stocks

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Thoughts on mining and exploration stocks #2

As somebody interested in investing, I want to figure out how to generate unusual returns from mining stocks.  Here’s a look at what “worked” in the past. Continue reading →

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Special situation opportunity: Liberty Ventures

Thesis: Liberty Ventures stock may be undervalued when it starts trading due to its complexity and misleading balance sheet.  Ventures has a stated book value of -$1,9871M.  After adjusting for the market prices of its investments and its anticipated cash balance, Ventures would have an adjusted book value of around $570M.  Making adjustments for its deferred tax liabilities will add a few (to several) million dollars on top of that.

Continue reading →

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KWG Resources Revisited

What is it worth?  I still really don’t know.

Chromite properties in the Ring of Fire area

Data from http://www.mndm.gov.on.ca/mines/ogs/resgeol/rfe/documents/Chromite.pdf

  1. Black Thor.  Owned by Cliff’s.  69.6Mt @ 31.9% Cr2O3.
  2. Big Daddy.  Cliff’s 70% KWG 30%.  39.5Mt @ 39-40% Cr2O3.
  3. Blackbird.  Noront 100%.  11.05Mt @ 34-36% Cr2O3.
  4. Black Creek.  Probe Mines 100%.  8.44Mt @ 40-41% Cr2O3.  *Probe’s 2010 NI-43 101 Resource Estimate has higher numbers.
  5. Black Label.  Cliff’s 100%.  I haven’t been able to find information on the size or grade of this deposit.

*Note that these figures include Inferred resources.  The actual economic tonnage may be a lot lower.

Economics of the deposits

Cliff’s has indicated that it will mine Black Thor first.  This probably makes sense.  As to which deposit is the most economic, it comes down to various factors:

  1. Size of the deposit.  Mines benefit from economies of scale.  A larger mining machine will still require the same number of operators and support personnel.
  2. Strip ratio.  I am guessing that the Black Thor deposit is attractive here as it is larger and wider than the Big Daddy deposit.
  3. Grade of the deposit.  All of these deposits will have some ore that is relatively high grade (>40% Cr2O3) as well as lower grade ore.  The high grade ore can be shipped directly to a ferrochrome processing facility or smelter without any processing at the mine site.  Lower grade ore will need to be processed at the mine site to increase the concentration of chromite (as transportation costs of the product is very high).  Processing costs will be higher than normal as Cliffs will be using diesel generators to power the processing plant (more expensive than grid electricity).  The lower grade ore will obviously be marginal though it should be possible to turn it into a concentrate product that can be sold profitably.
    I don’t think that there is enough information to determine which deposit is the “highest grade”.  Using a higher cutoff value will increase the overall grade (and vice versa).
  4. Impurities in the ore (e.g. silicon, sulfur, etc.).  I can’t find much information here.  I’m pretty sure the companies themselves do have such information (they are probably assaying their drill core for impurities)… they just don’t bother reporting this information publicly.
  5. Distance to processing facilities.

Black Thor will probably be mined first.  This makes the other deposits (e.g. Big Daddy) have a lower  present value as they won’t be mined until the future.

Black Thor will likely be mined with a combination of 2 mining methods: open pit and underground mining.  In open pit mining, costs increase as you go deeper and deeper as more waste rock has to be moved aside / the strip ratio increases.  Eventually you hit a point where it makes sense to switch over to a cheap form of underground mining (e.g. Cliffs is thinking of blasthole stoping).  The cost of underground mining should be relatively steady after the initial capital costs.

What I think will happen is this: Cliffs will mine Black Thor as an open pit, then it will start mining Big daddy as an open pit.  Eventually (at least 10-15+ years from now) both will be mined with an underground method.  Cliffs may also be interested in Probe’s deposit (it sits between Black Thor and Big Daddy).  Maybe Cliffs will mine it too as an open pit operation before switching to underground mining at Black Thor.  However, Cliffs hasn’t shown much interest in Probe as it has not done a private placement with Probe nor has it tried to acquire Probe (unlike KWG and Spider).

Size of the mine

A larger mine will have lower operating costs due to economies of scale.  And there is a lot of chromite in the region that could support a very large operation.  However, the overall size of the chromite deposit is so huge that Cliffs would risk flooding local markets and therefore getting a lower price for its chromite.  (As transportation costs to the customer are very high, I would expect chromite to be somewhat of a local market.)  Cliffs has to determine what mine size would be appropriate based on its expectations of the elasticity of chromite prices to supply, inflation, the appropriate discount rate, etc.

In 2010, the USGS reported worldwide chromite ore production to be 23.7 million metric tons.  Cliffs has indicated that it may produce “up to” 2.3 million metric tons of concentrate per year.  This would be roughly 10% of the world chromite supply.  (Technically you have to normalize the figures for the different grades between Cliffs’ concentrate and the USGS assuming 45% Cr2O3.)  If Cliffs mines at half the rate, then it might only account for 5% of world supply.

There is also the risk of a competitor opening a chromite mine, thus increasing local supply and driving costs down.  When Cliffs bought out Spider Resources, it became the operator of the project and didn’t have to worry about a combined Spider+KWG becoming one of its competitors in the region.

History

Cliffs bought out Freewest after a bidding war with Noront.  At the time, Noront was trying to use its shares (which were worth a lot at the time) to buy out Freewest.  After Noront’s share price fell and Cliffs sweetened its offer, Cliffs eventually won out.  (Some of the press releases in that bidding war were a little acrimonious between the two parties.)

This gave Cliffs 100% ownership of Black Thor and Black Label.

Later on, Cliffs offered 13cents/share for Spider or KWG.  Spider and KWG decided to merge instead.  Cliffs ultimately won the bidding war by offering 19 cents/share for Spider.  Subsequently Cliffs took a stake in KWG via private placement but it did not try to buy the entire company.

Option agreement between KWG and Cliffs (formerly Freewest)

As it currently stands, KWG has a 30% stake in the Big Daddy deposit.  Since Cliffs bought Spider, it then took control of the joint venture.  This puts KWG in a bad spot.  As I understand it, Cliffs doesn’t have to bring the deposit to production.  Or it can start production at Big Daddy and then decide to stop it.  If Cliffs decides to mine Black Thor over Big Daddy, then it takes a small hit financially while its JV partner would take a huge hit financially.  So Cliffs could hold its JV partner hostage.

(The worst case scenario is if Big Daddy isn’t mined at all, or if Cliffs decides to mine it after Black Thor has been exhausted.)

The other problem that KWG faces is that it would need to put up its share of capital if Big Daddy goes into production.  If it doesn’t, its interest will eventually be watered down to a 0.5% NSR on base metals.  (Thus its 30% stake in Big Daddy would be worth far less than the 1% royalty it held on Big Daddy, Black Thor, and Black Label.)

In a way, KWG and Cliffs are frenemies.  It makes sense for them to co-operate and at other times they end up in disputes with each other.

Trying to get back in the game

KWG is in a dispute with Cliffs over whether Cliffs has the right to build a road to the chromite deposits.  I am not a lawyer so I do not know where KWG stands.

KWG also has staked railroad claims and performed engineering studies on how much a railroad to the deposit would cost.  I honestly don’t know enough about the economics of a railroad versus an all-season road to know whether or not KWG’s railroad scheme makes sense.

Cliffs has indicated that the economics of a railroad doesn’t make sense.  So ultimately I don’t think a railroad will be built as they are considered to be in the “driver’s seat” in the transportation route to the chromite deposits.

KWG has a presentation on its website that provides some numbers on the relative costs between a railroad and a road.  Adjusting their figures for a mining rate of 12kt/day instead of 10kt/day and the ore being concentrated to 60% of its original weight, the railroad would save around $84M/year.  At a discount rate of 0% (and ignoring savings from flowthrough shares and possible cheap financing from the Canadian government), the mine life would need to be 23.74 years to recoup the investment on a railroad.  At a mining rate of 12kt/day the mine life might only be 13.7 years.  I don’t think that there is enough tonnage in the Ring of Fire area to justify a railroad.  There is a really small chance that KWG obtains really favorable financing for the railroad that might justify its economics.

Mine life

Certainly I think that the mine life will be much longer than Cliff’s lets on.  6,000 – 12,000 tonnes/day of ore X 330 days = 1.98 – 3.96 Mt/year.

Black Thor – 69.6Mt  (@25% cutoff, which may be too low)

Big Daddy – 39.5Mt

Mine life could be potentially 13.7 to 27.5+ years.  (Technically not all of those tonnes will ultimately be mined offset by any expansion in reserves.)

Value of KWG’s assets

Its main assets are:

  1. 30% stake in Big Daddy.
  2. Cash.  $13.5M in cash, $16.3M in current assets.
  3. Railroad assets.  Likely worth 0 if it is unsuccessful in its claim against Cliffs.

#1 is the hardest to value especially when KWG’s PEA is wildly off (it estimated $900M for the railroad which now costs $2B) and therefore I don’t really trust it.  Regardless, the deposits will generate billions in revenue.  If you don’t think that Cliffs will chase a profit margin of less than 10%, then the implied NPV of KWG’s 30% stake in Big Daddy would likely be something very very high.  Ultimately I think that if Cliffs does offer to buyout KWG, it will be in the ballpark of 13 cents/share (its original offering price for KWG).  Since the original buyout offer, the 30% Big Daddy stake is worth more now whereas the $13.5M in cash would be worth less than the 1% royalty that KWG used to hold.

That’s a big if.

Cliffs might let KWG flail in the wind for a few years and KWG will bleed a little from all of its overhead costs.  Cliffs could mine at 6,000tpd so it will be several years minimum before it makes sense for it to start mining Big Daddy as an open pit.  It doesn’t have to buy out KWG… so they will have the advantage in negotiations.  KWG’s only alternative is to firesale itself to a senior miner with deep pockets or to somehow raise a huge amount of equity to maintain its 30% stake.

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Mineral processing notes

Metallurgical recovery

Oftentimes metallurgical recovery may be (intentionally) overstated.  Actual recoveries when mining commences is often lower than figures given by management.

Misleading context

A mining company will always run tests to determine the optimal amount of mineral processing.  More expensive mineral processing techniques will yield higher recoveries.  However, the higher recovery may not be economically justified.

Company management may quote the highest recovery achieved in initial testing.  However, this may not have anything to do with actual recoveries as the additional mineral processing may not be economically justified.  Also, the recovery figure may only be applicable to the high grade ore in a mine.  The recovery for high grade ore may be higher for lower grade ore.

How mining companies guess future recoveries

#1- Compare the ore to similar ores in other mines.

There are obvious methods of cheating here.  It is possible to cherry pick higher numbers from mines with higher recoveries.

The author of a preliminary economic assessment may also conveniently “forget” that the ore has problems that make it difficult to process (these ores are usually referred to as refractory ores).

I would not take this method very seriously in any type of economic assessment.

#2- Run tests on drill core

One method is to take drill core and to form 2 samples: one from high-grade ore and one from low-grade ore.  High-grade ore may have higher recoveries than low-grade ore.

Tests may look at:

  • Energy needed to grind the ore to particular sizes.
  • Grind size versus recovery
  • Usefulness of different mineral processing techniques

#3- Take a bulk sample

The problem with small scale tests is that they may not necessarily extrapolate to a full-scale operation.  For example, milling equipment in a lab scale behaves very differently than a production-scale model.  You can run tests using a production-scale mill, but it requires a lot of ore.  If it is not possible to obtain that much ore (or production-scale equipment does not exist because it uses new processing techniques), then an engineer can run tests at various scales and build a model to predict how a full-scale operation would behave.  These models are never perfect.

Mining companies may obtain a bulk sample by digging a trench and mining a small amount of ore for testing purposes.  Or they may sink an exploration shaft if the ore is not close to the surface.

The bottom line is that larger scale tests are usually more accurate.  However, they are not necessarily economically justified for a given stage in mine development.

The things to watch out for

  1. As previously mentioned, economic assessments should include information from more reliable methods of metallurgical testing.
  2. Refractory ores and ores that are difficult to process.  A simple check is to skim through the technical report and look for the word refractory.  Unfortunately this may not be enough.  Ideally, you should know potential problems for that particular mineral or that type of ore.
  3. Marginal low-grade deposits.  In these deposits, mineral processing will likely be critical to the economics of the project.  This information depends on a number of different factors and information that may not be available without expensive testing.  Mining companies will perform such testing in feasibility studies before building a mine.  However, they may not necessarily release such information to shareholders.  (Personally I don’t think that these types of projects are good investments because insiders can have such a huge information advantage and usually have incentives to promote the stock.)
  4. New cutting-edge mineral processing techniques.  You don’t really know what exactly will happen unless the company runs a large-scale test.  Bench-scale/lab-scale tests may be wrong.  It is rare for mining companies to emphasize the risk involved.  Sometimes this is because a mining company badly needs to raise capital and to promote itself.  Sometimes it is simply a matter of professional pride or ego.  Some people may not like to say: “Actually we don’t really know if our science project will work on a production scale.”

Does focusing on the recovery figure really make sense?

In my opinion, not really.  There is always a balance between higher recovery and lower mineral processing costs.  This balance isn’t well known until a feasibility study is run.  A lower recovery may be a good thing.  However, management may prematurely cite recovery figures and these are usually overly optimistic.

What investors want to know is the predicted future cash flow of a particular project.  And these predictions are heavily dependent on engineering data such as grind size versus recovery, energy costs for particular grind sizes, mineral processing costs, and a large number of other factors.  “Knowing” the expected metallurgical recovery (which may change or be totally inaccurate) doesn’t necessarily help an investor predict the future cash flow of a given project.

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QXM/XING: I am probably wrong

Originally my thesis for investing in these related stocks were:

  1. It’s undervalued.  (Unless it is a fraud.)
  2. Insiders will try to inflate earnings and to promote the stock.

I am probably wrong on both counts.  As far as promoting the stock goes, investor communication has been terrible (e.g. website not updated in ages) and insiders have not responded to Shah Capital Management’s letter to the board.

As far as undervaluation goes, the stock will likely ultimately be a zero if insiders are intent on stealing (almost) everything.  The mining companies that were merged into XING may be a fraud considering Riu Lin Wu’s history with Real Gold (see posts on chinaminingblog.com).  QXM hasn’t released new models of cell phones in a long time and there is little information on what happened to its VEVA stores.  I don’t believe that QXM has a cell phone business that is really operational right now.

So unfortunately for my net worth, I was incredibly wrong on these stocks.  Perhaps there is some residual value in these companies from cash that hasn’t been misappropriated yet.  I suppose I will find out when these companies undergo forensic audits.