ATON - Atomredmetzoloto, In Search of the Right Element, Apr 10, 2012.
In Search of the Right Element
With this report we continue to present our somewhat hypothetical and hopefully thought-provoking analysis on how to benefit from any potential expansion by Russian uranium mining giant Atomredmetzoloto (ARMZ).
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Chain reaction started. The uranium M&A theme has become somewhat less hot, in our view, as the availability of potential acquisition targets is diminishing. We note that two out of five companies we identified in our previous report Nuclear Industry: Chain Reaction (published on 19 Oct 2011) have been acquired.
Not by uranium alone. In this note we decided to shift our focus from uranium to other mining areas to which ARMZ could decide to expand its presence. We recall that initially, Atomredmetzoloto was established to develop uranium (Atom-), rare earth elements (-redmet-) and gold (-zoloto). And while the company is well on track in developing its uranium mining projects (Uranium One, Mantra Resources, Priargunsky), it has almost no exposure to rare earth elements (REE).
What to expect? Inspired by the success stories of Uranium One and Mantra Resources, we believe that ARMZ may follow the same path by acquiring foreign companies to develop its REE expertise. We argue that the focus should fall not only on exploration assets but also on companies that own key processing technologies.
Why ARMZ? Atomredmetzoloto enjoys an exceptionally strong position in the industry: it has a robust balance sheet and enjoys solid state backing to promote Russia as a leading producer of uranium and innovative metals and alloys.
Where should we look? While the list of potential targets of interest for ARMZ is not limited to listed companies, we have decided to use these as our focus. We screened listed companies engaged in the development of REEs operating in Russia, Africa, Australia and Canada to select those we believe could be tempting for ARMZ to acquire. In the end we picked five foreign companies and one Russian producer which, in our view, could be on ARMZ's radar screen for potential M&A. Nevertheless, we recommend that investors follow their own judgment in deciding which, if any, equities to purchase among those we have selected.
Why invest? As was the case with the uranium exploration companies we identified in our previous reports, we argue that ARMZ would likely have to offer a generous premium to shareholders in order to win their support and obtain control of any desired asset.
The race is on. We believe that the recent offer by US-based MolyCorp to acquire leading rare earth processor NEO Materials for $1.3bn signals that the REE race is on. We underline that the buyer offered a more than 40% premium to NEO's market price, valuing the company's EV at 5.0x 2012E EBITDA and its equity at 7.7x 2012E earnings.
In this note we present our views on the potential expansion of ARMZ's REE division, and how investors could benefit from such a move. Although our analysis might seem somewhat opportunistic and its key conclusions a bit premature, we argue that it may serve as a platform for better understanding the company's longterm strategic goals.
Nevertheless, we recommend that our readers follow their own judgment in deciding which, if any, equities to invest in among those we have selected.
Rare Earth Elements: What, Where and Why?
According to the International Union of Pure and Applied Chemistry, rare earth metals (or elements) are the 15 lanthanoid elements with atomic numbers of 57 through 71, as well as scandium and yttrium. However, according to Technology Metals Research (TMR), scandium is seldom found with the lanthanides, while promethium is a radioactive element that is not usually found in nature. This effectively limits REEs to a group of 15 metals.
Despite their name, REEs are relatively plentiful in the earth's crust: even the two least abundant elements (Tm and Lu) are nearly 200x more common than gold, according to the US Geological Survey (USGS). The name ararea is largely attributable to REEs' tendency not to be found in concentrated and economically exploitable form.
Rare earth elements are frequently grouped into light and heavy categories as depicted in Figure 1: Rare Earth Elements. According to the USGS, light REEs constitute 80-99% of the total in most rare earth deposits. It is therefore clear that HREE-rich deposits tend to be scarcer and hence more valuable. We note that REEs are usually sold in their oxide form.
China is the biggest producer of rare earth oxides, accounting for over 90% of total rare earth oxide (REO) production in 2011 (130,000 tonnes), according to the USGS. The country has maintained a strict policy of regulating the export of REEs. Export quotas have been steadily declining from 65,609 tonnes (55% of the country'soutput) in 2005 to 30,184 (23%) tonnes in 2011. In addition, China's export duties on REEs are high, varying from 15% to 25%.
The industrial application of REEs is quite broad: they are used by the automotive industry, in the production of fluid cracking catalysts and the manufacture of permanent magnets, and in television and flat-panel displays.
Demand for REEs in recent years has been driven by their increased use in clean energy technologies such as Electric Vehicle (EV) batteries, magnets for EVs and wind turbines and phosphorus for energy-efficient lighting. This increase in use, coupled with China's stringent export policies, was reflected in REO prices until 4Q11.
REO prices started to decline in 4Q11 with weakness stretching into 2012. We believe that the correction was inevitable following a strong rally in 2011, given that high REO prices threatened to destroy demand as buyers sought ways to reduce their dependence on certain REEs.
However, we note an interesting observation from Industrial Minerals Company of Australia (IMCOA): IMCOA estimates that by 2015 the supply of REO outside China will be insufficient to cover demand, leaving a gap of 15,000-35,000 tonnes to be covered by Chinese exports. Coupled with the low transparency and unpredictability of China's REE export policy we believe this points to significant upside risk for midterm REO prices.
Additionally, after peaking at 120,000 tonnes in 2011 (USGS estimate), it appears that China's REO production has reached maximum capacity. With output running at full throttle we see very limited scope for further mid-term expansion. Even if China's REO consumption rate were fixed at the current 77,000-80,000 tonnes/year, we estimate that the supply/demand balance would be very tight by 2015.
ARMZ: New Kid on the Block?
Russia ranks in the top-three countries by REE reserves but its production is extremely limited. Moreover, the few Russian companies engaged in the industry lack the advanced REE processing technologies needed to produce high-value products.
Our view is that ARMZ may wish to expand its rare earth market presence, which could be achieved via acquisitions. Atomredmetzoloto boasts a robust balance sheet and solid state backing and has been tasked with promoting Russia as a leading producer of uranium and innovative metals and alloys.
Inspired by the success stories of Uranium One and Mantra Resources, we believe that ARMZ may follow the same path of acquiring foreign companies to develop its REE expertise. We further believe that the focus would be not only on exploration assets but also on companies that own advanced processing technologies.
As was the case with the uranium exploration companies we identified in our previous reports, we now argue that ARMZ would have to offer a generous premium to shareholders in order to win their support and obtain control in any desired asset. The recent offer by US-based MolyCorp to acquire leading rare earth processor NEO Materials for $1.3bn signals that the rare earth race is on, in our view. We note that the buyer offered a more than 40% premium to NEO's market price, valuing the company's EV at 5.0x 2012E EBITDA and its equity at 7.7x 2012E earnings.
REE Producers: In Search of the Right Element
While the list of potential targets of interest for ARMZ is not limited to listed companies, we have decided to focus on the latter. We screened the listed companies engaged in the development of REEs in Russia, Africa, Australia and Canada to select those we believe could be tempting for ARMZ to acquire. We picked five foreign companies and one Russian producer which, in our view, could be on ARMZ's radar screen for potential M&A.
We recommend that investors follow their own judgment in deciding which, if any, equities to invest in among those we have selected.
Avalon Rare Metals
Listed on the Toronto Stock Exchange (ticker: AVL CN), Avalon Rare Metals is a mineral development company that focuses on rare earth elements in Canada. Avalon's flagship project is the Nechalacho Deposit which has the potential to
become one of the largest sources of REEs in the world. The deposit is located in Canada's Northwest Territories.
Avalon believes that Nechalacho is unique in the exceptional enrichment of its heavy rare earths such as europium, terbium, and dysprosium.
The company plans to deliver a definitive feasibility study on Nechalacho in late 2012. It currently expects to start commercial production in 2015 and aims to produce 9,000 tonnes of REO per year. The initial estimate for required capex is $1.0- 1.2bn.
It is worth noting that in addition to REO, Nechalacho is rich in valuable by-products such as zirconium, tantalum and niobium.
We believe that Avalon could offer interesting exposure for ARMZ given the company's unique HREO-rich deposit as well as its potential to diversify revenue via the sale of niobium (used in producing high-grade structural steel) and zirconium
Quest Rare Minerals
Based in Canada, Quest Rare Minerals is an exploration company focused on the development of rare earth projects in North America. The company is listed on the Toronto Stock Exchange (ticker: QRM CN). The Strange Lake and Misery Lake areas of north-eastern Quebec are currently the main focus for Quest Rare Minerals.
The Strange Lake project is unusually rich in valuable HREEs with an HREO/TREO ratio (heavy rare earth oxides as a percentage of TREO) of 40.6% (vs 14.6% for Avalon) and HREO resources (indicated and inferred) totalling 850,300 tonnes. The company aims to deliver a pre-feasibility study in 2H12 which should shed more light on the project's prospects. A definitive feasibility study is scheduled for completion in 2H13.
Quest Rare Minerals plans to launch production in 2016. When full output is reached in 2017, 12,000 tonnes of material should be produced every year.
We think QRM could be on ARMZ's radar screen given its strong resource base and relatively high planned production capacity. However, we believe that ARMZ should wait at least until the publication of the pre-feasibility study in order to gain a better understanding of the company's potential.
Arafura Resources is an emerging rare earths producer listed on the Australian Stock Exchange (ticker: ARU AU). The company's flagship asset is the Nolans Bore mine in Australia's Northern Territory. Arafura plans to construct a processing complex at Whyalla, approximately 65km from Nolans Bore.
Nolans Bore is rich in neodymium (21.2% of the REO in the deposit), which is used in the production of magnets.
According to Arafura, the Whyalla Rare Earths Complex will include a series of chemical plants and a processing facility where chemicals such as hydrochloric acid and sulphuric acid will leach out the rare earths and other by-products (uranium and phosphates) for recovery and sale. We highlight that the company will employ a patented pre-leaching process based on hydrochloric acid to separate the concentrate.
With a definitive feasibility study due in 1H12, Arafura aims to produce up to 20,000 tonnes of REO per year with commercial operations commencing in 2015.
We put Arafura on our list because it offers the most interesting exposure to neodymium among the listed emerging REO companies. For a similar reason, we believe it could also be on ARMZ's radar screen.
Stans Energy is a Canadian resource company focused on the development of REE properties in areas of the former Soviet Union. Listed in Toronto (ticker: HRE CN), the company's flagship asset is Kutessay II in Kyrgyzstan, a closed mine that was acquired in Dec 2009. In May 2011, the company completed the purchase of the Kashka Rare Earth Processing Plant which had previously been used to refine REEs from Kutessay.
For over 30 years, Kutessay met up to 50% of the Soviet Union's demand for HREEs. Concentrate produced at Kutessay II was refined into 120 rare earth compounds. However, with the break-up of the Soviet Union in 1991 operations at Kutessay ceased and the mine was placed under care and maintenance.
While Stans Energy has yet to deliver a preliminary feasibility study (scheduled for 1H12), we believe it could restart operations at the mine in 2013. We note that the company enjoys support among the local population which expects its operations to create new jobs in the region.
Kutessay was historically rich in HREEs (43.7% of TREO) such as yttrium (26.7%) and dysprosium (6.14% of TREO).
Stans Energy could be interesting to ARMZ due to its proximity to Russia and established regional infrastructure, which will however need to be overhauled.
Great Western Minerals Group
Listed on the TSX Venture Stock Exchange in Toronto (ticker: GWG CN), Great Western Minerals Group is a Canadian firm that is developing its own REE production and reprocessing operations. Its major focus is the refurbishment and reopening of the Steenkampskraal mine in the Western Cape Province of South Africa.
Steenkampskraal is located approximately 350km north of Cape Town. The mine was in operation from 1952-63, producing monazite concentrate that was sold mainly for its thorium content (a potential nuclear fuel).
GWG holds a crucial advantage in our view via its exposure to REE processing technologies acquired through wholly owned subsidiaries - Great Western Technologies Inc (GWTI) and Less Common Metals (LCM).
GWTI focuses on the processing of speciality alloys used in battery production and the hydrogen storage industry, while LCM's goal is the production of rare earthbased alloys and high-purity metals.
Great Western Minerals Group's goal is to become a vertically integrated rare earth producer which, in our view, could make it a target of interest for ARMZ.
Solikamsk Magnesium Plant
Based on our analysis, Solikamsk Magnesium Plant (ticker: MGNZ RX) may be the only reasonable Russian-listed exposure to the rare earths market. Trading at just 1.7x 2011 EV/EBITDA, Solikamsk Plant is Russia's largest magnesium producer with a market share of better than 60%, on our estimates.
More than 60% of the company's revenue comes from the sale of rare earth metals. However, magnesium-based product sales are also an important contributor to revenue, accounting for nearly 30% of the total in 2011.
Solikamsk Plant can produce up to 4,000 tonnes of REO (mainly Ce and Nd oxides) per year but it is currently operating at only 35-40% capacity, on our estimates.
The company was one of the many assets inherited by Uralkali after its merger with Silvinit in 2011. For a major potash miner (which we expect to book more than $1.3bn in net profit for 2011), a magnesium producing company with annual revenue of $220mn was clearly a non-core business, so it was spun off.
We believe Solikamsk Plant would be a good platform for ARMZ to expand its REE operations in Russia.
Copyright: Aton OOO (LLC), All rights reserved.
For further Information please contact: Aton OOO (LLC),
27 Pokrovka str., bld.6, 105062 Moscow, Russia
phone: (495) 777-66-77, (495) 228-38-99
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|Publication:||Russian Banks and Brokers Reports|
|Date:||Apr 10, 2012|
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