Australia | Nov 04 2013
-Opportune time to acquire
-Better bet than Inca de Oro
-Narrows the gap to OZ Minerals
By Eva Brocklehurst
Copper-gold miner PanAust ((PNA)) has turned its attention to PNG and acquired a stake in the Frieda River project. The company has the Inca de Oro project in Chile on simmer but brokers think PNG is a better bet and question the ability of the company to proceed with both. PNG's topography is similar to Phu Kham in Laos, where the company has successfully built a greenfield operation.
The company has bought the 80% stake in Frieda River from Glencore Xstrata. The deal also includes an investment in the junior partner, Highlands Pacific ((HIG)). The price is US$75 million, consisting of two instalments, and Glencore will also receive a 2% net smelter royalty. PanAust will take a 7.5% placement in Highlands, equal to around $5m, with an option to acquire an additional placement of equal size. Highlands has the right to require PanAust to subscribe to the additional shares.
UBS thinks this is a positive deal as PanAust is effectively paying US$25m, with a deferred payment of US$50m, for a large scale copper project that contains 12m tonnes of copper and 20m ounces of gold. Investors may be concerned about the location but the broker thinks the timing is opportune – and counter cyclical – buying assets when the majors are pulling out and divesting. In terms of the timing, any potential development at Frieda River could help offset the eventual decline at Phu Kham.
PanAust expects the PNG government will take up its rights on a 30% interest and subsequently reduce PanAust's interest and capital commitment in the project. Assuming that both the government and Highlands Pacific fully fund their share, then PanAust's commitment would be 55% of the US$1.5-1.8 billion capital expenditure that is required. Studies and permits will take until the end of 2016 to accomplish and UBS estimates that PanAust will have a US$450-500m cash balance at that stage. There is also the potential for PanAust to fully fund its 80% stake and free carry the PNG government, reducing dividend payments to the government as a result. Under the revised scoping study, the mine would produce 100,000t copper and 160,000 ozs gold per annum at US$1.25/lb in C1 costs, with first production in 2018, assuming feasibility studies are supportive. The initial mine life is 18 years.
The most positive aspects, in UBS' opinion, are potentially higher throughput rates in the initial years, which PanAust has suggested could lead to throughput increasing 30%. While life-of-mine head grade is 0.6% copper, it's likely the company would mine the higher grades in the initial years. Significant work has already been conducted to understand grade and metallurgy. There are downside arguments, including the higher capex and potential cost inflation in PNG as well as adverse currency moves. Also, the capex plan assumes contractor mining which, should margins and prices increase, will also increase the unit cash costs.
JP Morgan is also mindful of the significant capital expenditure required and cautious on the risks around developing a greenfield project in PNG. On the same vein as UBS, the best aspect in the broker's view is the acquisition offers PanAust a long-dated option to replace the Laos operation. The company has said that Inca de Oro is not on the back burner as a result of the Frieda acquisition and believes it can manage peak capital for both projects sequentially. JP Morgan is dubious about this two-pronged expansion. The potential funding challenges may come should copper prices weaken, and/or the PNG government not take up the 30% option.
While the company probably paid fair value for the acquisitions and the near-term funding burden is relatively small, JP Morgan thinks the market is unlikely to attribute much value to the project because of the long-dated nature and the risks and relatively modest returns. That said, PanAust now has greater leverage to long-term copper prices, which are expected to be buoyant, and the broker likes the project more than Inca de Oro.
A majority position in a world-scale project at a reasonable price. That's how Credit Suisse views the acquisition. Despite this, the broker acknowledges Frieda River is low grade and not without significant risks. What gives PanAust a leg up is that the company developed Phu Kham in similar topography with a lack of established infrastructure. The broker thinks deferring Inca de Oro would be the best way to proceed. Frieda River is a better understood, lower risk project and would compete for capital. Credit Suisse does not believe PanAust can fund both. Frieda River, if capital is not deployed to Inca de Oro, offers a long-life extension that's outside the company's current concentration in Laos.
Credit Suisse also thinks it draws PanAust closer to OZ Minerals ((OZL)), with a lower capital, but similar risk project to OZ Minerals' Carrapateena. Carrapateena has higher grade and a far more benign location. Under Credit Suisse's metal price assumptions, PanAust's balance sheet will be significantly stressed by the project capital, particularly if the PNG government does not participate as expected.
The broker envisages the funding requirement could ultimately see a merger between the two companies in order to ration scarce capital across competing projects. Such a merger would allow Prominent Hill cash flow to be deployed to help fund Frieda River, including the probability that PanAust would end up with more of Highlands' current equity in the project and a funding headache. Credit Suisse postulates that Frieda River and Phu Kham cash flow could then be channelled back to building Carrapateena. The broker favours this, as it would push Inca de Oro much further into the future. That project has major challenges with acquiring water and power. After including a 50% discount for the early nature of the project and assuming an ultimate PanAust stake of 55%, Credit Suisse calculates an addition to valuation of 21c per share. The broker has upgraded the recommendation on the stock to Outperform from Neutral.
PanAust has six Buy ratings and one Sell rating (Citi) on the FNArena database. The consensus price target is $2.54, suggesting 34% upside to the last share price.
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