Galaxy Resources — Update 19 December 2016

With the reopening of the Mt Cattlin operation, one of the objectives was to redesign and reconfigure parts of the plant to increase its earnings capability. To achieve this, throughput rates were increased from 0.8mtpa to 1.6mtpa and measures were taken to substantially increase the recovery (or yield) and grade of the lithium concentrate (Li2O). Lithium concentrate is sometimes referred to as spodumene. One of the measures taken included the removal of a substantial proportion of the mica, which had previously reported to the product stream and diluted the lithium grade of the concentrate.

Under the new plant configuration, earnings benefit from higher sales volumes and a higher value concentrate. Lithium concentrate is the raw material sold to the converters, which then upgrade the lithium concentrate to lithium carbonate or lithium hydroxide. These are the higher priced end-feedstocks, which are sold to battery makers. There is an approximate formula for lithium concentrate prices, which is linked to the lithium carbonate price. Prices are generally higher for higher-grade concentrates. There may be penalties for impurities such as mica. Price formulas may vary between contracts and may be affected by supply-demand conditions at the time.

GXY is the only existing, independent source of lithium concentrate supply in the market. This is due to the fact that both Greenbushes (operated by Talison Lithium, 51% owned by Tianqi and 49% by NYSE-listed Albemarle Corporation) and Mt Marion are selling their concentrate supplies to their project shareholders rather than in the open market.

With no formal spot market for lithium concentrate prices, GXY’s concentrate prices are being driven by the incremental supply-demand characteristics of its production.

GXY has now commenced 24-hour production at the Mt Cattlin processing plant. The company was targeting a lithium concentrate grade of at least 5.5% Li2O with <5.0% mica in the concentrate. However, GXY has achieved better than this. The first five composite samples of production achieved grades ranging from 5.8 to 6.4% Li2O with mica no higher than 4.7% and as low as 1.7%. Both mica and moisture levels were below the contract specification thresholds. The achievement of continuous operations and the improved specifications represent the completion of major milestones for the Mt Cattlin project.

GXY has recommenced mining at Mt Cattlin using a mining contractor. Initial material for the processing plant was from stockpiled ore. Production of run-of-mine ore is now needed to support the ramp-up of the Mt Cattlin processing plant

Although GXY knows it can produce a concentrate at 6% Li2O, this may not necessarily generate the optimum cash flow for the company. As the concentrate grade is increased, Li2O recoveries tend to decrease. There is a trade-off between achieving a high concentrate grade and sacrificing some recovery. GXY currently has insufficient data to analyse the financial impact, so it will carry out production tests and assessments that will look at the relationship between concentrate grade (from 5.5% to >6% Li2O) and Li2O recovery and the financial impact. The impact will be quantified over the next couple of months.

The initial targeted Li2O recovery level is 50%. GXY is to work on a number of initiatives during 2017 that have the objective of increasing recovery above the 50% level. If successful, this would increase the lithium concentrate GXY would have available for sale.

Trucking of the Mt Cattlin concentrate to the Port of Esperance began on 5 December 2016. This followed inspection of the product for mica concentration and moisture content by representatives from Esperance Port Authority and Qube Logistics.

GXY has given formal instruction to Mitsubishi Corporation to nominate a vessel for the first export shipment of concentrate from Esperance. The company expects the first shipment to take place by the end of December 2016.

GXY had a binding agreement with its existing China-based buyers for the sale of 120,000 tonnes lithium concentrate to be delivered in calendar 2017. These buyers are chemical converters that produce both lithium carbonate and lithium hydroxide. Pricing was not fixed and was finalised as guided and expected in Q416. The lithium concentrate price has now been negotiated at US$830/t FOB, minimum 5.5% Li2O. This is higher than our forecast of US$750/t. There is upside to this price, with US$15/t escalation for every 0.1% improvement in the grade of Li2O delivered. This would lead to an agreed price of up to US$905/t for a 6% lithium concentrate.

GXY is discussing longer-term arrangements with its existing customers beyond 2017 and will also look at options to diversify its customer base. Offtake arrangements are settled through partner Mitsubishi Corporation.

GXY’s production guidance for 2017 is for 160,000 tonnes of lithium concentrate (spodumene) based on an approximate 50% recovery. This production level will satisfy the c 40,000 tonnes of 2016 contracted volumes to be delivered at US$600/t and the 120,000 tonnes of newly contracted 2017 volumes at a minimum US$830/t. It is expected that 35,000 tonnes of 2016 contracted offtake will be delivered in 2017.

GXY will continue working to improve recoveries at the Mt Cattlin processing plant. This may result in incremental production in 2017. This would be sold to existing and/or new customers.

Our valuations have been revised for Mt Cattlin updates in December 2016 and the revised Sal de Vida DFS in August 2016. Although we have incorporated higher lithium concentrate prices for FY17, the effect on valuations has been immaterial due to the long dated nature of the projects, additional shares in issue and recoveries that are still at the lower end of the future expected range.

The share issue was announced on 11 November 2016 for total additional shares of 25.7m comprising conversion of 25m options at A$0.03/share, 0.63m shares issued to a contractor for services at Mt Cattlin with the balance issued as consideration for the acquisition of tenements.

We have produced valuations for a base case (conservative) and two scenarios, Case 1 and Case 2 for GXY using price scenarios from Exhibit 2. These are shown in Exhibit 3. Case 1 represents a lower demand scenario than Case 2 with prices falling after 2020. Case 2 represents a high demand scenario with higher prices sustained to 2025.

Our valuation assumptions include:

We have assessed the sensitivity of the GXY valuation to the long-erm LCE price and increased mine lives from exploration success:

Upfront prepayments of US$13.5m were received in 2016 in respect of 22,500 tonnes of lithium concentrate.

Physical concentrate shipments are anticipated by the end of December 2016.

Our net income forecast for FY17 has increased from A$68.6m to A$80.0m, mainly as a result of the higher than expected lithium concentrate settlement of US$830/t vs our forecast of US$750/t. We have not changed price forecasts beyond FY17 and earnings forecasts are essentially unchanged.