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Executive summary
- Tsodilo is located in Botswana, the only African country to be compared to most Canadian countries regarding mining policy and stability.
- A maiden resource estimate is expected in Q2, 2014 on their Xaudum iron ore project, which appears to be large, suitable for high percentage concentrate and profitable.
- Asian parties are looking very hard for large and profitable iron ore projects in poor regions like Africa at the moment, so the Xaudum iron ore project could be a rare opportunity for them.
- Tsodilo has enormous long-term upside potential, but despite their current run up I have estimated a target share price of $1.60 for a profit of 40% right after its maiden resource estimate comes out in Q2, 2014.
- For the 30-year base case scenario at a conservative price for concentrate 67% CFR China of $110/t after releasing the FS in Q4 2016, a target share price is estimated at $7.2, for a profit of 532%.
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All images are sourced from company material, unless stated otherwise.
1. Introduction
This is an article about Tsodilo Resources (OTC:TSDRF), a diamond, base and precious metal exploration company located in Botswana. Although Botswana is located in Africa, and is adjacent to South Africa, it is regarded as a very mining friendly country by the Fraser Institute as it is ranked 17 out of 99 countries worldwide.
Geographical map, Botswana
The company has large properties with a lot of exploration potential, especially in copper and iron ore. Their last discovery, the Xaudum iron ore project, could be a real company maker on the longer term as I will show later on.
2. Company
Tsodilo Resources is a Canadian based exploration company, operating in Botswana, and has a variety of projects. The company started out on exploring for diamonds, copper and uranium, and lately the Xaudum iron ore project is being explored as being the flagship project of the company. First Quantum Minerals (FQM.TO), which is also a major shareholder with 7,45% O/S is their JV partner on the copper projects. Biggest long-term shareholders are Azur LLC (16.39%) and IFC (14.83%). Especially IFC is a solid partner, as they perform very thorough due diligence, and are usually in it for many years.
The management and Board of Directors are very experienced, ranging from developing and operations worldwide, to evaluating projects for the IFC, to many years of exploration in Africa on various types of diamond, base and precious metal projects.
As of February 20, 2014, Tsodilo Resources has a share price of $1.14 and a market cap of $34.7M, with only 30.47M shares outstanding. The company has just $40,5M shares fully diluted, so it still has a very tight share structure.
Share price over 2-year period
The current run-up has been caused by the news release about the Xaudum 5-7Bt Fe potential, and some coverage on the company.
It is recommended to trade the stock on the mainboard TSX Venture, ticker TSD.V.
The company is fast-tracking a maiden NI43-101 by SRK Consulting on the Xaudum project at the moment, and this report is scheduled for Q2 2014.
3. Projects/Claims
A. Gcwihaba
The Gcwihaba claims consist out of licenses of 11,159 km2, and covers copper and iron prospects:
In addition, the following map shows why First Quantum has a JV with Tsodilo Resources, as the copper belt extends into Botswana:
FQM is exploring an area of 90 x 30 (up to 40) km. Some of the world's largest copper deposits were found on this copper belt, like Kamoa in DRC (Ivanhoe Ltd), and a number of operations in Zambia (for example by First Quantum and Barrick). Big difference between these two countries and Botswana is of course the much better mining friendly environment, so diversifying from Zambia would derisk FQM as a company.
Xaudum iron ore project
The current flagship of Tsodilo is the Xaudum iron ore project. It takes its name from the Xaudum River that runs through the northern portion of the Ngamiland region in the North-West District of Botswana. This early stage exploration project is in the delineation stage. A part of the extensive location (1594 km2) is being drilled now, in order to release a maiden resource estimate in Q2, 2014. Airborne magnetic surveys have indicated a very large magnetic Fe-Magnetite formation (37 x 3-7 km), or in plain English a possible source for iron ore, see magenta objects:
To get an impression how large this is: BHP Billiton's Mt Whaleback mine is the biggest single-pit open-cut iron ore mine in the world being just over five kilometers long and nearly 1.5 kilometers wide.
Only a relatively small part (5 x 3 km) of the entire Xaudum formation is explored now, which had the highest readings on magnetics, see the high magenta peak to the left:
This area located north at the end of the target is called Block 1, which is currently drilled to get a better understanding of the geology and resources:
The company is benefiting from the accuracy of the magnetic survey, as incoming drill results continue to confirm targets, at a drill space grid of 50x400m:
From recent drilling, some kind of folding structure appeared to be present on the so-called Eastern Limb:
A typical 3D section looks like this:
The company made an internal estimate of the Northern part of the Eastern Limb of 55.3M tonnes of iron ore per kilometer, the entire Block 1 is estimated at 500M tonnes. A global estimation of the total resources has been projected by Tsodilo to be in the range of 5-7 B tonnes of iron ore, at 15-40% Fe. The Xaudum project consists of a Magnetite Banded Iron Formation MBA (ranging between 25-40 % Fe) and a Magnetic Schist DIM (ranging between 15-25% Fe). Therefore, I would like to assume an average grade of 25% Fe for the deposit.
The iron ore is planned to be concentrated to an end-product containing over 67% by thermal coal powered plants, into metallic iron. Metallurgic testing confirmed a concentration grade of over 68%, which is higher than the usual benchmark for iron ore of 62%.
Again a quick comparison to BHP Billiton regarding the possible size of the Xaudum deposit: this company, which is one of the biggest iron ore producers worldwide, had for 2013 Proven and Probable reserves of 3.7 B tonnes, Measured and Indicated resources of 6.8 B tonnes, and Inferred resources of 15 B tonnes. Average grade is much higher though at over 50% Fe, but it will be clear Tsodilo Resources could have found something of a decent size.
The area also indicated an excellent potential for copper mineralization through positive drill results, and this is the reason why First Quantum Minerals arranged a strategic partnership with Tsodilo Resources. This partnership enables Tsodilo to focus further on exploration and resource delineation drilling of the Xaudum Iron Formation. The working capital of Tsodilo is currently estimated at $1M so this is limited. My expectations are, as the company is currently in the middle of a drill program, that further funding is needed soon, so a near-term private placement or other financing cannot be ruled out.
B. Ngamiland
Tsodilo Resources also has a large land package of 3299 km2 divided into the Ngamiland and Jwaneng projects, and is exploring for diamonds over here.
C. Uranium
The uranium claims are overlapping a part of the Gcwihaba project claims, including the Xaudum project area. As uranium already has been found on the Xaudum project (see below), it will be clear extra stages have to be built in regarding the eventual processing and concentrating of the iron ore:
4. Iron ore
The future profitability of the Xaudum project is of course closely connected to the price of spot iron. This price has reached heights of as much as $187 per tonne, but has come down to levels of about $135/t:
This is predominantly caused by the continuously slowing down of the economy of China, the largest steel consumer (which accounts for 50% of the world demand). As China stockpiled enough iron ore recently for Chinese New Year (January 31, 2014), spot iron prices for 62% Fe CFR Tjanjin port (this means Cost and Freight: the seller arranges the carriage and documentation of the goods to Tjanjin port in China) concentrate fell to $122.60/t, the lowest in 6 months. Concentrate is grinded and concentrated iron ore:
Iron ore concentrate is forecast to fall towards $121,5/t during 2014, and a bit further to $115/t in 2015 (see same referenced Reuters article). Another frequently used term is the Free On Board (or FOB) price, this means the iron ore is delivered at the nearest seaport and loaded on board a vessel. The buyer has to pay for further transport, documentation, unloading etc. As I am aiming at Chinese offtake partners, I am directing my thesis towards an iron concentrate CFR Tjanjin port price.
The long-term target for 62% Fe CFR Tjanjin concentrate is $115/t, I would like to be a bit more conservative and use a long-term target price for 62% Fe CFR Tjanjin concentrate of $100/t. This means a price for 67% Fe CFR Tjanjin concentrate of $110/t, and a price for 67% Fe CFR Tjanjin pellets of $125/t in my base case scenarios. Pellets are small spheres of concentrated iron ore, which trade at a volatile premium of $8-44 to concentrate:
The higher grade of the Xaudum concentrate (67% Fe) will generate a premium over the price for 62% Fe concentrate. It is difficult to predict what this premium will be in the future, as the difference between the two standard grades 58% and 62% isn't always relatively constant. This is illustrated by these two charts:
From December 2009 to April 2013:
In addition, more recent developments:
The most recent spot price for 58% Fe I could find was $108.59/t (2/5/2014), as 62% Fe has a spot price of $122.60/t, the difference is $14/t. According to the last chart, the average difference seems to range between $9-16/t, so I prefer to use a difference of $10/t between 62% Fe and 67% Fe. This results in an estimated conservative target spot price for 67% Fe of $125/t in 2015 and beyond.
Besides this, I expect the same gradual decline for copper, also caused by the slowdown of China, leading to an estimated target spot price of $3.00/lbs at the end of 2014, and an estimated target spot price of $2.75/lbs at the end of 2015.
Notwithstanding the slowdown of China, large Chinese companies (not seldom state-owned or related) are looking all over the world again to secure supplies for metals like iron ore, copper, zinc and gold. However, they are inclined to be more selective towards their investments, as metal prices have come down and many earlier investments turned out to be financial disasters. They prefer Africa, as it has many resources, where countries are not developed and wealthy so governments welcome foreign investors, and on top of that, the shipping distance isn't too high. A fine example of a very long term (100 years) nearby iron ore project in Africa is the Kunene project in Namibia, developed in cooperation with a large Chinese company, government and universities in both countries, to educate people and strengthen economy and relationships.
This renewed interest of Chinese investors in African assets comes at the right time, as the Xaudum project might be the only large iron ore deposit (5Bt +) available in Africa, plus it is located relatively close to the East coast.
5. Valuation
To value Tsodilo Resources is no easy task, as not one of their projects has a resource estimate or economic study. As I am not into diamonds and this project seems very early stage as well, I feel comfortable to ascribe a very limited value to these claims of $1M. The same value is ascribed to the uranium claims. For its copper project, I am inclined to project an estimated value of $5M on their claims, as First Quantum Minerals (which has extensive knowledge of local geology) did not arrange a JV with a 2Mt Cu threshold for no reason. Should First Quantum actually succeed in finding a 2Mt Cu (or 4.4B lbs Cu) deposit with a decent average grade, it will be clear the 30% JV share of Tsodilo will be worth much more than $5M after lots of successful exploration. As a NI43-101 resource estimate is part of the obligations of First Quantum, I expect for example M&I resources to be worth at least $0.01/lbs Cu according to peer comparisons, resulting in an estimated and very conservative $15M market capitalization just for the copper project.
My focus of valuation is of course the Xaudum iron ore project, as it is the flagship project of the company, and I will not take into account any other parallel scenarios on copper or other commodities. Tsodilo is currently working towards an inferred resource estimate of Block 1 in Q2, estimated by itself at about 500Mt Fe. As Block 1 is estimated to be 10% of the total resource based on airborne magnetic surveys, the company thinks it could extrapolate Block 1 into a total resource of 5-7Bt Fe.
The valuation of this company will be worked out in two main scenarios. The first one is near term to determine the value right after the maiden resource estimate, and the second one is long term, at the stage of a Feasibility Study.
For the near-term scenario I would like to perform a global peer comparison on some advanced explorers/developers regarding EV/tonnes:
Part one:
Source: own spreadsheets
Part two:
Source: own spreadsheets
It is not easy to compare Tsodilo to its peers, but I prefer the smaller Indicated and Inferred resources. This results globally in an average EV/tonne of 0.03. Based on an Inferred resource of 500Mt Fe the company would be overvalued, as an EV/tonne of 0.03 corresponds with a market capitalization of $5M just for the iron ore project. Together with the other projects and cash a sum of parts of $13M is derived, however compared to a current market capitalization of $34.7M this looks rather bleak. Investors are obviously already looking further ahead of what is about to come.
As the company already established the bigger picture at Xaudum, and incoming drill results keep confirming the survey data very convincingly, the incoming maiden resource estimate will clearly serve as a confirmation of the overall geology of the entire deposit. Assuming a potential for 5Bt Fe, the project value is extrapolated at a tenfold $50M, and the market capitalization could be estimated at $58M. However, an inferred resource estimate of 10% of the property isn't exactly the same as a 5Bt resource estimate, so even if I do expect a lot of excitement when the maiden resource estimate is released, a project value of $40M looks more reasonable, resulting in a target share price of $1.60 for a profit of 40%.
To calculate an FS target share price, I would like to do a peer comparison on a number of economic studies first:
Part one:
Source: own spreadsheets
Part two:
Source: own spreadsheets
Part three:
Source: own spreadsheets
It will be clear that large iron ore projects have large capex. Only exception is New Millennium, but I have serious doubts if their FS is indeed an official NI43-101 technical report. It looks as if it is put together by management, it lacks all sorts of standard NI43-101 references and items, is very limited and is rather vague about NI43-101 compliance. It is filed at SEDAR though, so who knows.
Based on my comparison, I would like to make a number of assumptions:
1. As the total resource could very well be over 5Bt Fe at an average grade of 25%, the theoretical total amount of iron extracted would be over 1.25Bt, or 1.9Bt Fe @ 67% concentrate. A mining resource always experiences dilution when mined, so 1.0Bt will be more realistic. As Chinese companies are looking for profitable, but long life large projects, capex is not really an issue and the project could be designed with a considerable size. The resource estimate isn't in yet although all drill results confirm the magnetic survey very well, so I have to be conservative, and therefore I would assume a 0.6 Bt Fe @ 67% project.
2. With a base case scenario life of mine (or LOM) of 30 years, an annual production of 20Mt Fe @67% could be maintained. I will also calculate a longer LOM to show the full potential of the deposit.
3. Two types of operation will be calculated: concentrate and pellet production.
4. A long-term 62%Fe CFR China price of $100/t will be the base case price level for iron ore concentrate.
5. For 67% Fe CFR China concentrate a long-term price of $110/t is used
6. For 67% Fe CFR China pellets a long-term price of $125/t is used, for a premium of $15/t, which is very conservative. At the moment, a premium of $44/t is prevailing, but the premium is very volatile as mentioned, and has been as low as $8/t last year.
7. As there is no nearby railway, this has to be constructed. The preferred route is to the East Coast (Mozambique, Maputo Seaport), to connect to existing railways (Victoria Falls) some 300km has to be built. I assume a price per kilometer of $1.5M in Africa (Canada is $3M/km).
8. The cost for railing iron ore in Africa is estimated at $0.015/km. The total route to Maputo Seaport is estimated at 1100 kilometers, resulting in $16.5/t transport cost:
9. Shipping to China is estimated to cost $20/t using Panamax bulk carriers (60,000t). The port of Maputo is currently dredging the access channels to a depth of 14m, but this will not be enough for Capesize vessels (100,000t and more). Otherwise, shipping costs could be lowered to $17-18/t, which would lower operating costs with $40-60M pa. For these vessels a depth of 21m is required (for Panamax only 12m), and probably an extra terminal. Such an adjustment is estimated at $200M, as Maputo already is a mature seaport. This will be a separate scenario.
Botswana; Maputo main port
10. As the project will most likely be financed by a large Chinese partner, the weighted average cost of capital (or WACC) is estimated at 4%. I project this cost in my DCF analysis as higher cash cost during the period of payback.
11. The corporate tax in Botswana is very low at 22%, gross revenue royalties are 3%.
12. Capex per tonne throughput per annum is estimated at $45/t for the pellet scenario, and $32/t for the concentrate scenario, as I expect costs of labor, power, etc., to be considerably cheaper in Botswana compared to Canada. An extra processing stage to neutralize eventual radiation from uranium is accounted for.
13. Cost per tonne concentrate (mining, concentrating) is estimated at $22/t. This is higher than for example Adriana and Alderon that have Canadian projects, so it is conservative.
14. Sustaining capital is estimated at $33M pa, or $1.65/t. G&A is estimated at $25M pa, or $1.25/t, ongoing exploration is estimated at $20M pa, or $1/t. These three items are rounded at $4/t.
15. Total cost per tonne (FOB Maputo) concentrate is estimated at $22 + $16.5 +$4 = $42.5/t. Total cost per tonne (FOB Maputo) pellets is estimated at $49/t, as I estimate the additional cost to produce pellets at $6.5/t.
This results in the following estimates for a hypothetical FS for Tsodilo Resources:
Part one:
Source: own spreadsheets
Part two:
Source: own spreadsheets
Part three:
Source: own spreadsheets
To picture three most likely scenarios, I have calculated a 30-year base case scenario for concentrates and pellets, a 30-year scenario for both with a port terminal, and a 60-year scenario for both with a port terminal. The base case example follows, after this all various scenarios at different iron ore prices will be presented in sensitivity tables.
30-year base case scenario concentrate @67% Fe CFR China $110/t:
Source: own spreadsheets
As for example the corporate tax is very low, this results in a very high after tax NPV of $6607M.
The after tax Internal Rate of Return is very good for a project of this magnitude, but not that spectacular at 21.5% since the capex is high:
Source: own spreadsheets
After several hours of calculating work, the following tables were generated:
Source: own spreadsheets
As it is a profitable and large project, after tax NPVs are enormous at higher prices as can be noticed. A seaport terminal for capesize vessels does not have much of an impact; a double mine life predominantly generates a higher NPV, especially at higher iron ore prices. The pellet scenarios generate larger NPV differences at lower prices (below $100/t resp. $125/t), above these levels NPVs get closer. As project reserves really hit 7Bt @25% Fe in the not too distant future, it could be an option to expand production capacity with extra modules if necessary. Also, note that I only used conservative iron ore pricing as I am convinced we are not seeing a ten-year growth frenzy like China experienced any time soon again.
Today's prices are above the highest prices used for my calculations, so in the event iron prices would go even higher for a long period of time, owners of this project probably will not have to worry about balance sheets anytime soon. This project is very solid, and will probably have a zero NPV for concentrate at about $77/t and for pellets at about $95/t (both 67% Fe CFR China, today's pricing is around $132/t and $160/t).
For a valuation, some further assumptions have to be made, also regarding a joint venture (or JV):
1. The Xaudum project is divided by 30/70 project stakes, meaning Tsodilo gets 30% and is responsible for financing 30% of capex
2. The capex part of Tsodilo will be financed by 30/70 equity/debt
3. The equity part is assumed to take place after the Feasibility Study (or FS) is released, and I assume a flat share price of $1.50 at that moment, which is very conservative (today's closing price was $1.14), as I expect it to go much higher already when iron ore prices remain at for example today's levels.
4. As the FS share price will be flat at $1.50, the amount of O/S ranges between 193-295M, depending on capex. For calculations I assume existing, fully diluted shares.
5. I assume an after tax 8%NPV/market cap ratio of 0.7 at the time of a FS.
These assumptions result in the following target share prices:
Source: own spreadsheets
As can be concluded, the concentrate scenarios are not resulting in very different targets at price levels of $100/t resp. $125/t and higher. Below these levels the pellet scenarios are clearly resulting in higher shareholders' value, as NPVs are significantly higher.
Looking at other iron ore explorers and developers, it is possible to have a NI43-101 resource estimate with M&I resources in Q1 2015, a PEA in Q3 2015, a PFS in Q1 2016 and a FS in Q4 2016. This is all dependent on arranging sufficient financing, preferably as soon as possible with a JV partner.
For the 30-year base case scenario at a price for concentrate 67% CFR China of $110/t after releasing the FS in Q4 2016, a target share price is estimated at $7.2, for a profit of 532%.
For the 30-year base case scenario at a price for pellets 67% CFR China of $125/t after releasing the FS in Q4 2016, a target share price is estimated at $6.1, for a profit of 435%.
I have studied other projects, which are far more advanced, but all projects are based on FOB Canada studies, which mean some $30-35/t has to be added in order to get the ore to China, which is the main buyer. This extra cost renders most studies not economically viable. Studies that do result in profitable projects have other issues like approval problems regarding necessary railroads. This is why most of these advanced projects are valued far below NPV figures. It is even more remarkable as most projects have solid JV partners with deep pockets like WISCO, a Chinese giant. Tsodilo Resources is different in my opinion, as it has a large enough project to be interesting to Chinese investors, located in Botswana where permitting issues don't seem to exist, and has a project which is very robust, even at very low iron ore price levels.
6. Catalysts & Risks
A maiden NI43-101 resource estimate on the Xaudum project is expected in Q4 2014, which could serve as a major catalyst, as it could confirm the overall geology of the deposit.
As Chinese investors seem to have rejuvenated their interest in African commodities, and as the Xaudum project will be highly sought after as it could be a rare, profitable long life iron ore project, I expect Chinese interest in this property soon. When Tsodilo Resources succeeds in finding such a JV partner, my guess is the company has a very good chance to make it into production.
Other catalysts for 2014 are of course drill results and maiden resource estimates on its other projects, most likely candidate to succeed are the copper projects, which are JVed with First Quantum Minerals. In 2015, if a JV partner would be found on the iron ore project, I would expect resource updates and a PEA.
With an early stage project like this, there are of course plenty of risks. As mentioned earlier, the company needs cash soon, so I expect a financing any week now. Since the share price experienced quite a spike, it seems likely a financing will be priced at considerably lower levels, to be expected in the range of $0.90-$1.00. A financing could be exactly the right moment to get in, as markets usually tend to overreact at lower price levels of financings. Of course this is also relying on macro conditions, when markets and/or metals are heading down it is better to wait some more. However, not too long as the maiden NI43-101 is due in Q2 2014.
To me the resource estimate can disappoint of course, but does not present the largest risk as all incoming drill results confirm the airborne magnetic survey very convincingly. The biggest risk in my view is finding a solid JV partner, as this kind of mega projects cannot be properly explored and not at all developed by a small junior explorer. Nevertheless, Chinese interest is omnipresent at African deposits of decent size, so there is a reasonable chance the company will succeed.
7. Conclusion
Although the Xaudum iron ore project is an early stage exploration venture, ongoing drill results are very promising, and confirming the layout of a very large deposit. Botswana is not your typical African discount country, and can be compared to the best Canadian regions. Big advantages of Botswana over Canada are very smooth permitting, low overall costs and it is located closer to China, which lowers transport costs.
This deposit is unique in its combination of probable size and location in a very mining friendly and low cost country, and this is exactly what Chinese investors are looking for nowadays, as they encounter high costs, permitting issues and increasing opposition in for example the United States and Canada. Because of this I think this project could succeed in finding a solid JV partner very soon, before or after the maiden resource estimate in Q2 2014.
This resource estimate could confirm the estimates of the management regarding a 5-7Bt deposit, and I estimated a target share price of $1.60 for a profit of 40% in Q2 2014 because of it. To establish the real extent of this possible mega project I calculated a hypothetical FS, which resulted in a 30-year base case scenario at a price for concentrate 67% CFR China of $110/t after possibly releasing the FS in Q4 2016, for a target share price estimated at $7.2, for a profit of 532%.
Notwithstanding the early stage and connected risks because of it, it could very well be Tsodilo Resources is on to something very big and profitable. Let us see how this project travels through all stages of development, I will monitor it closely the next two years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
Additional disclosure: I am planning on initiating a position directly after an eventual financing when it is priced below the then current share price.
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