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Galaxy Resources Opts For Grade Vs Recovery

Small Caps | Apr 23 2019

Lithium sales were significantly lower in the March quarter for Galaxy Resources, while the sell-down process for Sal de Vida has been formally closed without a deal.

-Priority at Mount Cattlin shifts to better lithium concentrate grades versus recovery
-Unlikely to conclude a Sal de Vida sell down as attractive as the POSCO sale
-Mount Cattlin may need to ship increased volumes in H2 to clear inventory


By Eva Brocklehurst

Galaxy Resources ((GXY)) is faced with finely balancing recovery and grade at its Mount Cattlin lithium mine and has conceded its yield optimisation target may have been optimistic.

Concentrate production of 42,000t at cash costs of US$453/t was reported for the quarter and 2019 production guidance is 180-210,000t. While mined grades improved at Mount Cattlin, the yield optimisation project is yet to deliver benefits, as recoveries have only increase to 51%, from 47% in the December quarter.

Meanwhile, concentrate grades actually decreased to 5.6% lithium oxide. Sales was significantly lower in the quarter, attributed to a second half weighting for deliveries. Shipment volumes are expected to increase in the second half but, brokers suspect, any catch up from the first half may attract lower prices.

The company has cited a lag between production and agreed delivery schedules. Three shipments are expected over the second quarter of 2019, of 15,000t each. Larger vessels are expected to be used over the second half to enable inventory drawdown to broadly match production.

No realised pricing was provided. UBS estimates US$630/t in the March quarter, likely affected by lower-than-anticipated grades. The broker forecasts a US$653/t average price over 2019, which compares with over US$900/t in 2018. The broker also notes the Chinese government has lowered subsidies on lower-range new electric vehicles and raised the eligibility requirements, which has affected sentiment adversely.

Macquarie remains concerned about weak recovery. The yield optimisation project at Mount Cattlin was designed to lift recovery to over 70% but the company has conceded this optimistic as its priority shifts to better concentrate grades.

Macquarie slows its expectations for a ramp-up in recovery over 2019 and reduces long-term assumptions to 67% from 72%. Product grade assumptions are lifted to 5.8% from 5.7%. Credit Suisse suspects the revised recovery target from the yield optimisation project may have implications for the next reserve revision. Canaccord Genuity agrees the 70% recovery rate may never be achieved.

Credit Suisse found several negatives in the report and struggles to identify a near-term catalyst for the stock given the issues at Mount Cattlin, the lack of a sale of Sal de Vida and a deteriorating macro environment.

Sal de Vida

The company has closed the process of selling down Sal de Vida, unable to agree on a transaction structure or value. Discussions still continue with some parties. Given a stronger pricing environment has passed, Canaccord Genuity believes this is a missed opportunity.

Galaxy Resources will continue to develop the project but has not presented a timeline or a firm funding strategy. The lack of a transaction on Sal de Vida means there is no catalyst in a difficult market for lithium equities. Yet Canaccord Genuity, not one of the eight stockbrokers monitored daily on the FNArena database, suggests the shares have been oversold and maintains a Buy rating and $2.75 target.

UBS had been expecting a further sell down in Sal de Vida and, while noting negotiations continue, does not expect a deal as attractive as the POSCO sale can be concluded. During the quarter POSCO's consideration of US$272m was released from escrow.

A strong cash position should support the development, UBS asserts. Macquarie considers Sal de Vida is increasingly uncertain, because of recent muted pricing and longer development times for brine resources.

Sourcing funding could also be difficult. The broker lifts the estimated cost of capital for the project to 14% from 10% and this reduces valuation to $90m from $395m. Still, post the sale of the northern tenements to POSCO, the company has entered the quarter with no debt.

Uncertain Pricing

Macquarie reduces its long-term outlook, lowering estimates for earnings per share in 2019 by -31% and by -9% in 2020-21. A higher debt loading for Sal de Vida means 2022 estimates are lowered by -27% and the broker downgrades to Underperform from Neutral.

Credit Suisse carries only 50% of its valuation of Sal de Vida in the stock's valuation to account for the uncertainties. Crystallising value through a partial sale and finding the finance to develop would offer opportunities but this appears of the table at present. The read-through price from the POSCO sale is US$700-850m and achieving a sale price near that level would add considerably to valuing the stock.

Achieving a sale is the principal re-rating opportunity, Credit Suisse believes but also points out that a progressive reduction in reporting disclosure, particularly around prices or margins, entails a risk to estimates, particular given the fact peers openly provide this information.

The broker assumes a spodumene price of US$740/t for the March and June quarters and reduces second half estimates to US$650/t. This remains a risk given recent declines and spot prices and the fact Mount Cattlin may need to ship increased volumes in the second half to clear the inventory build up, and this may lead to discounting.

FNArena's database shows four Buy ratings and one Sell (Macquarie). The consensus target is $2.45, signalling 51.2% upside to the last share price. Targets range from $1.50 (Macquarie) to $3.20 (Citi, yet to comment on the quarterly).

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