Cradle Resources — Update 31 January 2017

Cradle Resources has a 50% interest in the Panda Hill niobium project in a known mining jurisdiction. Unlike other projects, its geology and metallurgy are almost entirely conventional and, as such, it is poised to become only the world’s fourth producing niobium mine.

On 20 April 2016, Cradle announced the results of a definitive feasibility study (DFS), performed on the Panda Hill niobium project. Compiled by MDM in collaboration with Coffey, SRK, SGS, SLR and Roskill (among others), the DFS envisaged a 1.3Mtpa open-pit operation, expanding by 100% in year five, mining an average 0.68% Nb2O5 grade in years 1-10 (and 0.54% over the 30-year life of mine) to produce an average 8,200t of ferro-niobium per year at an average stripping ratio of 1.5:1 and metallurgical recovery of 61%. Initial capex was estimated to be US$196m, with a further US$93m (to be funded from project cash flows) in year four for the expansion. Average life-of-mine EBITDA was estimated to be US$112m pa (US$0.83 per undiluted share at that time) and the payback period at 4.75 years. Ultimately, the DFS calculated a pre-tax project IRR of 32% and a post-tax NPV10 of US$404m (equating to US$1.50/share, undiluted, at that time, for Cradle’s 50% share of the project) at an initial product price of US$37.65/kg Nb and average unit operating costs of US$48.04/t ore processed or US$21.34/kg Nb produced.

The mining study relating to Panda Hill envisaged conventional open-cut mining based on drill, blast, load and haul using a typical medium fleet arrangement of two 120-tonne excavators and six to 18 90-tonne haul trucks (eg CAT 777). The pit design incorporated six pushbacks – the first three occurring in the first 10 years of operations and the second three occurring in the subsequent 20 years. For the first 10 years of operations, run-of-mine material is to be sourced exclusively from the measured and indicated categories of resources, with inferred resources and low-grade material being stockpiled together for potential subsequent processing. In addition, sub-optimal metallurgical material will also be stockpiled along with waste material, albeit in a dedicated area, so as to be separately accessible if required. The effect of this strategy is to ensure the earlier mining and processing of higher-grade material, albeit at the cost of a higher initial stripping ratio. After the first 10 years of operations, inferred material is also included in the mining and processing schedule.

In summary, initial crushing will be effected by a primary crusher and two-stage SAG-ball mill combination. The milled product is then de-slimed and subjected to magnetic separation to remove magnetite before entering the staged flotation circuits. These comprise a pyrite float, a calcite float (with cleaning and de-watering) and then the niobium float to produce a c 40-45% concentrate. Phosphate, silicate and sulphur impurities are removed by a two-stage leach process. The final leach residue is then dried and fed to a DC furnace for standard grade ferro-niobium production using aluminium as a reductant.

Significantly, the flotation process at Panda Hill is similar to Niobec in Canada, which has a similar geology and mineralogy, while the leach process is based on Catalão and the converter process on some of the principles from the final stage of the CBMM pyro-metallurgical circuit.

On the basis of the DFS, in August, Edison calculated a value for the project of US$365m based on the net present value of cash flows, discounted at 10% per year. This compared with the DFS valuation of US$404m – the difference in the valuations probably being attributable to different pricing assumptions (the DFS uses pricing assumptions provided by Roskill, which were not disclosed for reasons of commercial sensitivity). As such, Edison’s valuation of Cradle’s 50% share of Panda Hill valuation equated to US$1.11/share (before potential dilution) vs US$1.50 based on the DFS valuation. Assuming equity financing at Cradle’s prevailing share price to fund its share of joint venture capex (ie via the issue of 254.7m shares at A$0.26 to raise A$66.2m, or US$51.1m), however, this valuation then diluted to A$0.70/share.

In the two quarters since Edison’s initiation note, Cradle has continued to progress the project via a number of initiatives relating to product offtake, financing and front-end engineering & design (FEED) as well as technical mining and engineering activities.

Significantly, Panda Hill Tanzania (PHT) is continuing its discussions with three separate potential counterparties in various regions regarding marketing and offtake agreements. Currently, it is awaiting feedback from the primary offtake party on a final set of comments in the offtake agreement, following which it will be circulated to all parties. Thereafter, it is anticipated that an agreement “will be finalized in the next few months following approval by the PHT and Cradle Boards”.

Similarly, PHT and the project debt arranger are targeting credit committee approval for the project finance facility early this year (subject to the usual conditions precedent). To this end, in the past few months:

Key matters to be concluded include finalisation of the independent engineer’s report, execution of the legal due diligence and an opinion from Roskill on conditions in the niobium market.

At the same time, the Panda Hill FEED has now been completed ostensibly on time and within budget, the main outcomes from the programme being:

Technical activity during the period focused on the progress of the activities defined in the FEED scope, including the following:

Within the context of the above, the initial capex estimate for the project has been lowered by US$10m to US$186m, after significant savings were made in the TSF construction, mine haul road and access road budgets. At the same time, life-of-mine opex was reduced from US$61.63/t to US$61.15/t and the construction schedule from 21 to 18 months.

Note that the above activities follow the conclusion of a major community initiative in July 2016. Since then, PHT has continued with the various community stakeholder liaison meetings. It is also in the process of conducting bi-weekly water flow sampling of the Songwe River for the environmental baseline assessment.

In October 2016, Edison published its annual mining overview, entitled Normalisation augurs well for exploration. Among other things, this report considered the relationship between the crustal abundance of a metal or mineral and its average in-situ value as a percent of the spot price as well as the relationship between the price of a metal or mineral and its average in-situ value as a percent of the spot price. In chart form, the results were as follows:

The x-axis of each graph is presented on a logarithmic scale in order to accommodate the range of data points. Nevertheless, within this context, it is possible to apply a ‘best fit’ line to the data displayed. As such, two ‘best fit’ lines are shown on each graph. One depicts the conventional linear ‘best fit’ trend line (ie as if the scale on the x-axis were linear, rather than logarithmic). The other depicts the linear ‘best fit’ trend line to the data as displayed on the logarithmic scale shown.

Owing to the paucity of listed explorers in the sector, it was not considered practical to include niobium in the analysis at the time. Nevertheless, given its price and crustal abundance, it is possible to use the ‘best fit’ lines shown to estimate where niobium should appear in the above graphs, all other things being equal. A summary, considering each of the two ‘best fit’ lines for two variables (crustal abundance and price) is as follows:

Dated April 2015, Cradle’s actual niobium resource at Panda Hill is summarised in the table below (at a cut-off grade of 0.3% Nb2O5):

Note that Cradle’s current enterprise value of US$28.5m (using end-September cash) equates to US$91.49 per tonne of attributable contained niobium metal in its resource at Panda Hill – or 0.26% of the price of niobium contained within ferro-niobium. Applying the lowest derived 0.5145% in-situ value relative to price ratio (see Exhibit 3) to Cradle’s 50% interest in the niobium metal content of Panda Hill implies a value attributable to Cradle Resources of US$56.3m, or US$0.34 (A$0.46) per existing Cradle share. Applying the average 0.8057% in-situ value relative to price ratio implies a value attributable to Cradle of US$88.2m, or US$0.54 (A$0.71) per Cradle share. At the same time, expansion potential exists to the extent that only approximately 40% of the area of the Panda Hill carbonatite has been properly drill tested with the result that the operators have an ongoing exploration target of 200-400Mt of mineralised material at a grade of 0.4-0.6% Nb2O5.

Our valuation of Cradle has always been (and continues to be) conducted as at the start of FY17 (ie 1 July 2016). Since the publication of our Outlook note last August, Cradle has reported its FY16 financial results, as a result of which we have made minor adjustments to our cash burn forecasts. We have also incorporated updated capex and opex estimates – albeit these changes are relatively small (see above). As a result, our fundamental value for the Panda Hill project therefore remains ostensibly unchanged at US$369m (cf US$365m previously) based on the net present value of cash flows, discounted at 10% per year. This compares with the DFS valuation of US$404m – the difference in the valuations probably being attributable to different pricing assumptions used by Edison and Roskill (Roskill’s pricing assumptions were not disclosed in the DFS for reasons of commercial sensitivity). On this basis, Cradle’s 50% share of our Panda Hill valuation equates to US$1.12/share (before potential dilution) vs US$1.50 based on the DFS valuation at the time of Cradle’s DFS results announcement on 20 April 2016. Assuming equity financing at Cradle’s current share price (and the prevailing A$/US$ exchange rate) to fund its share of joint venture capex commitments, however (ie via the issue of 263.4m shares at A$0.25 to raise A$64.7m, or US$48.6m), this valuation now dilutes to A$0.69/share.

In the event that it were to re-rate to something approaching a sector-appropriate valuation given the size of its in-situ niobium resource and the price and rarity of niobium, Cradle’s share price could be expected to rise to in excess of A$0.46 per share. That being the case, the dilution associated with Cradle’s equity funding of its joint venture capex commitments would reduce to 143.2m shares at A$0.46, in which case its valuation dilutes to only A$0.96/share, rather than the A$0.69/share.

Edison’s base-case scenario assumes that Cradle will meet its equity funding obligations ostensibly via the issue of its own equity. To the extent that it is able to finance its equity funding obligations via its own debt, however, the value of its effective interest in the project may be geared as follows (albeit attended by increased financial risk as measured by financial leverage):

The same analysis, performed with a sensitivity related to the share price at which new funds are raised, is then as follows: