More risks still remain despite BNC turnaround

Business Editor
Bindura Nickel Corporation last week reported increased revenue of $65,01 million from $1,026 million recorded in the prior year.
The group said the performance was as a result of the increase in nickel sales as well as for by products, copper and cobalt. The group reported pre-tax profit of $16,36 million against a loss of $12,95 million posted in the prior period.
Generally mining companies are attractive to the sophisticated investor with an in-depth knowledge about the industry.

This is mainly because mining projects are partially irreversible and very uncertain; in the end this might be costly to ordinary investors.
Therefore it is imperative that mining companies have high levels of disclosures. There is also the difficulty in evaluating a mining company with many valuations methods needing adjustments to accommodate the many uncertainties associated with the industry.

Bindura has, however, done well in this case in terms of disclosure as most information they provided at the briefing was not new. It has been moved at tours, interviews and updates.

Risk is one major variable associated with mining projects over the entire life of the mine and in Bindura’s case the enterprise value of the company is heavily discounted due to the perceived political risk of Zimbabwe.

Besides the company fundamentals, one has to also consider a number of factors which in most cases are difficult to ascertain with great accuracy.
Mainly these are price cycles and economic cycles. Sensitivity analysis of the main value drivers are assessed on a wide range of inputs which are broadly split into four categories: production assumptions, price path, cost growth assumptions, and Financial. In the end this tries to give a potential value of the mining company.

It is then critical that as we analyse BNC’s just released financials we should also look at the company’s future prospect as we cannot divorce the two.
We also have to keep in mind that the fundamental assets which underpin the value of any mining company are its ore reserves, which by any standard should be at least JORC compliant.

However, sampling, by its nature, is a statistical procedure and so is the estimation of reserves. All reserve estimates, therefore, are subject to a greater or lesser degree of uncertainty. Therefore there is some degree of risk to the valuation of the ore reserves.

To be fair BNC’s 2014 results are impressive and they highlight a company that has turned around. EPS of 2c and a price of 4,5 gives you a PER of 2,25x, which is undemanding for a recovery story.

It’s a turnaround story largely driven by the unprecedented surge in the nickel price, where that will be tomorrow, is a guess.
BNC has just started to pay off banks and creditors, they are still in that hole, but all else equal, there is every chance the company will trade out of it comfortably.
All the company’s economics show some significant growth, a plus for many investors and analysts, however not so much for all of the analysts.

This is so, because we are still to be comfortable with Zimbabwe’s extractive sector for a number of reasons, chief among them price uncertainty; the risks involved including financing.

Let us delve more into the matter. BNC has four mining projects which are grouped into exploratory (Damba Silwane), development (Hunters Road), and production (Trojan). With the fourth, Shangani Mine under care and maintenance (costing money).

All these stages require different levels of capital investment, and a different risk and valuation matrix. With no doubt the company has a decent project pipeline of a combined 380kt (keep in mind that there is a degree of uncertainty in resource estimates) of nickel which at a forecasted average market prices of $16 000, has a market value of plus or minus $6 billion over 10-20 years, but we have to take into consideration the capital intensity and total investment required to achieve that level of output, which could also run into the billions of dollars.

And we doubt and certainly cannot predict the company’s ability to raise that level of capital given the Zimbabwean address. Maybe that is why the company did not disclose the amount of capital required for Damba Silwane and Hunters Road in order to take them to production stage.

Let us look at Glencore’s nickel assets in a comparable analysis for a more eloborate valuation matrix. Glencore by 2015 will have an annual output of 200kt of nickel, which is certainly almost the total resource at all BNC’s mines.

Simply put BNC is still a minor in the whole scheme of things. It then is a given that BNC is a potential acquisition target if they do not improve on their project pipeline. But this requires a lot of capital which is beyond the company’s capabilities.

Add to potential troubles, the main revenue driver in this case the Trojan Mine has a forecast mine life of 10 years, which is not much given the level of output which is insignificant with comparable peers around the globe.

This is made worse by the fact that it might take 4-6 years to bring Hunters Road to production stage. This might mean going forward there would be material changes to the companies potential future earnings. BNC we might then conclude is more about speculation than real opportunities.

The company also has a plan to restart its smelter at a capital cost of $26 million which is split into 50 percent debt and the other 50 percent from cash generated internally.

This will obviously prove difficult for a number of reasons. Firstly BNC is not currently generating enough cash to sustain a $13 million-18 month debt security as well as another $13 million cash investment.

While the company argues that a price of $16 000/t would make the project attractive, however with the current nickel market oversupply and a forecast increase of 2,2 percent in global nickel production in the period 2014 to 2018 mainly driven by the majors; the forecast improvement in price is unlikely to happen.

To think prices of nickel once hovered around $50 000 in the early 2000s. If they were to go back to these levels, Bindura would be very attractive.
Outside of a cash call to shareholders the current financing model is not sustainable. Secondly unreliable power supplies would be a major challenge to the profitability of the operation putting into question the company’s ability to successfully operate a smelter.