BCI Minerals — Increasing iron ore royalties supporting Mardie

BCI reported A$2.8m in EBITDA during Q3 from operations at Iron Valley (including a positive prior quarter adjustment of A$0.6m), influenced by:

The prices of both standard grade 62% iron ore and 58% lower grade ore have continued to exhibit material strength since late January and into Q419, while the discount of the latter to the former has narrowed significantly (as predicted in our Outlook note, see BCI Minerals: Salt plus potash plus iron equals value, published on 7 February 2019):

While Q319 prices were materially higher for Iron Valley than those experienced in H119, since the upward momentum only began in late January, they nevertheless did not reflect the full extent of the actual movement in the spot prices over the period. For example, whereas we estimate that the average price for benchmark 58% iron ore was US$60/t in Q319 (vs US$42/t in H119), the spot price had actually reached US$79/t by early April. Similarly, whereas we estimate that the average price for benchmark 62% iron ore was US$83/t in Q319 (vs US$69/t in H119), the spot price had actually reached US$96/t by early April. In conjunction with its interim results (announced on 22 February) and the report of its third quarter performance, the assumption that iron ore prices will remain at elevated levels for the remainder of the quarter (and that the discount of 58% iron ore vs 62% iron ore will remain narrow) has caused us to revise our FY19 forecasts for BCI as follows:

In addition to the operating and financial performance of Iron Valley during the quarter, BCI has also provided an update on developments at its Mardie salt and potash project.

So far, during 2019, BCI has made three material engineering appointments. The one remaining, material design contract outstanding is the Mardie port design and engineering contract, which is expected to be awarded next month, following recent receipt of Western Australian (WA) state government support for a new port facility there.

On 22 March, BCI appointed GR Engineering as lead DFS engineer, responsible for the co-ordination and integration of the key process and engineering design packages and the preparation of detailed capex and opex estimates.

GR Engineering is a reputable Perth-based engineering group with significant experience in study management, engineering design and the construction of resource projects in Western Australia and globally, both as an EPCM and an EPC contractor.

It will also design and supervise the construction of pre-FID (final investment decision) site works and supporting infrastructure throughout the remainder of 2019.

As per its quarterly activities report, BCI has also appointed WorleyParsons to complete the process and engineering design of the evaporation and crystallisation ponds as well as the sulphate of potash (SOP) plant.

WorleyParsons is a global engineering services consultant providing engineering, procurement and construction management services in a range of industries. More specifically, it has more than 20 years’ experience of engineering in the fertiliser industry, including completing design and engineering engagements for brine-based SOP projects globally, which has allowed it to assemble a Potash Centre of Excellence in Saskatoon, Canada.

Finally, Salt Partners has been appointed to complete the process and basic engineering design of the salt plant at Mardie. BCI’s engagement of Salt Partners continues an existing relationship between the two. Salt Partners was responsible for the salt plant designs used in the Mardie pre-feasibility study, although the detailed engineering of this project component for the DFS will be completed by the Mardie DFS lead engineer, GR Engineering.

Salt Partners is a firm of engineering contractors based in Switzerland. It has decades of experience in salt production, processing and hypersaline biotechnology. Salt Partners has established a proprietary salt purification process – Hydrosal – which produces high-purity salt with low product losses, which has been adopted by numerous plants around the world.

Construction of a small-scale evaporation trial pond is currently underway at site. The trial will comprise pan evaporators plus a 1:40,000 scale version of the entire project layout, including the eight evaporation ponds and one series of the primary salt crystallisers and SOP crystallisers. The trial is being conducted on a small, raised ‘island’ off the Mardie mudflats in order to protect it from the potential effects of preternatural weather. As a result, the ponds and crystallisers will be lined with plastic in order to simulate the low-permeability conditions of the mudflats. Nevertheless, the trial is being designed to provide site-specific evaporation data at a range of densities and simulate the full evaporation process at a reduced scale, as well as producing raw salt and kainite-type mixed salts for salt and SOP processing test-work and marketing samples.

In the meantime, a geotechnical drilling and test-work programme in order to confirm the optimal locations for the evaporation ponds and infrastructure, including the alignment of the proposed export jetty, is nearing completion.

A number of recent pronouncements have indicated WA state government support for the Mardie project. The minister for ports, in particular, has provided approval for BCI to commence the planning process for the development of a multi-user port facility at Mardie (as opposed to the port being located at Cape Preston East, which was originally conceived to also accommodate output from BCI’s erstwhile iron ore assets at Kumina, etc, and was the assumption on which its Mardie PFS was based). This ‘in principle’ approval for a port at Mardie follows positive discussions with various government bodies over a number of months. Developing port facilities at Mardie is BCI’s preferred logistics solution for the project, as it eliminates material road haulage costs to the alternative Cape Preston East port. In receiving ‘in principle’ approval therefore, BCI’s expanded target DFS for Mardie (see Improvements vs the PFS on page 21 of our initiation note, BCI Minerals: Salt plus potash plus iron equals value, published on 7 February 2019) becomes a more realistic possibility (ie it contributes to its de-risking). While this expanded target scenario does not yet represent our base case valuation (which continues to be based on the Mardie PFS for the time being), we estimate that its adoption would add c 30.4%, or 9.62c (updated from 9.32c due to updated dilution assumptions), to our valuation of the present value of the dividends payable to BCI shareholders of 31.62c (see below) to take it to 41.24c. Simultaneously, BCI is working with the Pilbara Ports Authority and other government departments to establish the tenure and agreements required for BCI to develop the multi-user Mardie Port as a foundation proponent.

In the meantime, all of the environmental surveys and studies required to support the assessment of the Mardie project have now been completed. The next key step in the Environmental Protection Authority (EPA) process is the Environmental Review Document, which has now been prepared and is due to be submitted to the WA EPA within a matter of days, which will keep BCI on track for full ministerial approval of the project by early 2020.

BCI has native title agreements in place with the Yaburara & Mardudhunera (YM) and Kuruma Marthudunera (KM) peoples that allow for production at Mardie. Of the planned project footprint, 90% is within the YM claim area, to which end BCI has received the required heritage-related consents to proceed with construction and operations. A heritage survey with the KM people is planned in April 2019 over the remaining 10% of the project footprint area.

BCI has stated that it will advance development funding options and ownership structures for the project in detail during the preparation of the Mardie DFS. Notwithstanding the de-risking of the Mardie port option therefore, pending the publication of the DFS at Mardie, our valuation continues to be based on the parameters defined in its pre-feasibility study (the results of which were published in June 2018). Within this context, project development capex of A$335m is “likely to be funded from a combination of project debt, equity, product offtake pre-commitments and via build-own-operate (or similar) models where feasible.” However, it has also said that it “will consider all feasible funding structures for the equity component including raising equity in BCI for investment into the project, or raising direct equity into the project.”

Assuming that BCI were to fund Mardie via equity into the company, we estimate that it would have to raise c A$100m in FY20 in order to maintain a maximum leverage ratio (net debt/[net debt+equity]) of no more than 50% in FY23 when net debt to fund the project would peak at c A$192m (some of the equity having been provided by retained earnings from income from Iron Valley). Conducted at the current share price, this would involve the issue of an additional c 644.4m shares, in which case Edison’s long-term estimates of BCI’s earnings, (maximum potential) dividends per share and valuation trajectory are as follows:

Discounting at Edison’s customary discount rate of 10% per year, the value of these dividend flows to shareholders is 31.62 Australian cents (cf 30.66c/share previously) fully diluted as at 1 July 2018 (the change being principally as a result of BCI’s prevailing share price rising to 16c from 13.5c previously). Note that our valuation, on this basis, peaks at 70.66 Australian cents (cf 68.46c previously) in FY28, when EPS would be 5.43 Australian cents, therefore putting it on a contemporary P/E ratio of 13.0x. Self-evidently, this valuation could increase further to the extent that iron ore prices remain at elevated levels beyond June 2019. Moreover, as noted previously, optimisation and expansion of the parameters defined in Mardie PFS will add c 30.4%, or 9.62c (updated estimate as mentioned above), to our valuation to take it to 41.24c. We will update our project assumptions and valuation following the publication of the DFS.