Baker Steel Resources Trust — Facing a challenging funding environment

Baker Steel Resources Trust (LSE: BSRT)

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Research: Investment Companies

Baker Steel Resources Trust — Facing a challenging funding environment

Baker Steel Resources Trust (BSRT) has been affected by the challenging funding environment for mining development projects, especially for single-project junior mining companies. The funding environment led Tungsten West to carry out an interim fund-raising at a depressed valuation. BSRT’s key potential NAV trigger for this year remains a possible successful funding by Futura Resources to launch production at its two coking coal mines in Australia. While the fund-raising has again been delayed and the demand for coking coal may be affected by a global economic slowdown, the project’s economics remain favourable at current coking coal prices.

Milosz Papst

Written by

Milosz Papst

Director, Financials

Investment Companies

Baker Steel Resources Trust

Facing a challenging funding environment

Investment trusts
Metals and mining

21 June 2023

Price

45.0p

Market cap

£48.0m

NAV

£75.6m

NAV*

71.0p

*At end-May 2023.

Discount to NAV

36.6%

Yield

0.0%

Shares in issue*

107.2m

*Including 700k treasury shares.

Code/ISIN

BSRT/GG00B6686L20

Primary exchange

LSE

AIC sector

Commodities & Natural Resources

52-week high/low

66.50p

43.0p

83.90p

71.0p

Gearing

Net cash at 31 May 2023

1.0%

Fund objective

Baker Steel Resources Trust (BSRT) is a closed-ended investment company aiming to achieve long-term capital growth through investing in equity, loans and related instruments issued by private natural resources companies. It targets a global, concentrated portfolio of 15–20 investments. BSRT’s objective is to create value through driving the development of investee companies, as well as exploiting market inefficiencies and pricing anomalies.

Bull points

Exposed to project development gains – not a simple beta play on commodity prices.

Downside protection is provided by BSRT’s focus on realising value from project development, valuations based on consensus forecasts for commodity prices; and the use of convertible debt (currently only in case of Cemos).

Maturing portfolio, with several projects approaching mine construction or production.

Bear points

The tough funding environment may delay project progress and/or result in fund-raising at depressed valuations.

Risk of cost overruns due to the inflationary environment.

Some projects are located in high-risk mining jurisdictions.

Analyst

Milosz Papst

+44 (0) 20 3077 5700

Baker Steel Resources Trust is a research client of Edison Investment Research Limited

Baker Steel Resources Trust (BSRT) has been affected by the challenging funding environment for mining development projects, especially for single-project junior mining companies. The funding environment led Tungsten West to carry out an interim fund-raising at a depressed valuation. BSRT’s key potential NAV trigger for this year remains a possible successful funding by Futura Resources to launch production at its two coking coal mines in Australia. While the fund-raising has again been delayed and the demand for coking coal may be affected by a global economic slowdown, the project’s economics remain favourable at current coking coal prices.

BSRT’s portfolio by investment type as at end-March 2023

Source: Baker Steel Resources Trust data

Potential from structural demand for commodities

BSRT’s investment manager highlights several factors that may support the company’s portfolio, including: (1) structural growth in demand for commodities (eg from the electric vehicle and renewable energy industries); (2) demand from China following the reopening of its economy; (3) low inventory levels of base metals (eg copper, nickel, zinc) versus historical averages; (4) a potential pickup in M&A activity from miners, manufacturers and energy firms; (5) persistent high inflation; and (6) the West seeking to secure supplies of critical commodities in ‘friendly’ jurisdictions.

The analyst’s view

BSRT is more than a simple beta play on commodity prices, given its focus on realising the valuation upside from project development and its investment in projects that offer a solid safety margin in terms of an internal rate of return (IRR) based on consensus price forecasts. The majority of BSRT’s current portfolio is held either in producing assets – Cemos, Caledonia Mining Corporation (CMCL), Silver X – where further production ramp-up/expansion offers re-rating potential, or in projects approaching mine construction (eg Tungsten West) and production (Futura Resources) whose valuations may benefit from project de-risking in the case of successful progress. We believe that, once the fund-raising/M&A environment improves, this portfolio may experience several positive NAV catalysts from project progress, leading to a potential asset sale/IPO and/or recurring royalty/dividend streams. Following the expiry of the lock-up on CMCL shares, BSRT is again looking for potential new investment opportunities.

Tungsten West’s developments illustrate persistently tough funding environment

Monetary tightening and macroeconomic uncertainty (further exacerbated by the issues of US regional banks) continue to weigh on corporate funding, making the financing of mining development projects more challenging. This is reflected in the recent developments at Tungsten West (TUN, LSE), one of BSRT’s portfolio holdings developing the tungsten Hemerdon mine in the UK.

Exhibit 1: Contributions of key holdings to BSRT’s NAV total return in 2023 to date (pp)

Source: Baker Steel Resources Trust data, Edison Investment Research. Note: *Contribution of Polar Acquisition to end-March 2023 (last available data).

Forced to conduct an interim fund-raising at a steep discount to end-March share price

In January 2023, Tungsten West released the results of its revised feasibility study (FS) that indicated a base-case post-tax net present value of £297m and an IRR of 25%. The FS included an estimate for pre-production capital expenditure, corporate commitments and working capital requirements of £54.9m in total.

Last year, Tungsten West agreed to a non-binding term sheet for a US$30m royalty sale with a global mine royalty investment fund, which was expected to close in Q123 following the completion of the revised FS. It also planned to secure an additional £10.0m of funding, which would allow it to commission the Hemerdon project (which was originally planned in H123). However, the company struggled to secure the funding and decided in early April 2023 to conduct an interim fund-raise through: (1) the placement of convertible loan notes (CLN) bearing a payment-in-kind coupon of 20% pa; and (2) an open offer for newly issued shares. As a result, Tungsten West raised around £7.1m in gross proceeds (out of the maximum planned £8.95m), which will provide capital to meet its near-term contractual liabilities and annual expenditure, as well as finance its planning and permitting activities. Tungsten West is now focused on securing the mineral processing facility permit, which will include imminent low-frequency noise trials, as the management drives progress of Hemerdon towards production. The interim fund-raising was carried out at a 77.5% discount to the closing price on 31 March 2023, resulting in a significant decline in Tungsten West’s share price.

Board changes and review of funding and strategic options

The funding measures were coupled with changes to the company’s management and non-executive board. Neil Gawthorpe was appointed as the new CEO in March 2023; Francis Johnstone (BSRT’s representative) and Grace Stevens stepped down as non-executive directors in March 2023; James McFarlane (managing director) stepped down in April 2023; and Mark Thompson (one of the founding directors of Tungsten West) stepped down as executive vice chairman in May 2023.

The new CEO led a review of the funding and strategic options. On 2 June, the company announced that the cost reduction programme was nearing completion, with a forecast 42% headcount and monthly payroll cost reduction (resulting in minimal one-off costs). Meanwhile, project capex for the front-end rebuild has been scaled back to existing capital commitments for equipment purchase, as well as low-frequency noise trial work. This was coupled with the halt of refurbishment work, pending the completion of permitting and funding processes. Tungsten West also carried out small-scale production of tungsten and tin concentrate at the Hemerdon mine (shipped to an offtaker in May 2023). Finally, we note that the company recently announced a strategic partnership with fusion energy company Oxford Sigma to explore and establish critical supply pathway options for the use of tungsten for radiation shielding and plasma-facing components within fusion energy devices.

Futura Resources and Cemos remain key drivers

We note that the impact on BSRT’s NAV from Tungsten West’s issues has been moderate in 2023 to date, as the investment represented just 5.4% of BSRT’s NAV at end-2022. BSRT’s key portfolio drivers remain Futura Resources and Cemos Group, which have a combined share of BSRT’s portfolio value of around 54% at end-May 2023.

Futura Resources’ fund-raising still pending

As discussed in our previous update note, a potential successful fund-raising of Futura Resources (28.9% of end-May 2023 NAV), followed by production launch (with Wilton likely to come first given limited start-up capex of c A$25.0m), represents the key potential catalyst for BSRT this year. Here, we note that funding has been pending since 2021, initially postponed by the COVID-19 pandemic and subsequently by an unofficial Chinese ban on Australian coal. BSRT expected the funding to close in Q123 (following the award of mining licences in November 2022), but the process is taking longer than expected. Management indicated that one of the reasons for this was the introduction of a higher royalty by the government of Queensland (where Futura Resources’ projects are located) in 2022 (which we discussed in our August 2022 note), which led some investors to remain on hold with financing the project.

NAV upside on successful production launch still sizeable

According to BSRT’s management, Futura Resources can start mining at the sites around three months after a potential closing of funding. Management expects that, at full capacity, Futura Resources’ two mines should produce two million tonnes of saleable product after washing and processing. Management highlighted that, based on coking coal prices when the 2022 annual report was published in late April 2023, the project’s profits would allow it to repay the start-up capex of around US$35.0m in under a year. This compares with Futura Resources’ total equity valuation (implied by the current fair value of BSRT’s stake) of A$63.0m at end-March 2023. Therefore, we continue to see potential for a significant NAV uplift if BSRT can secure funding for the project and start production at current coking coal prices (although we note that it may potentially have to sell its output at a discount if the financing involves an offtake agreement or for other reasons, such as impurities). Current Australian coking coal prices are around US$220–230 per tonne compared to Futura Resources’ all-in sustainable cost of US$80 per tonne.

BSRT’s investment in Futura Resources is a combination of equity (26.9% stake), a 1.5% gross revenue royalty and a A$600k bridge loan. The fair value of BSRT’s holding has remained broadly stable in 2023 to date in local currency terms, although the sterling value has declined slightly due to weakness of the Australian dollar against sterling.

Nussir looking for strategic investor; Kanga Potash seeking funding or trade sale/IPO

Nussir (4.0% of BSRT’s end-May 2023 NAV) has also faced challenges in raising funding for its project copper mining project in Norway and is now seeking a deal (sale or merger) with a strategic investor. BSRT will seek to retain exposure to the project, for example through royalties (similar to Bilboes Gold). BSRT also continues to explore the possibility to finance or sell the Kanga Potash project in the Democratic Republic of the Congo (6.1% of end-May 2023 NAV). The definitive FS completed in 2020 indicated an IRR of 22% based on a muriate of potash price of US$282 per tonne, compared to the current price of around US$350–400 per tonne.

Other portfolio developments

Exhibit 2: Potential portfolio NAV triggers with indicative timelines

Source: Baker Steel Resources Trust

Cemos still aiming to double capacity by 2025

Cemos (25.0% of end-May 2023 NAV) is in its third year of production, with BSRT’s management expecting production volumes and EBITDA to be broadly stable versus 2022 at 202k tonnes of cement and €8.5m, respectively. The company continues to target a doubling of production capacity to 570k tonnes pa by 2025 based on the second production line acquired in mid-2022, with required expenditure at around €7.0m (which should be financed internally). Moreover, Cemos is still exploring the possibility of building a low-cost clinker plant. BSRT assumes that Cemos will complete the FS on the clinker plant soon and commence installation of the second line around Q124. The valuation of BSRT’s stake in Cemos has remained broadly stable in euro terms so far this year.

Caledonia Mining Corporation (CMCL, NYSE) facing technical challenges in Q123

CMCL (10.4% of end-May 2023 NAV) reported its Q123 results in May 2023, with some technical challenges (equipment failures and logistical issues) affecting production and resulting in gross revenues of US$29.4m (vs US$35.1m in Q122). As a result, gross profit stood at US$5.9m (down 65.4% y-o-y), translating into a Q123 net loss of US$5.0m (vs a US$5.9m net profit in Q122). The company’s management believes these challenges have already been resolved and it is encouraged by production and cost data in April and between start of May and the date of releasing the Q123 results. CMCL restarted production from oxide mining at end-March 2023 and (despite some technical challenges) expects that gold mining from near surface oxide deposits will be cash neutral. This should allow the project to maintain operational integrity ahead of the revised FS related to the larger underlying sulphide project.

CMCL’s shares are up by 9% from January 2023 to 20 June (2% down to end-May 2023). We note that BSRT’s six-month lock-up (from the moment of the Bilboes deal completion on 6 January 2023) will soon expire. BSRT is likely to sell down its CMCL holdings over the medium term so it can deploy the proceeds in unlisted junior mining projects, in line with its core strategy. Meanwhile, its stake in CMCL offers regular dividend income; CMCL has declared two interim dividends of US$0.14 each so far this year, translating into an annualised yield of around 4.1% and a gross dividend for BSRT of US$0.45m. Moreover, we note that BSRT retained exposure to the Bilboes gold project it sold to Caledonia through a 1% net smelter royalty. BSRT expects it to generate an income of around US$2.6m per year (assuming withholding tax of 15% and a gold price of US$1,800 per ounce).

First Tin (1SN, LSE): Steady progress on both of its projects

On 5 May 2023, First Tin (3.6% of end-May 2023 NAV) announced that it had submitted the complete documentation for its mine permit application to the Saxonian Mining Authority for its Tellerhäuser underground tin project in Germany, with the authority’s decision expected before the end of Q324. It expects to complete the definitive FS in H124. Moreover, the definitive study for the Taronga open-pit tin project in Australia is scheduled for completion in Q423. First Tin announced on 12 June that it had completed all drilling at the Taronga project, with its results confirming an extension of around 400 metres to the south-west.

Polar Acquisition written further down due to geopolitical risks

In its March NAV update, BSRT highlighted that the Prognoz mine is on schedule for mining to start in late-2023 and first revenue to be generated in Q224. This should allow for BSRT to collect first royalties in H224. That said, BSRT acknowledges various Russia-related risks that may result in its inability to collect the royalty. Accordingly, BSRT marked down the value of its Polar Acquisition holdings by 75%. As at end-March 2023, the holding was valued at around twice the potential annual royalty cash flow, according to BSRT.

General disclaimer and copyright

This report has been commissioned by Baker Steel Resources Trust and prepared and issued by Edison, in consideration of a fee payable by Baker Steel Resources Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: 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 and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. 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.

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Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. 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, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

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United Kingdom

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

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London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

General disclaimer and copyright

This report has been commissioned by Baker Steel Resources Trust and prepared and issued by Edison, in consideration of a fee payable by Baker Steel Resources Trust. Edison Investment Research standard fees are £60,000 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: 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 and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. 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.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, 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 securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. 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, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2023 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

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. 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 (i.e. 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.

United Kingdom

This document is prepared and provided by Edison 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.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison 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. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

London │ New York │ Frankfurt

20 Red Lion Street

London, WC1R 4PS

United Kingdom

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