Small Caps | Sep 04 2017
Orocobre has delivered an upgrade to inventory at its Olaroz lithium brine project in Argentina amidst favourable product pricing and improved production potential.
-Better understanding of salt densities and inventory tracking in line with modelling
-Improvements in Chinese and ex-China carbonate prices signal potential for stronger margins
-Significant room for outperformance suggested should targets be delivered
By Eva Brocklehurst
Orocobre ((ORE)) has delivered an upgrade to inventory at its Olaroz lithium brine project in Argentina amid favourable product pricing and improved production potential. FY18 production guidance is for 14,000 tonnes with a 45:55 first:second half split. This follows a positive update on pond inventory re-balancing with brine levels recovering in line with the company's expectations.
Total expected inventory in the brine pond has risen to 44,000t based on bathymetric surveys and a better understanding of salt densities. Inventory levels are now tracking in line with revised models.
Deutsche Bank considers this incrementally positive, as the data should help reassure investors that the management of ponds is back on track. The process should be further improved through the installation of pumps in the primary and intermediate ponds. As the operation has now passed the winter season evaporation rates should begin to lift.
Macquarie suspects the forecast for 14,000t in FY18 is ambitious, particularly given the customs data on sales to date. The broker believes management will need to have an extraordinary second quarter to accomplish this target.
Pricing Outlook
The company has guided to lithium product pricing of over US$10,000/t for FY18 but improvements in both Chinese domestic and ex-China carbonate prices signal the potential for stronger margins in 2018. Canaccord Genuity currently forecasts an average of around US$11,000/t for Olaroz in FY18.
UBS speculates whether the company is turning the corner. Cash generation was strong within Olaroz and the debt has been repaid to the owners. With battery grade carbonate pricing at US$13,500/t and industrial grade over US$11,000/t UBS believes the guidance is conservative.
The broker maintains estimates for a realised price of US$12,000/t but reduces production expectations to the level of guidance, as the company has signalled a weak September quarter. Given the weak sales to date and the Mizuho repayment due this month, Macquarie expects the company must draw on debt to make the payment, or set up another shareholder loan in the interim.
As the company is forecasting additional repayments of shareholder loans based on current receivables, the broker suggests pricing must be substantially stronger, or volumes need to reach record levels.
FY17 results included a profit of US$14.8m booked on the sale of the Salinas Grande and Cauchari projects offset by a US$8m impairment against the Borax Argentina business. The write-down of the borax business is attributable largely to a poor price environment for boron products and the company acknowledges costs at the operation have not fallen as fast as prices. Morgan Stanley expects borax to continue to be a cash-negative business.
Costs
No costs guidance was provided but Canaccord Genuity expects costs to fall over FY18 to US$3300/t on improved volumes and potential for optimised reagent consumption.
Production guidance is still -10% below Morgan Stanley's estimates for Olaroz stage I and 20% below nameplate at 17,500t. The broker is also doubtful that guidance will hold up in terms of costs in the light of the operating difficulties that have been experienced. A year ago, FY18 costs were flagged to be falling to around US$2500/t while the actual costs for FY17 turned out to be US$3710/t. Morgan Stanley estimates FY18 costs to be more like US$3608/t.
Canaccord Genuity also believes it is a little early to be totally confident that ramp-up problems at Olaroz are in the past but accepts the company is tracking in the right direction. The broker observes, as with many of the ASX-listed lithium peers, the company's shares have underperformed global peers and lithium prices significantly over 2017, although given the production issues this is not entirely without justification.
Should the company deliver on its targets, the broker envisages significant room for outperformance, with the current trading multiple suggesting 60% upside to its target. Canaccord Genuity, not one of the eight brokers monitored daily on the FNArena database, has a Buy rating and $6.00 target.
Studies for the proposed expansion of capacity to 35,000tpa are progressing, with the phase 2 expansion decision likely in the first half of 2018. UBS believes a consistent operating performance and ramp up to nameplate for phase 1 at Olaroz is the main driver for the stock, which should cause the share price to close valuation gap.
The next catalyst is the approval of the lithium hydroxide plant in the second half of this year and a commitment to develop phase 2. Management has indicated a decision on this expansion will be taken to the board once the Olaroz demonstrates consistent in sustainable production at nameplate.
The database shows three Buy ratings, two Hold and one Sell (Morgan Stanley). The consensus target is $4.17, signalling 6.5% upside to the last share price. Targets range from $2.85 (Morgan Stanley) to $5.21 (Morgans).
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