Kimberley Rare Earths Ltd (ASX:KRE) SPECULATIVE BUY

Transcription

1 Update 1 Kimberley Rare Earths Ltd (ASX:KRE) SPECULATIVE BUY Sector: Rare Earths Target: $0.30 COMPANY STATISTICS Share Price $0.078 Valuation $0.30 Cash Backing $ Month Range $0.076 $0.235 Market Cap $9.9m Enterprise Value (negative) ($4.4m) Issued Shares 126.6m Unlisted Options 9.3m Cash Balance (30 Sep 2011) $14.3m Debt (31 Oct 2011) Nil Top Shareholders (Dec 2011): Navigator Resources 8.8% JPMorgan Nominees Aust. 7.2% Citicorp Nominees Aust. 6.7% Directors: Ian Macpherson (Chairman) Tim Dobson (Managing Director) Allan Trench (Non Executive Director) Gerry Kaczmarek (Non Executive Director) SHARE PRICE PERFORMANCE Source: ASX CUMMINS RANGE INFERRED RESOURCE Cut-off Tonnes REO+Y REO Value¹ %REO Mt % 000t $m 0.5% % 120 $240m 1.0% % 72 $142m 2.0% % 30 $60m 3.0% % 12 $24m Source: KRE, Canaccord BGF estimates. ¹ assumes a price of $100/kg REO and a value resource factor of 2%. Analyst: J-François Bertincourt jf.bertincourt@canaccordbgf.com WELL FUNDED, RARE EARTHS FOCUSED JUNIOR COMPANY Investment Perspective: KRE offers a fundamentally sound and cheap entry into the rare earths sector. Results of the recent drilling program have confirmed the geology and extended the existing JORC resource. The grade should also be lifted. Complementing Cummins Range, KRE has acquired the Malilongue project in Mozambique. The Malilongue REO project is large and samples of the pegmatite have returned outstanding TREO grades with a good proportion of Heavy Rare Earths (HREO). Mineralogical examination has found an exceptional concentration of xenotime. Overall, this project represents excellent value complementing the Cummins Range project in Western Australia. Having suffered from a negative market momentum globally and within the rare earths sector, KRE is now trading well below its cash backing. Rare earths prices are still about 10 times what they used to be when Lynas secured funding to develop the Mt Weld project. KRE remains well funded, far beyond any of its peers with $14m cash to progress and add significant value to its projects. We rate KRE as a SPECULATIVE BUY with a target price of $0.30. Investment Highlights Cummins Range REO Project Mine, Western Australia KRE owns 25%, is fully funded to earn 55% ($4m expenditure required) and has the right to earn up to 80% through the completion of a feasibility study. The existing JORC resource amounts 4.17 Mt at 1.72% TREO for 71,700 t TREO. The recent drilling programme has confirmed and extended the mineralisation. An updated resource estimate is expected in Q The open-pit mining scenario has enviable characteristics. Metallurgical testing is underway and the design of the process flow chart should the benefit of three advanced REO project developments within Australia. Malilongue HREO Project, Mozambique (earning 90%) KRE owns 40%, is fully funded to earn 80% ($4m expenditure required) and has the right to earn up to 90% by sole funding expenditure to production. The Malilongue intrusion is a large 7 km x 3 km pegmatite over which 65 separate artisanal workings are currently exploiting gemstones. Past rock chip samples have returned excellent grades in the pegmatite with 3 assays out of 4 in the order of 20% TREO. The proportion of HREO is high, in the order of 26% of the TREO mineralization. Exploration activities include geophysics reprocessing, mapping, rock chip sampling and stream sediment sampling. The Malilongue pegmatite presents many similarities with the Strange Lake deposit in Quebec, owned by Quest Rare Minerals (QRM.TSX). QRM has an enterprise value of $140m, equivalent to $149/t REO based on a resource of % REO. Canaccord BGF is the Australian partner of global capital markets group Canaccord Financial Inc. (CF:TSX CF:AIM) The recommendations and opinions expressed in this Investment Research accurately reflect the Analyst s personal, independent and objective views about any and all the Designated Investments and Relevant Issuers discussed herein. For important information, please see the Disclosures section in the appendix of this document.

2 Update 2 VALUATION METRICS ENTERPRISE VALUE AND CASH Figure 1: Enterprise value and cash Notes: 1. The following are out of range in the above graph LYC s EV of $1.3bn; cash $370m and ARU s cash $55m. 2. KRE is the best funded company among the rare earths juniors. 3. KRE enterprise value is negative and far below the market value attached to its peers. In comparison, KRE has a resource already defined and is about to be increased in terms of both tonnes and grade. KRE is well funded to explore both Cummins Range and Malilongue projects. KRE also appears significantly undervalued compared to its peers, as further supported below on an Enterprise Value / Resource basis: ENTERPRISE VALUE AND REO RESOURCE Figure 2: Enterprise value and REO resource Notes: 1. Based on a 55% ownership of Cummins Range. KRE has 25% ownership, but has the funds required to reach 55% and the right to earn up to an 80% interest in the Cummins Range project through the completion of a feasibility study in bankable form. With the shares currently trading at a significant discount to its cash backing and its peers, we rate KRE a SPECULATIVE BUY, with a price target of $0.30.

3 Update 3 CUMMINS RANGE REO PROJECT INTRODUCTION Cummins Range is one of several rare earths projects under consideration around the world. Three of the most advanced projects, Dubbo, Mt Weld and Nolans Bore, are in Australia. For Cummins Range the implications of the developments at Dubbo, Mt Weld and Nolans Bore are: The development of local expertise at management and consultant levels. Dubbo, Mt Weld and Nolans Bore have been the subject of intense metallurgical and engineering studies for several years. Australia (and Malaysia) will soon form a second regional rare earths expertise pool. This technical and practical experience will potentially be at the disposal of the developers of Cummins Range. The development of rare earths processing infrastructure in an arc surrounding Cummins Range. The construction of separate flotation, heavy media separation, chemical and rare earths separation facilities in the region potentially lowers the capital hurdle for Cummins Range. Awareness has been raised among the investment community of rare earths and the price upside on offer. Figure 3: Development Time Line Source: Company presentation.

4 Update 4 Figure 4: Cummins Range resource drilling results STRATEGIC BUSINESS PLAN Lead by a newly appointed General Manager (see Processing section), the budgeted and approved development plant is as follows: Preliminary Evaluation Study for delivery by July 2012; Pre-Feasibility Study with forecast completion in 2013; and Definitive Feasibility Studies with forecast completion in GEOLOGY AND MINERALISATION The Cummins Range resource has the following features: The mineralisation outcrops and mainly occurs in a sub-horizontal geometry, up to 50m in thickness. A low strip ratio is expected. Cummins Range displays carbonatite derived supergene mineralisation. Similar genesis to Mt Weld in that high thorium content of primary monazite found in most carbonatite intrusions has been reduced to sub 50 ppm. Cummins Range may be similar in primary mineralogy to Mt Weld but its grade and potential product profile more closely resembles the mineralogically distinct Nolans Bore. CSIRO identified monazite and apatite as the main rare earths bearing minerals from samples taken from the Cummins Range high-grade zone. RECENT DRILLING PROGRAMME The results of the recent drilling program are in line with previous results in terms of width and grade, but with some welcome extensions. Overall, there is now a number of significant drill intercepts with grades above the grade of the existing resource dated September The ore body geology is confirmed. Deposit is structurally controlled with a central shear zone, where a carbonatite intruded, then a deeper weathering profile developed. Source: Company presentation.

5 Update 5 The controlling NW-SE structure can be seen on the underlying aeromagnetic image. The high-grade zone remains open and needs to be tested for at least 200m to the NW and 400m to the SE. Current drilling extent is about 600m along strike. Within the high-grade zone, the rich core was not drilled during this campaign due to technical difficulties in this highly weathered zone. KRE plans to revisit that zone with a different drill rig. Additional high-grade drill intersections would further support an overall lift in the resource grade. Overall, the mineral resource has the potential to be further extended beyond the footprint of this drilling campaign in terms of both tonnage and grade. Three out of the five aeromagnetic targets, returned moderate results in terms of widths and grade and further work on these targets are now a second priority. The low level of thorium is in line with previous estimates of 42 ppm, well below the threshold of 500 ppm requiring special transportation conditions. It also augurs well for the development of a metallurgical flow chart to produce rare earths concentrate. MINING SCENARIO Given the characteristics of the deposit, we can envisage a mining scenario by open pit, with enviable characteristics such as: no pre-stripping required; a very low strip ratio overall; a clear potential to convert most of the mineral resource into mineable ore; and the opportunity to commence with a higher grade starter pit. PROCESSING SCENARIO In the rare earths sector, having a resource is a good starting point, but mastering the metallurgical process is key to unlock value. The mineral processing route to produce monazite concentrate are already well known. Arafura Resources successfully separated rare earths oxides from apatite ore in September KRE could benefit from the ARU project development, using the Whyalla metallurgical plant to treat the concentrates produced. To maximize value, KRE could opt for the production of two or three concentrates separating the light/medium and heavy rare earths oxides. In November 2011, KRE appointed Michael Chan as General Manager Project Development. Michael Chan is highly experienced in the development of complex metallurgical flow sheet and well versed in commercial dealings with Asia.

6 Update 6 MALILONGUE HREO PROJECT (40%, earning 90%) KRE has signed a farm-in agreement with Great Western Mining Ltd (GWM, a local operator) by which KRE can earn up to 90% interest in the Malilongue project. KRE already owns 40% of the project and is fully funded to earn up to 80% by spending $4m in exploration and development activities over the next five years ($1m expenditure within 2 years to reach 55% and $3m within a further 3 years to reach 80%). A further 10% can be earned by sole funding expenditure to the point of production. The project is located a few hours drive from Tete, Mozambique s new mining epicenter (iron ore and coal, particularly coking coal) and where a number of companies are making in-roads (BHP Billiton, Vale, African Eagle, Globe Metals and Mining, Baobab Resources) in parallel to Rio Tinto making a grab of Riversdale. The Malilongue intrusion is a large 7 km x 3 km pegmatite over which 65 separate artisanal workings have currently been operating, exploiting gemstones such as amazonite, aquamarine and topaz of exceptional quality. Mineralogical examination has found an exceptional concentration of xenotime. In addition to yttrium, the xenotime shows appreciable presence of dysprosium, terbium and erbium, heavy rare earths metals in critically short global supply. If this mineralisation occurs in a rock unit of substantial tonnage, it will be a very attractive exploration target. The agreement covers all metals and excludes gemstones. Past rock chip samples have returned excellent grades in the pegmatite with 3 assays out of 4 in the order of 20% TREO. The proportion of HREO is high in the order of 26% of the TREO mineralization. This project is in the early days of exploration. No systematic exploration for REO mineralization has been undertaken in the area. As such, the deal has been structured to include technical due diligence and staged consideration. The due diligence produced a positive outcome and the initial exploration program includes geophysics reprocessing, mapping, rock chip sampling and stream sediment sampling. The Malilongue pegmatite presents many similarities with the Strange Lake deposit in Quebec, own by Quest Rare Minerals (QRM.TSX). QRM has an enterprise value of $130m, equivalent to $224/t REO.

7 Update 7 RARE EARTHS MARKET UPDATE As displayed on the graphs below and despite the recent correction, rare earths prices are still about 10 times what they used to be when Lynas secured funding to develop the Mt Weld project. Figure 5: Cummins Range REO blend price in $/kg Source: Company presentation. Top: linear scale. Bottom: log scale. Prices for rare earths can be difficult to determine because they are sold in only small amounts and through private transactions. But industry observers say prices and broader global demand have been falling since June 2011, although they remain well above last year's levels. Prices for lanthanum oxide are down nearly 60% from the third-quarter average, while cerium oxide is down 58% in the same period, according to data from Australian rare earths producer Lynas Corp. Chinese export quotas For 2012, China s quota for rare earths exports should match the one for 2011 at 30,184 t, which is slightly below that of 2010 at 30,258 t. In the first 11 months of 2011, total exports stood at only 14,750 t amid a nationwide inspection and crackdown on illegal activities in the sector. The first tranche of exports quotas (i.e. H1 2012), the 10,546 t quota will be split for the first time into 9,095 t of light minerals and 1,451 t for the medium to heavy category.

8 Update 8 Light rare earths are used for applications like magnets. Heavy rare earths, which are used in more technologically sensitive areas and seen by exporters as more lucrative, had been more greatly represented in past exports. Heavy rare earths are found mostly in southern Chinese provinces like Guangdong and Jiangsu, while light rare earths are largely found in Inner Mongolia. Conscious of efforts to portray its quota reduction as protectionism, Beijing has unveiled a new system that would exclude from the quota companies that didn't meet its environmental standards. The government appears to be putting on notice companies that haven't fully answered the government's environmental requirements, including China s biggest producer Baotou Steel Rare Earth Group Hi-Tech Co. Ltd. Chinese demand key to growth over last five years Global demand for rare earths grew at 5%py between 2005 and 2010, although the market shrank in 2009, in line with the global economic downturn, which had a marked negative impact on demand in the rest of the world. Growth in demand in China was much higher, running at 11%py and the country now accounts for 70% of world demand. Estimated total demand in 2010 was 125,000t REO. Consumption of rare earths in the rest of the world declined by nearly 4%py between 2005 and The decline was partly due to the impact of the recession but also reflected the increasing volume of downstream processing within China and the tightening export quota. LREE vs. HREE Among the LREE, lanthanum (La) and cerium (Ce) are the high volume REE but are most amenable to substitution (particularly La in fluid catalytic cracking oil refining, and the move from nickel metal hydride batteries which contain La to Lithium Ion batteries), or consumption reduction (particularly Ce in the glass polishing industry, a major consumer polishers have been wasting a lot until recently as it has been so cheap, now using 50% of what they were by recycling and polishing with less for longer). These demands will rise again as prices fall. The HREE argument has been dominated by the massive reduction in production and export quotas from the Chinese Ionic Clay deposits in Southern China (the ones dominated by artisanal miners and shocking environmental legacies). Much of this production has been curtailed by the Chinese government causing a short-term undersupply situation. Key metals here are dysprosium (Dy, used to make the Nd/Pr magnets maintain their magnetic strength at a temperature greater than 80 critical for electric motor / generator magnets), and terbium (Tb, electronics and green phosphors for lighting and TV screens). However, these markets are very small (only tiny amounts of the metals are used in each application) and a number of projects outside China are advancing on this front, any one of which will cover the undersupply situation, and magnet research is advancing fast to eliminate the need for dysprosium. Neodymium (Nd) is the one metal, and to a lesser extent its brother praseodymium (Pr), that should maintain a healthy price in the long term due to supply and demand fundamentals. These two metals are normally classified as LREE as they come straight after La and Ce on the periodic table when mixed they have been termed didymium. Cummins Range TREO has 15% Nd and 5% Pr, or 20% didymium. The magnet market is the fastest growing of the rare earth applications, and you can t make an equivalent magnet with any other metal (no substitution opportunity). Rare earth mines may in fact become neodymium mines with other REs as byproduct credits.

9 Update 9 Disclosure: Canaccord BGF Limited and its related entities ( Canaccord BGF ), its Directors and/or employees may earn brokerage, fees, commissions and other benefits as a result of a transaction arising from any advice mentioned in this report. Canaccord BGF as principal, its Directors and/or employees and their associates may hold securities in the companies the subject of this report, as at the date of publication. These interests did not influence Canaccord BGF in giving the advice contained in this report. Details of any interests may be obtained from Canaccord BGF. Canaccord BGF as principal, its directors and/or employees and their associates may trade in these securities in a manner, which may be contrary to recommendations given by an authorised representative of Canaccord BGF to clients. They may sell shares the subject of a general Buy recommendation, or buy shares the subject of general Sell recommendation. Canaccord BGF has not been in receipt of any fees for the preparation or publication of this report. Canaccord BGF seeks to do business with the companies outlined in this report and as such cannot be considered independent. Canaccord BGF has received fees and options for capital raising activities from Kimberley Rare Earths Limited. The author of this report holds an interest in the securities of Kimberley Rare Earths Limited. Analyst Certification: The analyst certifies that: (1) all of the views expressed in this research accurately reflect their personal views about any and all of the subject matter contained in the report; and (2) no part of their compensation was, is, or will be directly or indirectly related to the specific recommendations of views expressed herein. Disclaimer: All information, terms and pricing set out in this document is indicative, based on, among other things, market conditions at the time of this writing and is subject to change without notice. This document is for informational purposes only and is neither an offer to sell securities, or other financial products nor a solicitation of an offer to buy securities, or other financial products. Canaccord BGF and each of their respective directors, officers and agents (together the Disclosers) have prepared the information contained in these materials in good faith from sources believed to be accurate and reliable. However, no warranty (express or implied) is made as to the accuracy, completeness or reliability of any statements, estimates or opinions or other information contained in these materials (any of which may change without notice) and to the maximum extent permitted by law, the Disclosers disclaim all liability and responsibility (including, without limitation, any liability arising from fault or negligence on the part of any or all of the Disclosers) for any direct or indirect loss or damage which may be suffered by any recipient through relying on anything contained in or omitted from these materials. Any reader is strongly advised to make their own enquiries and seek independent professional advice regarding information contained in these materials. In no way shall Canaccord BGF be deemed to be holding itself out as a fiduciary of the recipient hereof. The recipient must independently evaluate any investment, which include the tax, legal, accounting and credit aspects of any transaction. Financial products and trading strategies of the type described herein may involve a high degree of risk, and the value of such financial products may be highly volatile and may be adversely affected by the absence of a market to provide liquidity. To the extent that this document includes any financial product advice, the advice is of a general nature only and does not take into account any individual s objectives, financial situation or particular needs. Before making an investment decision an individual should assess whether it meets their own needs and consult a financial advisor, the product disclosure statement, prospectus and/or available research in respect of the financial product. Canaccord BGF does not make markets in the financial securities referred to in this document. Canaccord BGF and its directors and employees may hold such financial securities and may, as principal or agent, buy or sell such financial securities. Copyright 2012 Canaccord BGF Limited. All rights reserved. Canaccord BGF refers to Canaccord BGF Limited ABN , holder of Australian Financial Services Licence No , Canaccord BGF Equities Pty Ltd ABN , Canaccord BGF Capital Group Pty Ltd ABN , all of its subsidiaries and related bodies corporate, and all of their respective directors, officers, employees and agents. This material is proprietary to Canaccord BGF and may not be disclosed to third parties. Any unauthorised use, duplication or disclosure of this document is prohibited. The content has been approved for distribution by Canaccord BGF Limited AFSL