Very good article from Australian research analyst....
The Investment Doctor
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Orocobre's Recent Retreat Might Be The Final Opportunity To Get In
Oct. 20, 2014 5:00 AM ET | 5 comments | About: Orocobre Ltd. (OROCF)
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Disclosure: The author is long OROCF. (More...)
Summary
Orocobre's Olaroz project should be in production within weeks.
The recent contraction on the commodity markets has sent Orocobre's shares tumbling.
I see an easy 45% upside potential to the company's fair value.
(Editors' Note: Orocobre trades on the Australian Stock Exchange under the ticker symbol ORE.AX with ~$AUD 550K average daily volume).
Introduction
As it has been a year since I discussed Orocobre (OTCPK:OROCF) in depth, it was becoming necessary to write another in-depth update on the company. Since my initial article where I saw a 60% upside last year the share price has increased by roughly 50% only to come back down again to its original levels. As the project is now 12 months more advanced and further de-risked, I will now assess if it's a good time to get back in.
Source: company presentation
Keep in mind this is an Australian company and both its Australian listing as well as the listing on the Toronto Stock Exchange offer more liquidity than its US listing. The combined average daily dollar volume is roughly $500,000, so there's plenty of liquidity. I'd recommend to trade in shares of Orocobre through the facilities of the Australian Stock Exchange where the company is listed with ORE as its ticker symbol.
Where necessary I have re-calculated AUD into USD using an USD/AUD exchange rate of 1.14. And as always, all images in this article were directly taken from the company's website, presentation and other public documents. The calculations are my own and should not be interpreted as an official guidance.
A brief overview of the company
Orocobre's business is mainly built around two pillars. First of all, the company is in the final construction stage of its gigantic Lithium project in the province of Jujuy, but Orocobre also acquired the Borax operations from Rio Tinto in the summer of 2012. This allowed Orocobre to present itself as a diversified natural resources company as boron minerals actually complements the lithium side of the company, as boron chemicals could be produced from the brine at the Olaroz project.
Source: press release
As the Lithium part of Orocobre is much more important than the Borax Argentina acquisition from Rio Tinto, I won't go into too much detail on the Borax-pillar. A recent pre-feasibility for a new borax processing facility in NorthWest Argentina has revealed an after-tax NPV10% of $17.7M based on a useful mine life of 20 years. At this point in time I will give all of Borax Argentina's assets a valuation of $35M, and it's likely I'm underestimating the fair value, but as said, my main focus is on the lithium project in Jujuy.
The Olaroz Lithium project will be the company maker
As said, the Borax activities are just a nice addition to what Orocobre essentially is, a (very) near-term lithium producer. Its flagship project is the 63,000 hectare Salar de Olaroz lithium project which is just weeks away from starting up its production and will generate its first revenues before the end of this year.
After completing an impressive feasibility study in 2012, the company has fast-tracked the project and it secured Toyota Tsusho as a strategic partner. The latter has taken a 25% stake in the project and played an extremely important role in securing the debt financing for this $229M project.
(click to enlarge)
Source: company website
Signing on Toyota Tsusho was probably the best decision Orocobre could have made because the debt component of the financing package was guaranteed by JOGMEC, the state-owned company focusing on commodities. This has obviously kept the interest rate of the debt package very low as the expected cost of debt is just 4.5% for the $192M loan.
Source: company website
Right after securing this loan the construction started in March 2013 and no time has been wasted as the expected completion date of the construction is in November of this year already. The ramp-up period could be very smooth as all of the components which have already been finished are running smoothly at or even over the design rate.
About Argentina and the Jujuy province
The main negative factor which makes investors be careful about considering Orocobre for their portfolio is obviously its location. The salar de Olaroz is located in Argentina's Jujuy province, and as you know, Argentina has done some weird things in the recent past. For instance, it expropriated Repsol's YPF subsidiary to make it more efficient. But people seem to forget this wasn't an outright nationalization as Repsol effectively received compensation for its damages. Granted, this wasn't the nicest move by Argentina, but it's an understandable move as Argentina accused Repsol of under-investing in the Argentinean energy sector.
Even in the most recent case where Argentina needs to pay out some bond holders which didn't accept the country's debt restructuring offer approximately 10 years ago, the country seems to be acting in semi-good faith. It isn't even dismissing the claims by the remaining bondholders and has actually offered a bond swap whereby new bonds would be issued. The main reason why the country is unable to pay it in cash is its fast decreasing foreign currency reserve. As Argentina has a real double-digit inflation problem, its citizens were (and are) scrambling for US Dollars to protect themselves from this inflation problem. This has put severe constraints on the Central Bank of Argentina and there are now limits in place which people can buy how much US Dollars.
In an environment where both the country and the people are desperately trying to get their hands on a stronger currency, a new project like Orocobre's Olaroz Lithium project could be a god-send. As the lithium sales are usually settled in US Dollar, Argentina could strike a deal with Orocobre whereby the latter pays its tax bills in US Dollars rather than in Argentinean Pesos. So the country does have an interest to move this project forward, and I think a nationalization is out of the question.
Additionally, even the province of Jujuy holds an 8.5% equity stake in the project and has been very helpful to advance the Olaroz project. So, long story short, I don't think there's a real risk of nationalization in Argentina at this point in time, as that would immediately set the country back to the level of Venezuela and Bolivia. This would scare away any foreign investment in Argentina which the country desperately needs.
The fair value of Olaroz and why an extended mine life isn't important at this point in time
As you probably already noticed, I'm quite enthusiastic about the company's Olaroz lithium project. Let me try to convince you now with some numbers.
The initial capital expenditures of the plant were $229M, and this should result in an annual output of 17,500 tonnes of lithium per year at a cost of $2,000 per tonne. Given the current lithium price of roughly $6000/t, the operating margin is a very impressive 65%. As the demand for lithium is expected to grow at an CAGR of 12% throughout this decade, it's not unlikely Orocobre will receive more than $6000/t as some analysts are even expecting a price increase to $8000/t. This would be excellent news, but in my calculation I'll try to be more conservative and will use a lithium price of $6000/t throughout the life of mine.
The Argentinean corporate tax rate is 35%, and I will use a discount rate of 8% for my calculations. When a project is fully funded and almost ready to go into production I'd generally use a discount rate of 6% or 7%, but to be on the conservative side I'll stick with 8%. The initial mine life is 40 years (!) and this was based on just 15% of the total resources.
Cash Flow
Corporate Tax Rate (35%)
After-tax cash flow
Discount rate (8%)
NPV 8%
-229,000,000.00
-
-229,000,000.00
-229,000,000.00
61,000,000.00
0.0%
61,000,000.00
1.00
61,000,000.00
62,500,000.00
0.0%
62,500,000.00
1.08
57,870,370.37
64,000,000.00
0.0%
64,000,000.00
1.17
54,869,684.50
65,000,000.00
0.0%
65,000,000.00
1.26
51,599,095.67
70,000,000.00
15.0%
59,500,000.00
1.36
43,734,276.24
70,000,000.00
35.0%
45,500,000.00
1.47
30,966,535.47
70,000,000.00
35.0%
45,500,000.00
1.59
28,672,718.02
70,000,000.00
35.0%
45,500,000.00
1.71
26,548,812.98
70,000,000.00
35.0%
45,500,000.00
1.85
24,582,234.24
70,000,000.00
35.0%
45,500,000.00
2.00
22,761,328.00
70,000,000.00
35.0%
45,500,000.00
2.16
21,075,303.71
70,000,000.00
35.0%
45,500,000.00
2.33
19,514,170.10
70,000,000.00
35.0%
45,500,000.00
2.52
18,068,676.02
70,000,000.00
35.0%
45,500,000.00
2.72
16,730,255.57
70,000,000.00
35.0%
45,500,000.00
2.94
15,490,977.38
70,000,000.00
35.0%
45,500,000.00
3.17
14,343,497.58
70,000,000.00
35.0%
45,500,000.00
3.43
13,281,016.27
70,000,000.00
35.0%
45,500,000.00
3.70
12,297,237.29
70,000,000.00
35.0%
45,500,000.00
4.00
11,386,330.82
70,000,000.00
35.0%
45,500,000.00
4.32
10,542,898.91
70,000,000.00
35.0%
45,500,000.00
4.66
9,761,943.44
70,000,000.00
35.0%
45,500,000.00
5.03
9,038,836.52
70,000,000.00
35.0%
45,500,000.00
5.44
8,369,293.07
70,000,000.00
35.0%
45,500,000.00
5.87
7,749,345.44
70,000,000.00
35.0%
45,500,000.00
6.34
7,175,319.85
70,000,000.00
35.0%
45,500,000.00
6.85
6,643,814.67
70,000,000.00
35.0%
45,500,000.00
7.40
6,151,680.25
70,000,000.00
35.0%
45,500,000.00
7.99
5,696,000.23
70,000,000.00
35.0%
45,500,000.00
8.63
5,274,074.29
70,000,000.00
35.0%
45,500,000.00
9.32
4,883,402.12
70,000,000.00
35.0%
45,500,000.00
10.06
4,521,668.63
70,000,000.00
35.0%
45,500,000.00
10.87
4,186,730.21
70,000,000.00
35.0%
45,500,000.00
11.74
3,876,602.05
70,000,000.00
35.0%
45,500,000.00
12.68
3,589,446.34
70,000,000.00
35.0%
45,500,000.00
13.69
3,323,561.43
70,000,000.00
35.0%
45,500,000.00
14.79
3,077,371.69
70,000,000.00
35.0%
45,500,000.00
15.97
2,849,418.23
70,000,000.00
35.0%
45,500,000.00
17.25
2,638,350.22
70,000,000.00
35.0%
45,500,000.00
18.63
2,442,916.87
70,000,000.00
35.0%
45,500,000.00
20.12
2,261,960.06
429,847,154.78
As you can see, the after-tax NPV8% of the project is roughly $430M. It also doesn't make any sense to calculate the NPV of a 50- or 60-year mine life because the cash flow already gets discounted by a factor of 20.
If the lithium demand will indeed increase, I would expect Orocobre to expand its production rate. It has the resources to do so, and with its ultra-low cost of $2000/t it will never be 'pushed' out of the market. According to the company, an expansion would be possible at roughly 60% of the capital intensity of the initial capital expenditures.
So let's make a calculation to know the exact capital intensity. The capital intensity for the start-up was $229M for an output of 17,500 tonnes of lithium per year. This equates to a capital intensity of $13,000 per tonne. At a discount of 40%, any expansion capex would cost Orocobre roughly $7850/t (because several costs only have to be incurred once).
In the next calculation I'll use an optimistic scenario for the lithium demand. In the first 4 years I will use a lithium price of $6,000/t and a production rate of 17,500 tpa. In year 5 I'm budgeting an expansion to 30,000 tonnes per year which would have a capital cost of $100M ($8000 times 12,500 tonnes additional capacity). From year 6 on the output will be 30,000 tonnes per year and the used lithium price will increase to $6,500/t.
Cash Flow
Corporate Tax Rate (35%)
After-tax cash flow
Discount rate (8%)
NPV 8%
-229,000,000.00
-
-229,000,000.00
-229,000,000.00
61,000,000.00
0.0%
61,000,000.00
1.00
61,000,000.00
62,500,000.00
0.0%
62,500,000.00
1.08
57,870,370.37
64,000,000.00
0.0%
64,000,000.00
1.17
54,869,684.50
65,000,000.00
0.0%
65,000,000.00
1.26
51,599,095.67
-30,000,000.00
0.0%
-30,000,000.00
1.36
-22,050,895.58
135,000,000.00
25.0%
101,250,000.00
1.47
68,909,048.70
130,000,000.00
35.0%
84,500,000.00
1.59
53,249,333.47
130,000,000.00
35.0%
84,500,000.00
1.71
49,304,938.40
130,000,000.00
35.0%
84,500,000.00
1.85
45,652,720.74
130,000,000.00
35.0%
84,500,000.00
2.00
42,271,037.72
130,000,000.00
35.0%
84,500,000.00
2.16
39,139,849.74
130,000,000.00
35.0%
84,500,000.00
2.33
36,240,601.61
130,000,000.00
35.0%
84,500,000.00
2.52
33,556,112.61
130,000,000.00
35.0%
84,500,000.00
2.72
31,070,474.63
130,000,000.00
35.0%
84,500,000.00
2.94
28,768,958.00
130,000,000.00
35.0%
84,500,000.00
3.17
26,637,924.07
130,000,000.00
35.0%
84,500,000.00
3.43
24,664,744.51
130,000,000.00
35.0%
84,500,000.00
3.70
22,837,726.40
130,000,000.00
35.0%
84,500,000.00
4.00
21,146,042.96
130,000,000.00
35.0%
84,500,000.00
4.32
19,579,669.41
130,000,000.00
35.0%
84,500,000.00
4.66
18,129,323.53
130,000,000.00
35.0%
84,500,000.00
5.03
16,786,410.67
130,000,000.00
35.0%
84,500,000.00
5.44
15,542,972.84
130,000,000.00
35.0%
84,500,000.00
5.87
14,391,641.52
130,000,000.00
35.0%
84,500,000.00
6.34
13,325,594.00
130,000,000.00
35.0%
84,500,000.00
6.85
12,338,512.97
130,000,000.00
35.0%
84,500,000.00
7.40
11,424,549.04
130,000,000.00
35.0%
84,500,000.00
7.99
10,578,286.15
130,000,000.00
35.0%
84,500,000.00
8.63
9,794,709.40
130,000,000.00
35.0%
84,500,000.00
9.32
9,069,175.37
130,000,000.00
35.0%
84,500,000.00
10.06
8,397,384.60
130,000,000.00
35.0%
84,500,000.00
10.87
7,775,356.11
130,000,000.00
35.0%
84,500,000.00
11.74
7,199,403.81
130,000,000.00
35.0%
84,500,000.00
12.68
6,666,114.64
130,000,000.00
35.0%
84,500,000.00
13.69
6,172,328.37
130,000,000.00
35.0%
84,500,000.00
14.79
5,715,118.86
130,000,000.00
35.0%
84,500,000.00
15.97
5,291,776.72
130,000,000.00
35.0%
84,500,000.00
17.25
4,899,793.26
130,000,000.00
35.0%
84,500,000.00
18.63
4,536,845.61
130,000,000.00
35.0%
84,500,000.00
20.12
4,200,782.97
709,553,518.36
So under these (quite likely) assumptions, the NPV of the Olaroz project increases to $709.5M. If I'd now use a 60/40 ratio to calculate a weighted average of these scenarios, I'm currently estimating the after-tax NPV8% of Olaroz to be $542M. As Orocobre owns 66.5% of the project, the attributable value of Olaroz to Orocobre is $360.5M.
Investment thesis
Orocobre's Olaroz project has everything a lithium investor would be looking for. It has been fully financed and is weeks away from production, there's a strategic partner involved with Toyota Tsusho which provided cheap debt financing. Additionally, the project is a very low-cost producer and should be easily scaleable in function of the lithium price on the world markets. The currently known resource at Olaroz will support a 200-year (!!) mine life. And keep in mind Orocobre also owns other lithium projects in Argentina which haven't even been added into this value calculation.
So what's the fair value of Orocobre as a whole? I'm estimating the 66.5% stake in the Olaroz project to be worth $360.5M. Adding the $35M of the Borax operations and I think Orocobre should be valued at $395.5M or $2.97/share. As the company is currently trading at approximately $2.05/share, there's a 45% upside potential from here. And keep in mind this is a conservative calculation, excluding all other mining projects but Olaroz.
I'm happy the share price came down again, as I now have the chance to add to my position at the same share price as last year, even though the project is much more advanced now and has been de-risked. Orocobre is a buy at this point in time, and the cheaper it gets, the higher the eventual reward will be.
Editor's Note: This article discusses one or more securities that do not trade on a major exchange. Please be aware of the risks associated with these stocks Less
