We calculate an NPV for Braemore of \u00a3580m (45p per share), a 335% premium to the company\u2019s current fully diluted market capitalisation of \u00a3173m, but a significant reduction from our initial calculation in October 2007. We then discount our NPV valuation to take into account what we consider to be the main risks and hurdles facing Braemore and reduce our price target to 15p and our rating to Hold until greater clarity is provided.
This downgrade is brought about by an increase in capex, a lengthening of lead times and the likely take-up of equity stakes by various potential JV partners. Despite this, we still project substantial net earnings of \u00a3200m pa by 2016, albeit some two years after our original forecast.
Recent announcements have led us to increase our capex estimates to over $650m, spread across six years, six projects and two continents. In addition, our previous assumptions of 100% ownership of the operating assets are no longer valid as a series of JV announcements has led us to dilute the various revenue streams among several Australian and South African partners.
Although the business is generating revenue now from its small smelters in Johannesburg, we do not expect the company to report significant profits until 2011 when we forecast net earnings of \u00a375m, increasing steadily to \u00a3200m by 2016. Over a 20-year operating life, we think Braemore has the potential to generate over \u00a33bn of gross operating revenue (net of capex).
Long lead times to production leave the company exposed to commodity price moves. Our current NPV valuation is based upon metal prices 45% below current spot levels, and by using current prices this valuation increases to over \u00a31bn (81p per share).
Braemore\u2019s proposed South African PGM smelters are dependent on a reliable electricity supply \u2013 something that is not currently available in the region. We remain concerned about the ability of Eskom to meet growing demand.
Since we initiated coverage of Braemore with a Buy rating in
October, management has made various announcements relating
to its future plans for the business. We are lowering our rating to
Hold and our target price to 15p given the complexity of these
plans and await greater clarification over the coming year.
We initiated coverage of Braemore Resources on 15 October 2007 with a Buy rating and a target price of 20p. Since peaking at 24.25p on 14th November 2007, the share price has fallen back and traded in a range of 16-20p.
However, since we initiated coverage of the stock, the complexity, scale and revenue horizon of the Braemore story has developed to such an extent as to lead us to reduce our NPV valuation significantly. Recent changes, coupled with a large degree of uncertainty related to the exact operating costs and commercial arrangements yet to be finalised in the South African businesses, gives us cause to lower our rating to Hold and our target price target to 15p \u2013 at least until greater guidance is provided by the company over the course of 2008.
At the time of our initiation note, Braemore was a small company looking to develop a medium to large nickel (Ni) operation in Australia and a variety of platinum group metal (PGM) facilities in South Africa. On the back of recent company announcements, however, Braemore is now a small company looking to build one very large Ni operation and a second smaller Ni operation in Australia, as well as two or three large PGM/base metal smelters, a PGM/Ni mine and possibly a base metals refinery in South Africa. The company could therefore be looking to develop six or seven large industrial operations on two continents with four or five different JV partners and a capex requirement that we forecast to be in excess of $650m. While we retain confidence in management\u2019s ability to pursue these developments, we have become concerned that the scale and complexity of the proposed operations may overstretch the capacity of the team to deliver these projects on time and on budget in a operating environment in which all personnel and material inputs are in tight supply.
Since October, Braemore has made several announcements that have required us to significantly increase our capex assumptions, push back revenue projections and increase our level of uncertainty of our revenue projections.
BHP Billiton. The company has made public the terms under which BHP Billiton has the right to take a 50% equity stake in the Western Australian Ni developments.
Tharisa. The company has signed an MOU with Tharisa Minerals to examine the feasibility of constructing a smelter to process PGM-bearing ferrochrome concentrate. This proposal seems to be a significant deviation from Braemore\u2019s original focus on high chrome UG2 concentrate. Not only does such an arrangement introduce a dilutionary effect by virtue of Tharisa\u2019s likely equity stake in such a smelter, but the economics of such smelting are not covered by the guidance that Braemore has provided to date and therefore our cost and revenue assumptions are uncertain.
Pan Palladium. Braemore has entered into a binding heads of agreement with Pan Palladium Ltd to carry out a feasibility study into the development of the Grass Valley Platreef project in the Northern Bushveld. We view the investment as a positive step in terms of providing some security of supply of concentrate, but we forecast the capital cost to Braemore to be c$90m above what we initially estimated for its South African business.
Leinster. The company has announced that it is considering doubling the size of its initial Ni development at Leinster as well as adding an additional processing step to produce final metal rather than an intermediate sulphide product. We estimate this could increase the capex requirement at Leinster from $200m to $450m and push back production by at least 12 months.
As a result of these developments, we have significantly downgraded our NPV valuation to \u00a3580m as our capital cost estimates have increased and our revenue projections have been pushed back as a result of the larger and more complex developments. On our assumed fully diluted equity base, our NPV valuation equates to 45p per share. This reduction in NPV is largely a timing issue, brought about by an increase in the scale of the proposed Ni developments that we think will push revenue back by 12 months, and by an extended timeline in the development of the South African PGM business such that three smelters are constructed over six years rather than four years as we assumed earlier.
However, on a positive note, our NPV is based on commodity price assumptions 45% below current spot prices. If current price levels hold into the medium term, our NPV could increase to over \u00a31bn.
We forecast revenue commencing from Braemore\u2019s first 10MW PGM smelter in 2010 and from its Australian Ni operation in Q3 2010. However, we do not expect large cash flows until 2011 when the Leinster Ni operation is predicted by Braemore to be in full production and a second 10MW smelter is commissioned in South Africa. We have forecast net earnings of \u00a38.5m in 2010 (0.7p per share), increasing to \u00a375m (5.8p per share) in 2011 and ultimately to \u00a3216m (16.6p per share) in 2017 when all businesses should be in full production.
Our peak net earnings projection of \u00a3216m in 2017 is 22% below the peak of \u00a3280m that we forecast in our initiation note, primarily as a result of increased costs and outside equity in the operations. However, perhaps more importantly, we now expect earnings to peak some three years later than we had originally forecast, as Braemore has since proposed larger and more time-consuming developments. It is this delay that has largely driven the NPV reduction.
Braemore is a small company with a core team of technical specialists, but as yet without the engineering and management resources required to undertake such a large and diverse expansion. Such a team will need to be assembled and we assume that it will. However, in the current tight labour market evident across the mining industry, this could prove difficult and expensive, and we await updates from the company.
We also remain cognisant of the external risks that Braemore may have to deal with. Primary among these is the electricity supply situation in South Africa. The ConRoast DC Arc smelters that Braemore is proposing, are, as the name suggests, electric arc furnaces that require substantial and reliable electricity supplies. South Africa is currently in electricity deficit, with supply cuts a regular occurrence. We would need to see evidence that capacity expansion is being planned and implemented so that the proposed smelters will have a stable and secure supply.
Our other major concern is the unknown terms of offtake agreements that would need to be negotiated as a key plank of the company\u2019s South African strategy. Current offtake agreements are by and large kept secret between the parties with little information released publicly. Given this secrecy, the fact that the introduction of ConRoast technology changes the economics of UG2 PGM mining, and given recent announcements by Braemore relating to the processing of Platreef and chromite reef ore, the offtake terms that we have used in our model are assumptions at best, with significant room for error. Smelting generally operates on finer margins than mining and thus these businesses are sensitive to small variations in offtake terms; we would expect to see these terms discussed further by Braemore during the year.
Despite these concerns, we think that Braemore has the potential to generate over \u00a33bn in gross operating revenue (EBITDA less capex) over 20 years and so retain our view of the company as a future cash cow. Although Braemore is still an early-stage development play, with significant risks ahead of it, it continues to attract our attention for a number of reasons:
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