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Confidence Jolted In Independence Group

Australia | Jul 31 2018

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Reactions to Independence Group's downgrade to reserves at Nova have been mixed but brokers generally agree mine life has been shortened.

-Average nickel grade reduced to 1.86% and copper to 0.76%
-Earnings impact could be offset by targeted throughput
-Yet expansion at Nova throughput likely at the expense of mine life

 

By Eva Brocklehurst

Reduced grades will now be forthcoming from the Nova reserve, casting a shadow over the medium-term outlook for Independence Group ((IGO)). The latest reserve update at Nova has indicated a -23% decline in ore and -9% decline in grade, with a mine life of less than eight years.

Macquarie was one broker that was surprised by the magnitude of the reduced reserve grades, lowering its production expectations for nickel and copper by -17% and -20% respectively. Higher cash costs and lower production drive a -26% reduction to the broker's valuation of the Nova mine.

FY19 guidance for metal production at Nova is only marginally below Macquarie's forecasts, with the main impact in FY20-23. The 2018 reserve statement has reduced the average grade of nickel to 1.86% from 2.06% and copper to 0.76% from 0.83% over eight years at 1.5mtpa.

UBS, on the other hand, believes confidence in the reserve has lifted materially and raises nickel production estimates for FY20 by 2%, expecting a higher mining/milling rate will more than offset the grade decline. Canaccord Genuity models a higher cost profile at Nova but this is largely softened in its valuation by incorporating updated metal prices and FX.

The broker, not one of the eight monitored daily on the FNArena database, acknowledges the cash flow forecast for FY19 appeals to investors looking for low-risk exposure to diversified metal production, but retains a Sell rating on valuation grounds. Its target is $3.90.

Production Target Always A Stretch

The market considered the June quarter production target was unlikely to be achieved. It did pull up short of management's guidance, presumably from grade as throughput was above nameplate, Credit Suisse points out.

In hindsight, the broker now suspects this was a pre-emptive warning the downgrade to Nova's reserve was coming and remains apprehensive about the mine meeting guidance for average annual production.

Citi suspects that the miss to production guidance back in the March quarter may have resulted from a smaller-than-expected high-grade core at the deposit. Ord Minnett, while considering a downgrade was well flagged, found the outcome worse than expected.

Still, Independence Group expects to maintain 27-30,000tpa of nickel for the next three years and this is positive versus the broker's forecasts. Ord Minnett downwardly revises earnings estimates by -2% for FY19 and -4% for FY20.

The resource at Nova increases 32% in terms of total tonnage after accounting for depletion, because of changes in the cut-off grade to a net smelter return and after the inclusion of some lower grade zones.

Credit Suisse considers Nova an impaired asset compared with prior understanding, although the earnings impact can be offset by throughput as 1.8mtpa has been demonstrated and is now a target. Still, this expansion will come at the expense of mine life.

UBS observes, outside of the SAG mill outage that caused production to come in below guidance, the mill was actually operating at a 1.8mtpa run rate in the quarter. There is also 90,000t of ore at surface which de-risks production somewhat for FY19.

Life Of Mine

CLSA expects investors will now have to revise down lofty expectations for Nova's mine life, and lowers valuation by -11% after incorporating the updated Nova grade and life profile. The broker, not one of the eight monitored daily on the database, reiterates a Sell rating and $3.85 target.

The revised reserve now provides some certainty, Credit Suisse acknowledges, regarding the outlook for Nova following a 12-month wait for a revised reserve and completion of grade control drilling for the entire orebody.

Life of mine grade-control drilling is highly unusual, the broker points out, but apparently had nothing to do with concerns regarding the integrity of the reserve. Rather, management insisted it was an opportunistic decision to lock in favourable diamond drilling rates and exploit access afforded by the nature of the orebody.

Either way, the implication the broker draws for mine life on the revised ore is 7.5 years, at a lower average production rate on lower grade, and exploration success will be needed to support the $350m investment in technology.

The technology being contemplated involves converting low payability nickel sulphide to sulphate, which the company hopes to sell at a premium to nickel metal. Independence will spend $47-54m on exploration in FY19, with the focus still on the prospective Nova district.

Regionally, Citi highlights reports that indicate major shareholder Mark Creasy has made a nickel-copper discovery around 25km from Nova. If this proves positive then the broker suspects Independence Group could be favoured in negotiating treatment through its mill.

FNArena's database runs the gamut and has two Buy, three Hold and two Sell ratings. The consensus target is $4.67, suggesting 4.7% upside to the last share price. Targets range from $3.95 (Credit Suisse) to $5.20 (Ord Minnett, UBS).

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