Alabama Graphite — Gaining the industry attention it deserves

Unlike many of its graphite peers, Alabama is focused on developing a graphite mine and processing plant in Coosa County, Alabama, US to produce battery-ready graphite end products. The company is currently heavily focused on securing off-take agreements for its future mine’s end-products – a purified micronized graphite (PMG, marketed under the name ULTRA-PMG), a coated spherical purified graphite (CSPG) and a delaminated expanded graphite (DEXDG). In doing so, the door to project development will open and allow it to be one of the first graphite juniors to migrate from developer to producer status.

Speculation over the names of potential end-users by the stock market before agreements are signed is rarely helpful. Speculation can potentially sour relations between small junior mine developers and large global companies who are ever increasingly protective of brand and image. Alabama has stated it has 31 non-disclosure agreements (NDAs) active with interested end-users, and has a (very large in terms of this type of high-quality material) 150kg stockpile of battery ready graphite for end-user verification. Indeed, 24 of the 31 NDAs have had some of this stockpile delivered to them for exactly this reason. Alabama also states it has 14 of these 31 NDAs held with department of defence contractors/manufacturers. This in itself is testament to the quality of development of Coosa graphite material by Alabama, as DoD qualification is made to the very highest of technical standards.

With the large amount of quality technical detail on Coosa graphite already in the public domain (see page 4 for further developments in this area as well as our previous research on Alabama Graphite), we are quietly confident that out of all the confidential discussions Alabama currently says it has ongoing, that one or more will turn into a commercial off-take agreement.

Securing even one binding off-take agreement on commercial terms with a high-quality end-user would guarantee Alabama with a percentage of future revenues and likely create a snowballing effect for completing other project milestones. Off-take agreements are perhaps the most important factor in the development of any specialty commodity project.

For the investor, the key de-risking components of these off-take agreements which will probably be allowed to be disclosed are:

Any or all of the above may or may not be disclosed. In some instances even the name of the end-customer may never be disclosed in an effort to protect its brand and image. From our experience of writing on similarly characterised projects, located elsewhere, over a number of years, this level of secrecy is perhaps the norm, rather than the exception.

Alabama’s negotiations with potential end-users will remain confidential, perhaps in some cases, forever. Investors in any opaquely traded commodity company will have to get comfortable with this. If securing revenues is the key de-risking event to invest in these types of speciality commodity companies, then it is worth noting that the lowest risk entry point for investment, following the announcement of off-take agreements being finalised, may be far closer to the construction phase of a project than to the completion of pre-feasibility or definitive/bankable level studies. In fact, conventional mining wisdom would have the investor believe that feasibility study announcements deliver the most secure de-risking events on which to value a project. In any other openly traded commodity this might be true as commodity pricing and revenue forecasts are set according to either prevailing commodity market conditions, or to analyst projections calculated by, inter alia, supply and demand. In the case of bi-laterally traded commodities, such as graphite, the equivalent de-risking event is spread two-fold over technical study results for cost-input values (mining, processing, capex costs etc) and the weighted average price of all of its commercially binding off-take agreements for revenue projections. As such, graphite project development can provide the investor with few defined traditional catalysts with which to plan investment and so instead, greater emphasis should be placed on the technical data quality of a company’s products and the ability to demonstrate that it can consistently supply these products to end-users in a timely fashion. This in turn should lead to a favourable outcome in terms of securing offtake agreements. Indeed Alabama states its pre-commercial terms LOI (see below) came about by the potential end-user reviewing Alabama’s very detailed technical announcements. We would urge Alabama to continue providing the market with as much technical detail as possible as this in effect becomes the company’s strongest demonstration of the viability of its graphite to be used in lithium battery manufacture.

As evidence that emphasis on technical data quality delivers results, Alabama announced on 10 October 2017 it had signed an early-stage non-binding letter of intent with a US-based lead acid battery manufacturer. Battery-ready graphite is not usually associated with the older lead-acid battery type, but negative electrode performance in lead-based batteries can be enhanced through the addition of graphite. This potential future end-user of Coosa graphite has withheld its name for reasons of ‘commercial confidentiality’. The LOI requires Alabama to supply 10 tonnes per annum of its ULTRA-PMG and conductivity enhancement DEXDG products, starting in 2018. This coincides with the start to mining at Coosa under current assumptions. Note that Coosa has a very short development timeline of around a year due largely to its phase 1 output of 5,000ktpa.

This end-user wants Coosa graphite for use in its pilot-line of fast-charging automotive and stationary batteries, with production starting in 2018, and anticipated to ramp up by 2020. At this point the end-user may require far greater tonnages of Coosa graphite.

At present we will not adjust our base case valuation for this LOI as it is not, at present, for any material amount of Coosa end-products. However, it is a de-risking event in that Alabama is proving its Coosa graphite is good enough for battery standards, but again, getting these agreements converted into commercial terms and for far higher tonnages is critical to the successful development of Coosa.

Alabama states: “The specific terms of the LOI, including pricing and renewal rights, are confidential for competitive reasons.”

Over the course of 2017 Alabama’s technical evaluation and development of Coosa graphite has demonstrated that its natural graphite deposit, coupled with Alabama’s proprietary development process, is highly suitable for high-specification end-uses. At the current time, the highest rates of growth are linked predominantly to battery technology (though growth in graphite-based fire retardant materials is also gathering pace). Rather than stating word for word these technical achievements a brief summary of Coosa graphite technical data follows:

This appears to be a contradiction in terms. However, Alabama has managed to exceed the theoretical characteristics of (uncoated) battery graphite anode material through the addition of 4% by-weight silicon oxide onto its CSPG product. In doing so the following results were achieved:

The above chart can be read in conjunction with the following table. Note that Coosa battery anode graphite in its uncoated form in terms of reversible capacity is 5.7% more efficient at retaining energy (also known as a battery’s tendency to self-discharge). In terms of irreversible capacity (ie the battery’s permanent loss of capacity due to use), Alabama’s silica coated CSPG is 13.6% better at retaining charge than non-silica coated Coosa CSPG. These outstanding results are further testament to Coosa’s graphite quality and Alabama’s ability to upgrade its graphite to a battery-grade graphite produce. Note this is regardless of Coosa’s low in-situ graphite grade, which has been incorrectly viewed as a detrimental to the projects eventual success.

China’s environmental reform programmes are far reaching and are starting to result in particular commodity price increases via the curbing of domestic Chinese mine supply. This effect on prices runs parallel to China’s continuing demand for roughly half of the world’s mine metal. This is certainly the case for rare earths where China’s production still accounts for c 85% of global supply. The issue surrounding rare earth production and refining in China relates to the particularly harmful acid-based solvent extraction methods that are typically used in an unregulated fashion by legal and illegal producers. As a result of the ongoing regulation of this industry, certain rare earth prices have rebounded from the lows created post the 2011 REE ‘bubble’. This is particularly the case for those associated with magnets such as dysprosium, neodymium, praseodymium-neodymium alloy and praseodymium alloy.

While obtaining accurate graphite prices to understand historical price trends is very difficult due to the confidential nature of bi-lateral supply agreements, a similar situation in terms of China’s central government bearing down on polluters is starting to occur. China supplied 41% of US consumption of synthetic graphite in 2014 (the last available data). As such, Alabama’s intention to produce, initially, 5,000 tonnes of refined natural battery-ready graphite products will provide US end-users with a domestic source that is also environmentally sustainable. Synthetic graphite is largely derived from the thermal treatment (at between 2,500 and 3,000 degrees centigrade) and purification of petroleum coke. Thus the process is a heavy polluter in China and one that the central government is keen to expel to producers located outside of its borders.

Alabama is due to complete a feasibility study (FS) on the Coosa project. On 12 July it announced it had awarded the contract to complete the study to AGP Mining, a specialist independent engineering firm. The completion of the FS will incorporate all current and upcoming technical data as well as the already optimised flow sheet design for processing Coosa graphite material into high quality battery ready graphite products. NB: the proprietary process methods to be used are low temperature and do not use acids, and therefore relatively environmentally benign compared with synthetic graphite production methods that involve the treatment of petroleum coke.

Alabama previously completed and published the findings of its preliminary economic analysis (PEA) into Coosa in November 2015. Whereas PEA-level data reflect only the author’s opinion of cost assumptions based on industry norms and peer data, we understand from management the current relevant 2015 published Coosa PEA is more accurate in terms of costings than many mining PEAs currently available in the graphite space. This is because the level of graphite mining and end-product development and sales experience on Alabama’s board is considerable. As with all mining projects however, the level of accuracy required by mine financiers to fund a project is usually +/-10% (an accuracy level that is required for the completion of definitive feasibility studies).

We have taken the view that mining could potentially start, following a sixth-month build out of the small plant and mine site, in FY19 (late CY18). This reflects the need for financing to complete a feasibility study and a start date to mining being highly dependent on this factor, as well as obtaining key product offtake agreements and securing all the relevant regulatory approvals and mine financing. This is a relatively short-lead to production, but one we believe could be achieved considering the high-level of technical de-risking already undertaken by Alabama’s management to produce a saleable high-quality product.

The key assumptions we have used to value Alabama’s shares are unchanged and taken from the 2015 Coosa PEA, inter alia, and are provided in Exhibit 3:

On the basis that Alabama executes the Coosa graphite project as detailed in its 2015 PEA, adjusted for our assumptions on the mine’s start-up date and financing (see Financials section for further details), we estimate that the company will generate future earnings and dividends as displayed in Exhibit 4, below. The associated net present value of this potential dividend flow to shareholders (using a 10% discount rate) is displayed in the form of the DDF (discounted dividend flow) line.

As we show in Exhibit 4 above, positive earnings for Alabama are forecast to be first generated in 2019, after which a theoretical maiden dividend could be paid in 2023 and its first sustainable dividend in 2025, following both Phase 1 and Phase 2 ramp-ups. At a 10% discount rate, we calculate the net present value of the life of mine stream of maximum potential dividends payable to shareholders to be C$1.11/share on a fully diluted basis (discounted to FY18; from C$1.01/share discounted to FY17 before). In the event that the project is restricted (for whatever reason) to just Phase 1, with Phase 2 never undertaken, we calculate the net present value of the (reduced) life of mine stream of maximum potential dividends payable to shareholders to be C$0.64/share (from C$0.56/share before) at the same 10% pa discount rate.

In addition to the qualitative risks to development discussed throughout this report (ie financing, natural CSPG market growth, Coosa’s positive metallurgical results, competition from synthetic sources, regulatory approvals etc), we have highlighted a selection of sensitivity analyses and the effects each has on our base case valuation.

PEAs use cost input data that are derived from industry standard datasets (where available), peer data and industry experience of the authors. As such, not all data used are based on empirical findings, and cost input values may change as the accuracy levels required by pre-feasibility (usually +/-25%), and then bankable level studies (usually +/-10%) are satisfied.

Alabama’s nine month results to end May 2017 were filed on 19 September 2017 and indicate that the company had cash on hand of C$1.2m. We assume this cash balance should cover working capital sufficiently to the end of May 2018 (Q3 FY18). As such we expect the company to return to market to raise equity to cover not only working capital but also to fund its feasibility study (see below).

According to management, it would require a further C$3m to complete its Coosa feasibility study and concurrently undertake a secondary CSPG pilot plant programme. At present the company continues to pursue this funding, but is equally cognisant that commercially binding offtake agreements are just as valuable, if not more so as they represent revenue guarantees for any feasibility study outcome. We previously forecast this C$3m amount to be raised as equity in FY17, but have now removed it pending further guidance from management regarding the funding requirement.

The company has 13.5m options outstanding at end May 2017. All options are exercisable between C$0.105 and C$0.35 per share. Of the 3m options due to expire over the next 12 months, 91% are currently in the money with exercise prices of between C$0.15 and C$0.155 (CSPG’s share price as of 24 October 2017 was C$0.17).

We base our mining, revenue, cost and capex numbers on Alabama’s November 2015 PEA. We forecast first production to occur in FY19 (Q318), following C$59m (US$43m) capex spend over H218. To maintain maximum corporate financial leverage (net debt/[net debt+equity]) below 60%, we assume that Alabama will have to raise no less than C$23m in equity over H118 at the prevailing share price (equating to 51% dilution).