Almonty Industries — Update 16 August 2016

Currently one overriding factor dictates the script for Almonty: the tungsten price. However, the company’s underlying portfolio of tungsten projects, in production (Los Santos, Wolfram Camp Mine and Panasqueira) and pre-development (Sangdong, and Valtreixal), collectively provide a secure source of tungsten to Western customers at all-in production costs of c US$150/mtu (for the three producing mines mentioned, FY15 actual). The A$6.0m (plus debt) acquisition of ATC Alloys brings a negative NAV of C$2.5m but should be viewed on the basis of the replacement value of its Vinh Bao plant – c A$25m. The ATC deal brings in-house ferro-tungsten processing capacity, which is to be used to treat Wolfram Camp Mine (WCM) concentrates.

We have migrated our previous SOTP DCF valuation approach to our standard dividend discount flow (DDF) method, ie effectively discounted free cash flow. We retain all production profiles from our last valuation (September 2015) and add production from the Panasqueira mine acquired in early 2016. We note that at 31 December ATC Alloys recorded a negative net asset value of A$2.5m and a net loss of A$4.4m. For the purpose of our financial model, we include the acquisition as if it completes at end Q416. We have reviewed third-party unaudited data on the ATC Alloys operation in Vietnam and consider it to be broadly neutral to our valuation, adding a tentative C$0.05 per share. This assumes that Almonty enforces stricter cost controls at the Vinh Bao plant in Vietnam and reaches 2,000t of ferro-tungsten (FeW) by 2017, at a US$22,000t FeW price (equivalent to current spot). We include the recent Sangdong debt finance agreement for C$57.9m, and assume the remaining C$31.7m is raised as equity at C$0.35 per Almonty share. Assuming Almonty achieves its stated objectives (including the 10.3m shares issued in connection with the takeover of ATC Alloys) and tungsten prices average US$250/mtu over 2016, rally to US$300/mtu by early 2017 and are maintained until 2027 (the last year of our valuation period), we value Almonty’s shares on a fully diluted basis at C$0.77 (previously C$1.26, the main change being due to the equity raise price used for financing Sangdong reducing from a notional C$0.80 in our September 2015 note to C$0.35 now, plus the dilution caused by the ATC deal).

Q216 group APT concentrate production rose 15.4% q-o-q, driven mainly by Los Santos and Panasqueira. Production at WCM ceased in Q216, as tungsten prices deteriorated and management suspended ore production until a programme of optimisation completes. The APT price bottomed at c US$165/mtu in late January. However, higher production and a subsequent rally in prices pushed group revenues ahead by 27% q-o-q. Q2 operating costs included a C$2.4m WCM inventory revaluation (reflecting the lower tungsten price). Excluding this, mine costs rose only 2.2% in the quarter despite higher concentrate production, helped by lower production costs resulting from the newly acquired Panasqueira operation. Depreciation and amortisation of C$5.1m in H116 reflected the closure of WCM and the inclusion of amortisation at the Panasqueira mine. End-March 2016 net debt was C$45.1m, up by C$0.2m from end September 2015. Operating cash flow was C$0.3m. Cash outflows were C$5.6m (of which C$4.6m was capex), offset by new debt (C$4.3m net) and equity (C$3.7m). Since end March, Almonty has announced a further C$1.5m in financing via a 5m share placing at C$0.30. In all, we estimate end-September 2016 net debt of C$67m, rising to C$112.5m by end September 2017 (mainly due to the heavy outflows in 2016/17 related to Sangdong capex). This includes the recent announcement concerning a conditional agreement with a Korean bank over C$57.9m in debt for Sangdong’s development.

Almonty currently produces tungsten in APT and trioxide forms from its Los Santos and newly acquired Panasqueira operations on the Iberian Peninsula and at the Wolfram Camp Mine in Australia. Off-take agreements have been extended for five years for Panasqueira and Los Santos, providing security over future revenues from these mines. Almonty’s flagship asset Sangdong in South Korea is not yet in production, but is expected to start producing in 2017. Valtreixal is the company’s fifth main tungsten asset and is a smaller pre-development project. The following sections provide further detail on these mines and projects.

Almonty’s Q216 and H116 results were released on 30 May 2016. Almonty produced a (first half) total (across all operations) 47,535mtu of WO3 concentrates and sold 46,268mtu for total group revenues of C$10.4m. Almonty’s all-in sustaining cost of production at the half-year stage was C$176/mtu, roughly flat compared with Q116 (C$180/mtu). The average grade was 0.33% and the recovery factor 61.0%. A breakdown by operation is provided in the following sections.

The Los Santos operation has provided the mainstay of production for Almonty and continues to operate profitably at current tungsten prices.

Los Santos reported a 5.2% q-o-q decrease in ore production, and a 39.3% q-o-q decrease in revenue, driven by reduced throughput, lower ore grades (down 24.3% q-o-q) and lower recovery rates (down 3.7% q-o-q). Almonty’s focus on cost reduction was affected by the increased level of waste mining (up 88.4% q-o-q) , therefore lifting its all-in sustaining cost of production for Q216 by 45.2% q-o-q to US$180/mtu (Q116: US$124/mtu).

Although Los Santos’s Q216 recovery rate was below guidance, management expects tungsten recovery to be in the range of 60% to 65% (becoming 65% to 69% post optimisation) for the remainder of the mine’s life. However, the 59.7% realised during Q216 was without a corresponding loss of grade, which is what one would logically expect. Careful monitoring and management of the process plant recovery is needed in subsequent quarters to bring recovery back in line with projections. All-in Q216 sustaining costs rose 45.2%, reflecting lower ore tonnages treated and a quarter-on-quarter increase of 72.1% in waste rock mining costs, including deferred stripping costs.

The third-party tailings reprocessing study has been completed and a decision to proceed with this is now being considered. In view of current low tungsten prices, we would consider re-treatment of tailings as secondary to development of Almonty’s Sangdong asset and bringing back online WCM post completion of its optimisation programme and subject to APT prices.

The Los Santos mine is by far Almonty’s lowest-cost producer. In FY15 Los Santos sold 97,768t of WO3 at an all-in cash operating cost of US$150/mtu. The mine’s head grade was 0.32% and recovery 60.0%.

As a result of the very low tungsten prices experienced throughout Q216, Almonty’s management decided to cease production from WCM in Q216 while it completes the optimisation programme that has been running for the past year. For reference only, WCM’s last three operating quarters are detailed below. Almonty will re-start mining and milling operations as and when there is a sustained and improved outlook for APT.

The purchase of the Panasqueira tungsten mine in Portugal was completed in January 2016. Almonty acquired a 100% interest in Beralt Ventures, a holding company for the mine, from Japanese-owned Sojitz Tungsten Resources for €1.00. In connection with the purchase Almonty acquired €12.3m in debt owed by Sojitz in exchange for a cash payment of €1.0m on closing the deal and a promissory note issued by Almonty in the principal amount of €0.5m, bearing 4% per annum and maturing 29 December 2017.

We have modelled the mine based solely on 2014 operational data, such that the mine processes 0.75Mt of ore per annum at a WO3 grade of 0.13%, and recovers 79.6% of the contained tungsten trioxide into concentrate. We note there is no requirement for capital expenditure at the mine beyond maintenance capex totalling US$0.3m per annum. We use a 10-year mine life to value the mine, supported by 1.7Mt of proven and probable reserves and 9.5Mt of resources (all NI 43-101 compliant).

Final engineering design of the Sangdong processing plant has been underway since Almonty announced the appointment of specialist Korean engineering firm Korea Engineering Consultants Corporation, on 5 January 2016. Completing this design would pave the way towards obtaining the final surface permit required for construction to start at this brownfields mine site. With a contingent agreement in place with Korea Development Bank over two-thirds of Sangdong’s required capex, we look to Almonty to secure the remaining capex required; this itself is a requirement of the loan agreement. To assist with pre-development works for Sangdong, Almonty has appointed POSCO Engineering & Construction Co. as the pre-EPC (engineering, procurement and construction) contractor. Pre-EPC works are due to start in July 2016.

Almonty has increased its stake in Valtreixal from 25% to 51% over the last nine months, through a series of cash payments to SIEMCALSA, to a total of €1.4m, of which the latest instalment was €0.3m on 3 June. Almonty has an option, until 24 December 2016, to acquire the residual 49%, which would require three annual instalments of €0.75m from the initial exercise date.

Valtreixal is pre-development and has an NI 43-101 compliant reserve base (proven and probable) of 2.5mt at a WO3 equivalent (tungsten and tin) grade of 0.34% for 867,000mtu of WO3. Measured and indicated resources (inclusive of the aforementioned reserves) are 2.8mt of ore at 0.34% (WO3 equivalent) for 962,000mtu. Inferred resources are 15.4mt at 0.17% for 2,621,320mtu. Almonty intends to make a decision on filing for the necessary permits and is fine tuning its planning and budgeting for the potential build-out and commissioning of the Valtreixal mine to the extent it exercises its option to acquire the remaining 49% of the project. Subject to this, permitting and development is targeted for 2018.

Almonty announced on 24 April that it had signed a heads of agreement to sell its Wolfram Camp Mine in Australia in return for shares of the buyer, ATC Alloys (ASX: ATA). ATC was formerly known as Hazelwood Resources. This deal, if it had completed, would have seen Almonty becoming 53% majority shareholder in ATC, a specialist downstream ferro-tungsten producer with a 60% JV interest in a newly completed plant in Vietnam. This deal, as stated in Almonty’s 30 May announcement, has been revised and now sees Almonty seeking a full takeover of ATC Alloys, while retaining its full ownership of the Wolfram Camp Mine. While not clearly accretive in terms of its current balance sheet value, the deal does bring in-house specialist downstream ferro-tungsten processing capacity, which diversifies Almonty’s business and provides an ability to supply to market a far higher-value ferro-tungsten product (end March 2016 price: US$23/kg or US$23,000/t). The takeover, upon successful completion, brings:

The plant currently operates on a make-to-order production strategy. As of ATC’s last quarterly cash flow and activities report, dated 29 April for the period ending 31 March 2016, production occurred in January and February totalling 400 tonnes. No production occurred in February due largely to lunar new-year celebrations.

The ATC takeover bid is subject to the following conditions:

Subject to all financings, regulatory approvals and permits being successfully met or obtained, Almonty will bring in-house a state-of-the-art ferrotungsten production plant in Vietnam, along with three Japanese ferrotungsten customers. The status of these customer agreements are as follows:

Through conversations held with Almonty’s management we understand that ATC’s customer base will be maintained so as not to compromise the existing customer agreements Almonty has over its existing primary tungsten production. We also understand that production of ferrotungsten will be derived from the processing of WCM concentrates. Management expects to complete the deal during Q416 (ie by end September 2016).

Our previous SOTP valuation was based on a discounted cash flow approach, which we now migrate to our standard dividend discount flow (DDF) approach, this being effectively discounted free cash flow. We retain all production profiles from our last valuation of the company in September 2015 and add production from the Panasqueira mine purchased in early 2016. We have not included a DCF-type valuation of ATC Alloys and note that at 31 December 2015 the company recorded a net loss of A$4.4m, and a negative net asset value of A$2.5m. For the purpose of our model, we include the financial impact as though the acquisition completes at end Q416. We await Almonty’s guidance as to its strategy for returning the assets of ATC to profitability.

We have now adjusted our long-term tungsten price of US$325/mtu (US$260/mtu net of APT discount) down 8% to US$300/mtu (US$240/mtu net). We apply this price level flat across all Almonty’s mines and development stage projects.

Sangdong is a past producing mine and its development is pivotal to Almonty remaining a going concern. We have updated our production model for this asset based on the findings of the recently updated feasibility study announced on 6 January 2016. On 26 July 2015 Almonty also announced a revised Sangdong NI43-101 reserve base of 7.9Mt at 0.45% WO3, a material increase of 78% over the previously stated compliant reserve base tonnage of 4.7Mt at 0.42% WO3 (see following exhibit). This revised reserve estimate has the material effect of extending Sangdong’s mine life from the nine years given in the updated FS to 13 years. The revised 6 January feasibility study indicates a reduction in grades mined and a comparison of the old mine’s scheduled tungsten grades with those in the new FS are provided in Exhibit 5.

Sangdong’s updated reserve estimate is sufficient to extend its mine life by a further five years over the original eight-year mine plan. As such, the extended mine and improved profits that result have now been factored into our model. The following exhibit provides a comparison between the previous grades used and the new lower grades detailed in the updated feasibility study, announced on 6 January 2016. Note: the effect of lowering the grade at Sangdong is mitigated by the extended mine life now envisaged for the project.

We have also adjusted the capex profile of the project, chiefly due to rescheduling of the US$68.4m capex over two years – 2016 (US$32.1m) and 2017 (US$33.5m) – with the remaining working capital amount of US$2.8m to be used in 2018 as production ramps up. Other than for a 1% increase in the recovery factor used, from 80% to 81%, and very minor changes to some operating costs, no other operating factor has been significantly changed.

We have retained our production and cost profiles for Los Santos, Wolfram Camp and Valtreixal projects and adjusted the development stage Sangdong for the above FS changes. The main mining assumptions for all Almonty’s mines and projects are given in the following exhibit.

The resultant life-of-mine production profile for all these projects is given in the following exhibit.

The development of Sangdong would be transformative for the company, and bring back on line one of the world’s largest tungsten mines. Sangdong has average projected cash costs of C$151/mtu and should achieve an average gross margin around 50% over life of mine. The following exhibit gives a production weighted cash cost figure for Almonty of C$193.1/mtu. The tungsten (APT) price at US$220/mtu currently is therefore moderately above the level at which Almonty breaks even on costs.

Management has secured a contingent C$57.9m (KRW50bn) loan with Korea Development Bank. Drawdown on the loan is contingent on Almonty securing the remaining (c C$32m) in capex required to complete the build-out of Sangdong. Construction is due to start following completion of financing. For the purpose of our model, we assume that Almonty will raise the remainder of the capex required via equity at C$0.35 per share. However, it may be that Almonty secures this requirement via equity-linked instruments such as convertible notes. Initial development capex for the project currently stands at US$68.4m (C$90m) spread over 2016 (US$32.1m), 2017 (US$33.5m) and 2018 (US$2.8m).

We have included the above financing and equity raise assumption in our model. Raising C$32m at C$0.35 results in dilution of 55% (post-inclusion of ATC shares) through the issue of a further 91m shares. Raising such a level of equity in the current market environment remains a key risk, which could be reduced if the company secures funding via equity-linked instruments such as convertible loan notes. However, securing the remaining capex for Sangdong is key to this project’s development and to realising the full value of our base case valuation.

On the basis that Almonty achieves its stated objectives (including the 10.3m shares to be issued in connection with completing the takeover of ATC Alloys) and the production profile given in Exhibit 2, and tungsten prices average US$250/mtu over 2016, rally to US$300/mtu by start 2017 and are maintained until 2027 (the last year of our valuation period), we value Almonty’s shares on a fully diluted basis at C$0.77 (previously C$1.26, the main change being due to the equity raise price used for financing Sangdong reducing from a notional C$0.80 in our September note to C$0.35 now, plus the dilution caused by the ATC deal). Our valuation uses a 10% discount rate to reflect general equity risk. For a range of quantitative sensitivity analyses please see the following section.

Our valuation includes interest payments related to Almonty’s existing and forecast debt.

Based on the aforementioned valuation assumptions and production profiles, the theoretical distribution of earnings and ‘dividends’ to investors from 2016 to 2027 is C$0.77 per share, as shown (as the initial data point on the green DDF line and read off the y-axis) in the following exhibit.

Until the ATC deal completes and Almonty consolidates the 60% interest it will own in the Vinh Bao plant, we keep our valuation of this asset separate from our base case. We note that at 31 December 2015 ATC Alloys recorded a net loss of A$4.4m and a negative net asset value of A$2.5m. For the purpose of our model, we have included the financial impact as though the acquisition completes at end Q416. We have reviewed third-party unaudited data on the ATC Alloys operation in Vietnam and consider the value derived from these data as relatively neutral to our overall valuation, adding a tentative C$0.05 per Almonty share. This valuation is based on Almonty enforcing stricter control over costs at the Vinh Bao plant in Vietnam and reaching 2,000t of ferro-tungsten (FeW) by 2017 at a US$22,000/t FeW price (equivalent to current spot), rising to US$26,800/t by 2018. The average all-in sustaining costs over the life of mine are stated to be US$23,972/t (A$32,529/t at an A$/US$ forex rate of 1.36). The Vinh Bao plant has a nameplate capacity of 4,000t of FeW, providing further upside to this asset’s valuation.

Almonty’s current operational and financial performance is crucially linked to the prevailing tungsten price. Cost performance, careful balance sheet management and operational efficiency are key to weathering the current commodity downturn. Keeping costs low and being successful in financing Sangdong are, in our opinion, the two main challenges for Almonty’s management. We do not include the early-stage ATC Alloys valuation in these sensitivity analyses until greater clarity over the assets is announced to the market by Almonty.

The following exhibit shows the APT tungsten price (FOB Huangpu Port, China) in the currencies Almonty operates in. Notable is that the price-lows seen at the start of 2016 of c US$170/mtu have since rallied by 30% to a current level of US$220/mtu.

Foreign exchange rate movements have been less volatile over the last six months, relative to the main period of natural resource currency devaluation (largely) occurring from start 2014 to mid-2015. Peak to trough over this 18-month period, the Canadian and Australian dollars devalued against the greenback by 31% and 37%, respectively. Year-to-date both the Canadian and Australian currencies have, unsurprisingly, reversed the trend, both rallying against the US dollar by c 9%. This strengthening has a negative impact on Almonty as costs denominated in the local currency become relatively more expensive, while sales, which are priced in US dollar terms, receive no benefit from local currency movements against the US dollar. In terms of financial impact, Almonty estimates that, based on Q216, a 5% change in the US dollar relative to the Canadian dollar reduces net income by around C$518,000; a 5% change in the Canadian dollar to the euro changes net income by C$148,000; and a 5% change in the Canadian dollar to the Australian dollar changes net income by around C$102,000. Similarly, for our valuation, the main forex sensitivity is the US$/C$ exchange rate; in Exhibit 11 we assess its impact on our base case valuation.

Almonty’s Q216 results had many moving parts, with group APT concentrate production up 15.4% q-o-q, driven primarily by Los Santos and Panasqueira. Production at WCM stopped early in Q216, as tungsten prices deteriorated further and management decided to stop ore production until a programme of optimisation at WCM completes. The price of APT decreased during the quarter, reaching a low of c US$165/mtu in late January 2016, but increased production (driven primarily by Panasqueira) resulted in group revenues increasing 27% q-o-q from C$8.2m to C$10.4m. However, APT prices have rallied strongly since, increasing c 33% to US$220/mtu.

Almonty’s second quarter operating costs increased by C$2.5m, which included a C$2.4m charge relating to a revaluation of its WCM inventory on hand, adjusting it for the current tungsten price. Excluding this charge, mine costs rose only 2.2% during the quarter despite a 15.4% increase in concentrate production and reflecting lower production costs resulting from the newly acquired Panasqueira operation (Q116: US$148/t).

Depreciation and amortisation during Q216 were affected by the closure of WCM and offset by the inclusion of amortisation at the Panasqueira mine. This resulted in a depreciation and amortisation charge of C$3.1m in Q216 (C$5.1m in H1).

All in, Almonty reported an H1 net loss of C$9.7m ($0.11 per share). This reflected H116 revenue of C$18.6m, mine production costs of C$19.6m, G&A of C$3.6m and C$1.1m in interest expense (a 110% increase due to increased long-term debt and outstanding convertible debentures). Other income totalled C$0.9m, which included a forex gain on the translation of US dollar revenues to euros and the revaluation of interest-bearing debt and non-interest bearing payables valued in US dollars.

End March 2016 net debt was C$45.1m, up by C$0.2m from end September 2015. Operating cash flow was C$0.3m. Cash outflows were C$5.6m (of which C$4.6m was capex), offset by new debt (C$4.3m net) and equity (C$3.7m).

Since end March, Almonty has announced a further C$1.5m in financing via the placement of 5m new shares at C$0.30, a A$0.5m convertible debenture financing in connection with the ATC takeover and a non-brokered private placement of 5.6m shares at C$0.35 for gross proceeds of C$1.96m. In all, we estimate end-September 2016 net debt of C$67m, rising to C$112.5m by end September 2017 (mainly due to the heavy flow through on 2016/17 of the Sangdong capex). This includes the recent Letter of Commitment with Korean Development Bank (announced on 26 July 2016, relating to C$57.9m [KRW50bn]) in debt for Sangdong’s development. A definitive agreement to confirm these funds is, among other things, dependent on Almonty securing the remaining Sangdong capex requirement as equity or equity-linked instruments. We assume the remaining C$31.4m required will be raised as equity at an Almonty share price of C$0.35. The loan interest rate has not been disclosed; for the purpose of our model, we have assumed that it bears 7.5% pa (the same rate we use to repay all other debts).

Most of the company’s debt is held under instruments with maturities between now and 2019; the first matures in July 2016 and relates to an unsecured C$1.6m loan with Spanish banks.

We noted at end Q116 that if APT prices did not improve from the then prevailing levels of c US$170/mtu, then our FY17 net funding requirement would rise to C$67m. Now with APT prices increasing by upwards of 30% since, our end year net debt forecast is well within the limits of Almonty’s debt servicing facilities. As long as tungsten prices stay at current levels or continue on this upwards trajectory we would not expect Almonty to have to return to market for additional financing other than that associated with project development and the agreed takeover of ATC Alloys.

We assume a successful completion to the ATC Alloys takeover bid (due to complete in Q416), and thus include the related assets and liabilities. We have also included the 10.3m Almonty shares to be issued to ATC shareholders in payment for the company. Additionally, assuming the Sangdong capex (US$68m/C$90m) will be 40% funded by equity, this would add a further 102m shares, bringing our fully diluted forecast number of shares to 218m.

We also include in our full year forecast the fair value at acquisition of Sojitz Tungsten Resources, relating to the Panasqueira mine. This was included in the March 2016 balance sheet, and the acquisition completed on 6 January 2016. Of note is the very large restoration provision (€34.9m) for Panasqueira, which, in the unlikely event of it being realised in the near future, would likely incur considerable financial stress on Almonty, and may affect its ability to manage its existing debt load.