Mineral Commodities — Update 24 June 2016

The Tormin mineral sands project was commissioned in January 2014. The project mines a beach mineral sands deposit located on the west coast of South Africa, around 400km north of Cape Town. The area was previously explored by Trans Hex (TSE.JSE) and others for mineral sands and diamonds.

The deposit is located approximately 50km south of the Tronox Namakwa Sands large-scale, heavy mineral sands (HMS) operation at Brand se Baai, originally developed by Anglo American.

The current beach resource is unusual in that it has been replenished by normal tidal movements since mining started, although there is no certainty this will continue at the same rate indefinitely.

MRC also has extensive exploration opportunities from offshore activities, coastline extensions and onshore potential. These have the potential to provide substantial exploration upside.

The Tormin tenement area (see Exhibit 2) covers approximately 12km of mineralised beach zone, stretching from Cliff Point in the south to Skaapviel in the north. The area is north of the mouth of the Olifants River and around 30km north of the township of Vredendal.

The source of the Tormin beach deposit is eroded paleo strandlines and HM-rich offshore zones. The dynamic tides and wave action in the region transport sediment from deeper waters to the beaches. This process concentrates and upgrades the HMS below the high water mark. This leads to the mineralisation on the beaches being replenished after it has been mined.

Over the last two years, 99% of the beach mined at Tormin has been replenished through normal tidal movements. The replenishment is not uniform. In locations where the replenishment rate is high, some areas have been mined up to 10 times or more.

Resource replenishment is not unique to the Tormin project. It also occurs at other beach placer deposits along the west coast of South Africa and the Tamil Nadu coast located in south-east India.

Exhibit 1 illustrates that the inferred resource at Tormin did not change between December 2013 and December 2015 in tonnage terms due to replenishment activity, despite two years of mining. After two years, total material mined plus the inferred resource at December 2015 was 5.39Mt compared with the inferred resource at December 2013 of 2.7Mt prior to mining.

However, grades measured as total heavy mineral (THM), ilmenite, zircon, rutile and garnet dropped in successive years.

Although the grade of the inferred resource has been falling, the grades achieved during mining have been at a significant premium to the corresponding grades of the inferred resource for the year prior to mining (see Exhibit 1). This provides confidence for the mining schedule and earnings and cash flow.

For example, mined zircon grades in 2014 and 2015 were 40% and 76% higher than the zircon grades of the December 2013 and December 2014 inferred resources respectively. The premiums have continued with production in Q116, although the very high premiums to the resource grade may not be fully representative because of the smaller sample.

MRC conducts regular grade reconciliation and sample grading as part of the mining operation to correlate between the stated resource and actual resource in terms of quantity, grade and replenishment. At the end of 2015, it also took pit samples from mined areas that had undergone replenishment.

At this stage, it may not be possible to fully account for the poor correlation between the high grades experienced during mining and the lower grades of the inferred resources. In our view, a possible reason is sampling error. However, the positive aspect is that mined grades have maintained a significant premium over inferred resource grades over a period exceeding two years.

According to MRC, the current replenishment dataset is of insufficient size and time frame to allow replenished resources, as in Exhibit 1, to be classified. They are therefore not JORC compliant.

In November, 2015, Mineral Sands Resources Pty (MSR), MRC’s 50%-owned South African subsidiary, was awarded prospecting rights up to 10km offshore from the current mining area, representing an area of 10,500ha (see Exhibit 2). The objective is to investigate the offshore HMS potential that is currently the source of the replenishment of the mineralisation of the beach resource.

Drilling of the surf zone, which is the area between the low tide and the wave crest formation, was due to start in Q216. The programme objective is to achieve an offshore inferred JORC resource.

MSR has also lodged a prospecting and bulk sampling application along the beach and surf zone north of the current mining operations, representing around 24km of coastline and a target area of 398ha (see Exhibit 2). This area has been previously drilled by TSE for diamonds and HMS.

The application is currently under review by the Department of Mineral Resources – South Africa.

MSR has also lodged a prospecting application over the recently acquired Geelwal Karoo farm covering an area of 1,741ha (see Exhibit 2). Historical and in-house exploration work has indicated the area to be prospective for HMS deposits.

The application is currently under review by the Department of Mineral Resources – South Africa.

Mining is by small open pits using coffer-type dams constructed by excavators. The pits are usually only open during low tide except where it is possible to construct larger, more stable protection bunding where beach conditions allow. Extracted material is from surface to bedrock, so there is no stripping ratio.

There is natural replenishment of the pits as they are filled with HMS material from the surf zone during the next high tide. Replenishment is mainly a function of time and the number of sea storm events.

Because of replenishment, it may be possible to re-mine the same mining block. Over the past two years, some mining blocks have been mined up to 10 times or more.

The Tormin processing plant is located close to the beach, with ready access to MRC’s mining right area along the 12km of mineralised beach zone.

The Tormin project produces three saleable products:

Since the project was commissioned, MRC has progressively invested in new processing plant. The final plant item, the Garnet Stripping Plant (GSP), is planned to be commissioned in early July 2016. The objectives of the investment have included:

Outcomes have included:

In broad terms, the two main items of plant are as follows:

Enhancements to the plant after the original commissioning include:

Further plant upgrades are possible in the future, depending on future exploration success and the extent of financial benefit (such as higher-value products) relative to the investment required. These include:

Once the GSP is commissioned and all other enhancements fully configured, the processing plant will have additional spare capacity:

This capacity provides options to lower feed grades by increasing mined tonnes and overall utilisation of the various plant components.

It also provides additional capacity against a possible decline in feed grades such as zircon, as mining progresses. MRC may also consider using a remote primary beach concentrator for mining outside the current mining areas.

MRC’s Xolobeni project is located on South Africa’s east coast. It has the potential to be a globally significant asset. It has a measured, indicated and inferred resource of 346Mt at 5% HM containing 9.3Mt ilmenite.

There has been ongoing controversy and resistance to this project. As a result, MRC management is conducting a strategic review of the asset and its development profile. This is being considered relative to the company’s overall business in South Africa.

Our base case valuation is A$0.32/share with an upper case of A$0.52/share (Exhibit 4). These valuations are marginally higher than those in our report of 5 February 2016, reflecting a number of small changes to our financial model.

Major modifications to the Tormin processing plant are expected to be completed in early July 2016. The completion will lift production capacity and product specifications, leading to a substantial boost to revenue, earnings and cash flow. The financial summary is presented in Exhibit 5.

MRC reported normalised post-tax earnings of US$10.6m in CY15. We forecast a small improvement to US$10.8m (US$0.027/share) in CY16. The latter is slightly lower than our last CY16 forecast of US$12.2m, mainly due to weaker zircon prices.

Our CY17 earnings forecast of US$28.9m (US$0.071/share) factors in the completion of all the plant improvements, including the GSP, and the associated lift in plant throughput, HM recoveries, higher product grades, higher price realisations and higher absolute output of saleable products. We also assume a recovery of zircon and rutile prices to close to CY15 levels.

From CY18 onwards, we forecast a small decline in earnings to around US$25m pa due to an assumed reduction in mined zircon grades. MRC may be able to mitigate this decline by increasing ore throughput, mining higher-grade material from new areas delineated by exploration or further metallurgical enhancements.

MRC declared a dividend of A$0.01/share in respect of CY15. We forecast an increase to A$0.02/share in CY16 and A$0.064/share in CY17. Projected dividend yields are high. Dividends, payable in Australian dollars, are subject to the prevailing exchange rate with the US dollar.

We see MRC as a very cash-generative business, with future operating cash flow from operations exceeding US$30m from CY17 onwards. This is due to the high grade of its resource, metallurgical enhancements and limited required future capital expenditure.

MRC has a 50% interest in its South African subsidiary MSR under Black Economic Empowerment (BEE) arrangements. However, as MRC effectively has 100% control over the relevant activities for accounting purposes and controls the management and board of MSR, MRC’s financial statements include 100% of the results of MSR. Under the shareholders’ agreement between the shareholders of MSR, the majority of Tormin’s earnings and cash flow over the next four years is attributable to MRC in recognition of capital invested and debt provided. We have allowed for payments to MRC’s BEE partner in the years after the fourth year, as provided for in the shareholders’ agreement. These payments are taken into account in our NPV10 valuation for MRC.

At 31 March 2016, MRC had cash of US$7.8m. In the absence of new project initiatives and depending on dividend policy, the cash balance may continue to rise with time.

MRC has a loan agreement with GMA for US$4.5m funding to complete the GSP, which was drawn down by US$3.7m as at 31 March 2016. This has a three-year repayment term commencing with the restart of shipping of garnet concentrate product to GMA, planned for January 2017. MRC also had shareholder loans of US$1.3m, repayable in September 2016.

We have allowed for further debt facilities to assist with company growth projects.