Macro Tsimmis

intelligently hedged investment

BUY LionOre Mining International (LMGGF)—sulfide nickel play

Posted by intelledgement on Wed, 28 Feb 07

LionOre (LMGGF) are an international mining company with operations in Australia, South Africa, and Botswana. Their prime product is nickel, and in 2006 they mined 34M tons of the stuff…plus 155M ounces of gold as a side benefit.

Demand for nickel has risen along with most other commodities in the wake of the growth of the Asian economies, most especially, China who need nickel for their stainless steel habit. In 2006, nickel prices surged from $6/lb. in January to $15/lb. by December.

In the face of rising demand, world nickel production is undergoing a transformation. There are two sources of nickel, sulfides and laterites. The former are preferred, as the processing is cheaper but alas only one-quarter of the planet’s known nickel reserves are in sulfide form; the bulk are laterite. To make matters worse, the quality of sulfide ore is degrading as most of the best deposits have been played out. So while there is still more nickel produced from sulfide ore than from laterite ore—as has always been the case in human history—the gap is narrowing (56%-44% in 2006), and miners are developing improved processes for laterite and most new mines coming online are also laterite. Laterite ore nickel production is projected to surpass sulfide production in 2009.

About two-thirds of the new laterite ore will require relatively new hydrometallurgical processes—principally, a high pressure acid leaching (HPAL) technique—to be viable. On paper, it looks as if this new laterite ore production will keep supply in balance with rising demand. However, there are some HPAL-related challenges: HPAL plants are technologically complex and operationally demanding, and it is not clear if there are enough skilled workers to run all the ones on the drawing board. Consequently, delays—and concomitant price pressures—are likely.

The cool thing about LionOre is that they have three of the largest new sulfide ore mines under development. So the risk of delays effecting their forthcoming production are relatively small…and if they can get their mines up and running, they will probably benefit from increased nickel prices if laterite production is materially delayed (that is, barring a global decline in demand).

LMGGF is priced in the mid-$13s here. Last summer, a bidding war for two other nickel producers, Falconbridge and Inco. Falconbridge was eventually sold to Xstrata for $18.0B (15x cash flow), and Inco was gobbled up by CVRD for $17.6B (9x cash flow). LMGGF management are projecting 40M tons/88MM lbs. of nickel production in 2007, and the price is already up from $15/lb. to $18/lb. This implies cash flow of $1B this year, or a market valuation of between $9B and $15B for LMGGF. But at $13.50, the company has a market cap of only $3.8B.

Looks breathtakingly undervalued here.

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