Ivanhoe Mines Ltd (IVPAF)

[tootalljones]

Ursusbrame's analysis of our Kipushi Zinc mine:

"ursusbrumae
December 08, 2016 - 01:48 AM 239 Reads
Post# 25569933

5 starsv
Afrithmetic
Management has indicated an intention to have Kipushi near completion by late 2017. If capital costs have come down by 25% from USD 400M to USD 300M, and the company funds another USD 100M while banks and vendors finance another USD 200M, capital is taken care of. Steady state production is modelled at 530kt Zn concentrate, at a 53% concentrate grade, for 281ktpa elemental zinc, or 620M lbs zinc metal annually. C1 cash costs are anticipated to amount to USD 0.53/lb Zn equivalent net of copper credits, with no credit for germanium, which may or may not attract credit from smelters. But a decline in treatment charges from USD 200/t to USD 50/t of concentrate would translate to a savings of roughly USD 0.13/lb zinc metal. Ignoring the comment about a reduction in transportation costs (whether this is a reference to realisation costs which include refining charges, or rail freight fees falling for one reason or another) revised C1 costs would be 0.53 - 0.13 = USD 0.40/lb zinc. At current spot which is about USD 2,740/t, or roughly USD 1.25/lb zinc, the contribution margin would be 1.25 - 0.40 = USD 0.85/lb Zn. At steady state production this would be 620 x 0.85 = USD 527M/ann. At the company's 68% interest this would amount to 0.68 x 527 = USD 358M/ann. At current exchange rates of USD 0.75 = 1 CAD this would equal 1.33 x 358 = CAD 475M/ann. Assuming a 1/3 tax rate, including royalties, and that half of this cash flow is offset by depreciation, the effective tax rate on OCF would be 1/6, so at a tax shield of 83%, ATCF before sustaining capex would be 0.83 x 475 = CAD 395/ann net to the company. Over 779M shares this would be 395 / 779 = CAD 0.51/share. Again, at a 10x OCF multiple this would amount to roughly 10 x 0.51 = CAD 5/share. NPV is only a third of this, because of initial and sustaining capital expenditures, and the fact that mine life is limited to 10 years. But the deposit is open in a few directions, so there is exploration potential. Most mines, especially good ones, run quite a bit longer than initial study life of mine, hence the multiple approach. One could also argue that zinc supply is constrained as a result of five major mine closures from depletion (not price) and so even in a weak demand environment the price may have some ways to run.

All this is back of the envelope. Side of the envelope, adjust the CAD 0.86/share OCF for K&K from a previous post, as above, via 83% tax shield, to ATCF of CAD 0.72/share. And at a 10x multiple this is CAD 7.20/share. Assuming higher rates of production from increased concentrator capacity over a couple of years' ramp-up, to 8Mtpa or 12Mtpa modular run rates, then throw in a syndicated credit facility for a couple billion in capex for the smelter, and you get to the blister phase with ultra-low cash costs, where you're essentially shipping 99.99% copper out the door, and you have quite a respectable cash flow, maybe doubling the value again. You can see how you could get to a 2 handle a few years out, even without Platreef, which will take a little longer, but should also be good. (Here prices and costs are way off from study levels, and I imagine the engineers have made some alterations to the mine plan, so it would be interesting to take a look at the BFS when it comes.)

This valuation is more aggressive than I would like; I would rather an NPV at a high discount rate. But some here have advocated a lower discount rate, or a cash flow multiple approach. So here you have it. I do agree that this is in some ways more realistic, in that it anticipates where the market could be in a few years, inclined to a more generous appraisal of producing assets in a commodity boom. Double digits would be satisfactory, but some of the more rosy forecasts you may have read are not unreasonable. To that end I would simply offer the observation that a number of things are working in your favour here. In the short term, cost deflation; but more importantly and over the long term:

1. Ongoing optimisation of mine plans from improved geological understanding;
2. Operating leverage of rising commodity prices;
3. Financial leverage of (higher but still) low-interest rate debt financing;
4. Closing of the discount;
5. Ongoing exploration; and,
6. Improving sentiment.

These are some of the tailwinds to which the chairman alluded. In the upper part of the cycle equity tends to trade well over fair value. And given the ongoing exploration success, this is a story I think people could get behind when mining is more in vogue in the capital markets. Is it three Tier 1 discoveries thus far? When shall we come to expect it?

Wherefore the valuation discrepancy? Call it sentiment, or the fact the people are looking elsewhere. I think part of it is that among committed mining investors many do not follow the company closely (out of aversion to perceived political risk, or an exclusive zeal for precious metals mining) or study it carefully enough to appreciate the quality of the assets, the tremendous progress in bringing them forward to production, and the talent of the management team evident in this stealth creation of a major mining company. Others simply don't know the company. For example, when I mention the name to institutional investors, the most common response is, "don't they have that copper thing in Mongolia?" I guess Bay Street and Wall Street, at the end of the day, care about one thing more than anything, and that is quarterly earnings per share. When these assets are in production and zinc, copper and platinum are back to old highs, there should be plenty of EPS. Jim Grant said "the key to successful investing is having everyone agree with you...later."

Read more at http://www.stockhouse.com/companies/bullboard#35DqX2vyDo0vbQ50.99