement.

The exact financing structure of the DP has not been finalised. However, we understand from discussions with management that the financing structure for the total US$0.84bn (A$1.1bn) required to develop the DP could be secured by:

selling stakes in both Phase 1 and 2 equivalent to 10% of Phase 1 capex (ie A$68m) and Phase 2 capex (ie A$47m); and

raising 35% of Phase 1 capex (US$480m, A$632m) as equity. For Phase 1 this amounts to the notional issue in FY18 of 891m new shares priced at A$0.26 each to raise gross A$231m (US$176m). For Phase 2 this results in raising US$126m (A$166m) via the issue of 639m new shares in FY21.

In the above scenario, we calculate that this would leave Alkane with a maximum required net debt position in FY18 of A$327m to fund Phase 1, which equates to a gearing (debt/equity) ratio of 78% and a leverage (debt/debt+equity) ratio of 44%. Alkane is looking to cover this requirement using ECA loans incurring very favourable interest rates, as well as conventional project financing routes, potentially incurring higher interest rates.

Phase 2 development depends on the success of Phase 1 and prevailing commodity prices. However, if the same funding scenario is applied to raising 35% of Phase 2 capex; 639m new shares would be issued in FY21, giving rise to a net debt position in this year of A$78m, equating to gearing and leverage ratios of 11% and 13% respectively.

Exhibit 18: Financial summary

A$'000s

2014

2015

2016

2017e

2018e

Year end 30 June

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

35,474

101,813

109,624

98,011

104,290

Cost of Sales

(25,692)

(74,809)

(76,236)

(78,048)

(50,695)

Gross Profit

9,782

27,004

33,388

19,962

53,595

EBITDA

 

 

3,890

26,478

40,913

14,817

48,800

Operating Profit (before GW and except.)

3,890

(79)

10,984

(18,183)

(16,349)

Intangible Amortisation

0

0

0

0

0

Exceptionals/discontinued

(4,798)

(8,211)

(4,375)

(20,475)

63,244

Other

0

0

0

0

0

Operating Profit

(908)

(8,290)

6,609

(38,658)

46,894

Net Interest

(471)

153

54

490

140

Profit Before Tax (norm)

 

 

3,419

74

11,038

(17,693)

(16,210)

Profit Before Tax (FRS 3)

 

 

(1,379)

(8,137)

6,663

(38,168)

47,034

Tax

(4,893)

4,051

(1,968)

3,064

0

Profit After Tax (norm)

(1,372)

4,125

9,070

(14,629)

(16,210)

Profit After Tax (FRS 3)

(6,272)

(4,086)

4,695

(35,104)

47,034

Average Number of Shares Outstanding (m)

373.7

413.4

420.8

964.5

1,407.2

EPS - normalised (c)

 

 

(0.4)

1.0

2.2

(1.5)

(1.2)

EPS - FRS 3 (c)

 

 

(1.7)

(1.0)

1.1

(3.6)

3.3

Dividend per share (c)

0.0

0.0

0.0

0.0

0.0

Gross Margin (%)

27.6

26.5

30.5

20.4

51.4

EBITDA Margin (%)

N/A

N/A

N/A

N/A

N/A

Operating Margin (before GW and except.) (%)

N/A

N/A

N/A

N/A

N/A

BALANCE SHEET

Fixed Assets

 

 

160,174

162,624

182,691

175,315

757,150

Intangible Assets

53,406

65,251

72,553

55,078

59,078

Tangible Assets

100,032

89,787

102,941

113,040

690,875

Investments

6,736

7,586

7,197

7,197

7,197

Current Assets

 

 

40,811

28,342

38,569

21,881

13,284

Stocks

15,391

11,505

12,394

10,836

11,572

Debtors

4,906

1,988

1,720

1,603

1,712

Cash

15,569

14,849

24,455

9,442

0

Other available for sale financial assets

4,945

0

0

0

0

Current Liabilities

 

 

(14,726)

(11,251)

(10,448)

(17,099)

(333,018)

Creditors

(13,755)

(9,726)

(8,745)

(15,396)

(4,167)

Short term borrowings

0

0

0

0

(327,149)

Other

(971)

(1,525)

(1,703)

(1,703)

(1,703)

Long Term Liabilities

 

 

(12,039)

(9,265)

(20,502)

(20,502)

(20,502)

Long term borrowings

0

0

0

0

0

Other long term liabilities

(12,039)

(9,265)

(20,502)

(20,502)

(20,502)

Net Assets

 

 

174,220

170,450

190,310

159,595

416,914

CASH FLOW

Operating Cash Flow

 

 

(3,508)

28,454

37,432

23,947

36,725

Net Interest

(369)

153

54

490

140

Tax

0

0

0

3,064

0

Capex

(95,281)

(32,588)

(40,423)

(46,099)

(646,985)

Acquisitions/disposals

40,534

3,151

416

0

63,244

Financing

9,800

162

12,127

3,585

210,285

Dividends

0

0

0

0

0

Net Cash Flow

(48,824)

(668)

9,606

(15,013)

(336,591)

Opening net debt/(cash)

 

 

(64,294)

(15,569)

(14,849)

(24,455)

(9,442)

HP finance leases initiated

0

0

0

0

0

Other

99

(52)

0

0

0

Closing net debt/(cash)

 

 

(15,569)

(14,849)

(24,455)

(9,442)

327,149

Source: Note: We forecast DZP financing capex starting in FY17 including the planned sale of 10% of the DZP for A$64m recorded on the P&L. Assumes notional capital raise as described on page 12.

Contact details

Revenue by geography

89 Burswood RdVictoria Park
WA 6100
Australia
+61 8 9227 5677
www.alkane.com.au

Contact details

89 Burswood RdVictoria Park
WA 6100
Australia
+61 8 9227 5677
www.alkane.com.au

Revenue by geography

Management team

MD: David Ian Chalmers

Chairman: John Stuart Ferguson Dunlop

Mr Chalmers is a geologist and graduate of the Western Australian Institute of Technology (Curtin University). He has worked in the mining and exploration industry for over 40 years.

Mr Dunlop is a consultant mining engineer with close to 40 years’ surface and underground mining experience, both in Australia and overseas.

Non-exec director: Ian Gandel

Non-executive director: Anthony Dean Lethlean

Through Ian Gandel’s private investment vehicles, Gandel Metals Pty is currently a substantial holder in a number of publicly listed Australian companies.

Mr Lethlean is a geologist with 10 years’ mining experience. He has worked as a resources analyst with various stockbrokers and also consults to Helmsec Global Capital.

Management team

MD: David Ian Chalmers

Mr Chalmers is a geologist and graduate of the Western Australian Institute of Technology (Curtin University). He has worked in the mining and exploration industry for over 40 years.

Chairman: John Stuart Ferguson Dunlop

Mr Dunlop is a consultant mining engineer with close to 40 years’ surface and underground mining experience, both in Australia and overseas.

Non-exec director: Ian Gandel

Through Ian Gandel’s private investment vehicles, Gandel Metals Pty is currently a substantial holder in a number of publicly listed Australian companies.

Non-executive director: Anthony Dean Lethlean

Mr Lethlean is a geologist with 10 years’ mining experience. He has worked as a resources analyst with various stockbrokers and also consults to Helmsec Global Capital.

Principal shareholders

(%)

Abbotsleigh Pty Ltd

21.8%

Gandel, I J

21.8%

Fidelity Ltd

5.9%

Fidelity – other, multiple portfolios, equity funds

7.1%

Coupland Cardiff Asset Management

3.3%

Choice Investments Dubbo Pty Ltd.

1.3%

Pattinson W H Soul

1.1%

Funding Securities Pty Ltd

0.7%

Companies named in this report

Northern Minerals

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Alkane Resources and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

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Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Edison is an investment research and advisory company, with offices in North America, Europe, the Middle East and AsiaPac. The heart of Edison is our world-renowned equity research platform and deep multi-sector expertise. At Edison Investment Research, our research is widely read by international investors, advisers and stakeholders. Edison Advisors leverages our core research platform to provide differentiated services including investor relations and strategic consulting. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Pty Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Alkane Resources and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Investment Research Pty Ltd (Corporate Authorised Representative (1252501) of Myonlineadvisers Pty Ltd (AFSL: 427484)) and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 8249 8342

Level 12, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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