Volt Resources — High-ranking East African graphite project

Volt Resources’ Namangale graphite project is located in southern Tanzania, close to existing good infrastructure and proximal to available capacity at the coastal port of Mtwara. This region is host to a number of early- and advanced-stage graphite projects, and includes the western world’s first large-scale graphite mine, Balama, operated by Syrah Resources (ASX:SYR). The December PFS outlined a 170ktpa flake graphite operation producing a suite of products that could be used in a wide range of industrial applications, especially the high-growth LiB battery manufacturing and expandable graphite applications.

We assume that Volt develops Namangale as outlined in its PFS. To maintain maximum corporate financial leverage (net debt/[net debt+equity]) below 50%, we assume that Volt will have to raise no less than A$93.0m in equity at the prevailing share price (equating to 157% dilution). This then requires a maximum debt funding requirement of A$141.4m as at end FY19. We assume the equity component is raised at Volt’s prevailing share price of 3.7c, but expect this to rise as further de-risking events are announced to market (such as binding offtake agreements). On this basis, we value Volt’s shares at 27 cents, which rises to 40 cents in 2021 following all development capex spread equally over 2018 and 2019. Based on the PFS, our model shows Namangale generating its highest earnings in the first four years of operation, due in large part to mining out the Namangale 2 deposit. Namangale 2 has a greater portion of jumbo and super jumbo flake sizes compared to Namangale 1, which provides the mainstay of production throughout the mine life.

According to its quarterly cash flow and activities report, Volt ended the half year to Dec 2016 with cash of A$2.97m. This included cash outflows ytd of A$4.2m relating to Namangale PFS expenditure. Volt estimates total cash outflows of A$1.6m for Q317 as it advances the Namangale DFS and continues engaging with potential end-users of its graphite, and we therefore estimate that Volt will finish the year with A$1.3m in cash.

Volt’s Namangale PFS demonstrates project economics based on a ±25% cost accuracy. Further, it uses graphite product price assumptions from third-party consultants and not as provided by commercial binding offtake agreements. With accuracy to be refined as a matter of course by the definitive feasibility study, to ±10% currently underway, it is the product offtake agreements that require the company’s greatest focus to de-risk our valuation. From the current understanding of Namangale, we believe that the graphite produced could be used for LiB manufacturing (its purity levels after simple flotation and its resource size tackle both the purity and potentially the consistency of supply concerns held by end-users). We also stress that in terms of graphite, a commodity with little large-scale development history in the junior mining space, certain of these development risks are more prevalent than others (see page 9).

ASX-listed Volt Resources (formerly Mozambi Resources) holds tenements over ground containing graphitic carbon in Tanzania. Its flagship project is Namangale in Tanzania, located 50km from Magnis Resources’ (BFS-stage) Nachu Graphite Project (ASX:MNS, market cap A$252m at 15 March). Publication of the PFS for Namangale in December 2016 has provided the market with the first real indication of project operating and capital costs, and defined an economic ore reserve. The calculation of an ore reserve has more significance in terms of mining out a commodity that has no open market on which to trade. This is because a reserve calculation has to use product price assumptions to define the amount of the mineral resource that can be mined out economically. Further, it should reflect the pricing data received by the company from its end-user negotiations.

Volt announced on 3 March 2017 that it has secured a binding offtake agreement with a small, private pre-revenue New York-based graphene company called Nano Graphene. This agreement sees Volt providing early stage (pre-main phase mining at Namangale, potentially as early as 2018) extraction of small volumes of graphite, which will then be sold to Nano Graphene. This is significant in that a binding offtake agreement has been secured for Volt, a step ahead of many graphite companies. Although this binding offtake agreement is not related to lithium-ion battery manufacture, it does suggest that Namangale graphite is of a high enough quality and suitable for graphene development and, further, secures some early-stage small cash flows. The agreement sees Volt providing Nano Graphene 5,000 of premium-quality Namangale flake graphite concentrate over a five-year period at a price that is “at a premium to the Volt Resources PFS basket price of US$1,684/t”; this implies at least gross revenues of US$1.68m pa. We have not yet included these revenues in our financial model because the costs required to extract graphite to fulfil this agreement have not yet been disclosed. At the current time of writing, we do not expect our base case valuation to change significantly based on this offtake agreement.

As stated above, and probably of the most significance to Volt, Nano Graphene has validated, through its own testing, Namangale concentrate to be suitable for its graphene uses, regardless of particle size. Although still small and early stage, with many of the potential uses still to be proven viable in the laboratory, graphene is a very important industry. However, we caution as to the potential scale and importance it will have for the overall graphite mining sector. With graphene applications only requiring a few per cent replacement of the base material, the volumes required will be analogous to the use of rare earth elements in electronics and magnets. Whereas supply dominance still exists in rare earths with China the main producer, the same situation does not exist in graphite.

Further, one major caveat exists: the method for producing graphene products at industrial scales is still to be confirmed viable – this is the holy grail that graphene companies are chasing. Nano Graphene states on its website that it has a patented production method that is environmentally benign – in simplistic terms it uses water and cavitation techniques to exfoliate graphene from raw graphite.

If it proves successful, Nano Graphene will unlock significant commercial value in graphene and open the door to a vast range of applications including, inter alia, large-scale, near-frictionless coatings (for use in any of the transport industries), or any number of nanotechnology applications.

Namangale is a project that has recently seen a 108% increase in its total resource, which now stands at 461Mt at 4.9% total graphitic carbon (TGC). Importantly, the resource carries a significant portion in the highly valued larger-size categories.

Larger-size fractions have been widely accepted as being the best for use in the manufacture of lithium-ion batteries, a market which is expected to see double-digit growth on the back of the anticipated high growth in the electric vehicle market (see Graphite uses and demand on page 8 of Graphite for batteries – Value in natural graphite). However, our further research of the graphite sector sees no definitive evidence for as to why smaller flake sizes cannot be used in LiB manufacturing processes, as long as purity and consistency of supply are maintained at appropriate levels (and before any purification to at least 99.95% TGC). However, we do note that the very fine size fraction of graphite resources (including the ‘amorphous’ or cryptocrystalline size fraction) usually provides for a concentrate grade lower than for concentrates using the larger flake sizes. However, even in this regard the point is not definitive and some graphite deposits exhibit concentrate grades above 95% TGC even for the amorphous size fraction (eg certain Triton Resources and Magnis Resources metallurgical test data support this). Of far greater importance to end-users of graphite is the level and internal morphology of impurities. It is also important to note that larger flake sizes can have interstitial contaminants which, if the flake size is reduced through grinding, could be released into the concentrate.

As a means to expedite development of its flagship Namangale project, Volt has formed a team of engineers earlier than usual in the project development process to manage the necessary pre-development assessments and technical studies required to confirm the economic viability of the project. The first meaningful report was the pre-feasibility study (PFS) published in December 2016, which forms the basis of our valuation of Volt. Volt’s recent announcements provide a number of project advancements, including:

Crucially, as graphite sells via bilateral, long- and short-term agreements between producer and end-user, Volt has agreed MoUs with three Chinese end-users of graphite. These were signed with Optimum Nano, Huzhou Chuangya and Shenzhen Sinuo. All of these companies operate in the LiB market and could be seen as an endorsement of Namangale’s high resource value, attributed to its higher than average proportion of battery-applicable larger graphite flake sizes. The MoUs are currently non-binding and require conversion into commercial offtake agreements before project financing can be obtained and future Namangale revenues are guaranteed. The combined total graphite offtake contained in these non-binding MoUs amounts to 100kt pa. The total annual output of graphite from Namangale is 170kt pa.

Notable for being located adjacent to the north of Volt’s Namangale project areas (see Exhibit 1) is the Nachu project owned by ASX-listed Magnis Resources. Magnis has a market cap of A$252m (at 15 March 2017) and yet has a resource 39% of the size of Volt’s Namangale resource. Nachu has a comparable TGC grade of 5.4% vs Namangale’s 4.9%. However, Magnis’s Nachu project is much further advanced than Namangale, with a bankable feasibility study completed in March 2016, a demonstrable flow sheet design to produce a battery-grade spherical graphite product and all regulatory and environmental permits finalised. On the basis of this resource size (gross tonnage) differential alone, Volt’s shares should see a considerable re-rating when it achieves the same level of development as Nachu – a timeline that Volt has, as stated previously, sought to expedite. Magnis Resource’s current market cap of A$252m compares with Volt’s current market capitalisation of A$39m.

East African graphite deposits are numerous and highly varied in their deposit and economic characteristics. This is due in large part to the secondary metamorphic processes that govern their formation and the way these characteristics relate to the end-markets into which the graphite end-products are sold (deposit flake size distribution, among other things).

As a result of the variability of deposits and the lack of an open market on which products are sold, EV/t valuations are far too simplistic as a means of comparing one peer with another. To attempt to compare these highly variable graphite deposits, we have looked at the most advanced of the East African graphite deposits, ie those with at least a first-pass understanding of their deposits and economic viability.

Of the seven most advanced East African graphite projects we highlight above, Namangale compares very favourably in terms of operating margin (first), basket price (second) and concentrate purity (third, although these values are likely to be refined further). On the basis of the estimated C1 equivalent unit cash costs for each of these projects, Namangale ranks fifth. However, any improvement to the mining schedule by defining greater amounts of higher-value graphite (Volt is currently drilling at Namangale 2 to do just this) may improve Volt’s C1 cash costs. Further, the spread of C1 costs (omitting Balama’s estimated US$286/t concentrate as an outlier to the data set), is narrow, from US$458/t (Mahenge) to US$571/t (Molo), ie US$113. Namangale’s US$536/t sits only 4% above the median value for C1 cast costs of US$515/t. Note: all project data are estimated at the current time; Balama is still under construction and yet to operate.

We omit Magnis Resources from this comparison as it has recently cancelled all its Chinese MoUs and replaced them with a combined financing and offtake MoU for its super jumbo and jumbo sized graphite products, with Russian state nuclear company ROSATOM. As there is no detail from this announcement as to the prices Nachu’s products would fetch, we have excluded this project from our comparison. However, for reference, in terms of its concentrate purity of 98.3% it would rank second next to Mahenge’s 99.1%, and in terms of capital intensity it would rank fourth at US$1,223/t.

Volt Resources has one of the largest graphite resources in the world. With a total (across all resource categories) of 461Mt at 4.9% TGC, its Namangale project provides one of the largest resources of graphite anywhere, and further, its size distribution provides for a large proportion of the resource to be used for the high-value end-markets.

The following exhibit overlays Volt’s current understanding of particle size distribution as detailed in its metallurgical test data announcements, with its reserve estimate published as part of the December 2016 Namangale PFS.

We have also included the total graphitic carbon content for each size fraction (green line in Exhibit 5 above). Whereas before the Namangale PFS announcement, the project was being touted as mainly comprising the very largest flake sizes, it can be seen from Exhibit 5 above that a significant portion of the current mineral resource resides in smaller, and potentially lower-value size fractions. Again, we stress that we have found no definitive argument for why smaller flake sizes cannot be used in LiB manufacturing processes, as long as purity and consistency of supply are maintained at appropriate levels.

We advise caution as to the use of the concentrate purity grades stated in our peer comparison. We have looked to standardise data wherever possible; however, we note the lack of representative concentrate purity data across entire deposits. For example, the 99.1% concentrate purity value for Mahenge is a maximum value stated by the company and it is highly unlikely that this flotation test result will be found to be representative of the entire deposit. Conversely, Duwi’s 86% TGC purity value is taken as the midpoint of Sovereign Metals’ stated 83-89% range. This company states that the test was conducted using an open circuit. As such, some graphite will have gone to waste, when in reality scavengers would be used to recycle and recover any graphite not caught during the first pass of processing. In short, concentrate purity grades are likely to be refined further as more project data become available. Also, if we consider that certain rare earths projects can modify back-end processing designs right up to construction without compromising development timetables or project viability, we expect graphite process investigations to be conducted in a similar fashion. This will of course require ownership of a pilot plant such that these processing refinements can be managed concurrently with binding commercial offtake partner negotiations.

The industry threshold in terms of flotation concentrate purity for LiB production is stated at 95% total graphitic carbon. This is the threshold for concentrates to then be taken and further purified to 99.95% TGC, the purity level required for LiB manufacture. We have not found clear evidence that flake size is a critical path factor in determining the suitability for graphite to be used for LiB production. This bodes well for Namangale, which has a significant portion of its resource under 150 micron, the flake size threshold usually considered as required for LiB manufacturing, which probably reflects the general weakening of the concentrate purity below this particle size level.

We have used the outcome of the Namangale PFS as the basis for our valuation and set out the key parameters in Exhibit 6 below.

The company states that once Namangale is in operation, it will produce two products: a larger ‘premium quality’ product from Namangale South (comprising deposits 1 and 2) and a lower-quality product from Namangale North (comprising graphite from deposit number 3). The following exhibit is based on graphite product prices forecast by Benchmark Mineral Intelligence, Industrial Minerals Research, Macquarie Investments and discussions with industry end-users. Based on these forecasts, the weighted average basket price across Namangale North and South is US$1,684/t. As the graphite market is opaque and bilateral offtake agreements are signed between producer and end-user (with agreed prices often omitted for reasons of market confidentiality), we have used this basket price and provided a revenue sensitivity analysis on page 10.

We assume that Volt develops Namangale as outlined in its PFS and forecast US$173m initial development capex plus our own US$30m working capital assumption (ie totalling A$268m at a US$/A$ forex rate of 0.76). To maintain maximum corporate financial leverage (net debt/[net debt+equity]) below 50%, we assume that Volt will have to raise no less than A$93.0m in equity at the prevailing share price (equating to 157% dilution). We assume an interest charge on debt of 9%. On this basis, our estimate of theoretical DPS, EPS and dividend discount flow from 2017 through to the end of planned mining in 2041 is given in Exhibit 8 below.

On this basis, we value Volt’s shares at 27 cents, which then rises to 40 cents in 2021, following all development capex being fully committed in 2018 and 2019. As can be seen from the exhibit above, Namangale generates its highest earnings in the first four years of operation, due in large part to mining out the Namangale 2 deposit. Namangale 2 has a greater portion of jumbo and super jumbo flake sizes compared to Namangale 1, which provides the mainstay of production throughout the mine life.

Modifying the mining schedule to account for greater tonnages from the large-flake/higher-value Namangale 2 deposit moderately impacts on our valuation adding 5c, or 19%. This assumes no mining from Namangale 3 takes place in years 7 (2025) to 9 (2027) of the mining schedule as detailed in the PFS, and instead 1.9Mtpa of Namangale 2 ore is mined from 2025 to 2029.

All mining equities are exposed to financial, engineering, geological, metallurgical, environmental and political and socio-economic risks, with these factors also the foundation of resource and reserve classifications. However, we stress that in terms of graphite, a commodity with little large-scale development history in the junior mining space, certain of the aforementioned development risks are more prevalent than others. The following sections highlight those qualitative and quantitative risks we consider most relevant to Volt:

The following quantitative sensitivity analysis of our base case valuation has been performed, with the following results.

According to Volt’s quarterly cash flow and activities report, it ended the half year to December 2016 with cash of A$2.97m. This included cash outflows ytd of A$4.2m relating to Namangale PFS expenditures. Volt estimates total cash outflows of A$1.6m for Q317 as it advances its Namangale DFS and continues engaging with potential end-users of its graphite. We therefore assume that Volt finishes FY17 with cash of A$1.3m.

To maintain maximum corporate financial leverage (net debt/[net debt+equity]) below 50%, we assume that Volt will have to raise no less than A$93.0m in equity at the prevailing share price. This then requires a maximum debt funding requirement of A$141.4m as at end FY19. We assume the equity component is raised at Volt’s prevailing share price of 3.7c, but expect this to rise as further de-risking events are announcement to market (such as binding offtake agreements). This would result in 2.5bn new shares, or 157% dilution.