The investment case for phosphate, Quebec, and Arianne

When Michael Goldberg of Stonecap Securities looks at Arianne Resources (DAN-V) and its phosphate project in northern Quebec he sees one thing: a takeover target.

The Toronto-based research analyst believes the junior’s igneous hard rock phosphate deposit will appeal to integrated phosphate producers in North America who face dwindling supply at home and have had to look abroad to unstable political jurisdictions in Northern Africa and to Morocco in particular as a source of supply.

His investment thesis is simple: Over the last two decades phosphate rock production in the United States has fallen by an average of 2.1% a year while exports have dried up to nothing from about 6.2 million tonnes. Imports have filled the gap — rising from about 1.0% of consumption in 1990 to 6.9% in 2010. And much of the imported phosphate comes from Morocco, which has the largest share of the world’s phosphate rock reserves with an estimated 50 billion tonnes. (China, Algeria and Syria follow with 3.7 billion tonnes, 2.2 billion tonnes and 1.8 billion tonnes, respectively.)

“The U.S. has experienced a trade deficit in phosphate rock every year since 1996, which we believe is being filled by supply from politically unstable regions such as Northern Africa,” Goldberg wrote in a July 2011 report initiating his coverage of Arianne Resources. “We believe that the Lac a Paul deposit would be a more favourable alternative for the major U.S. fertilizer producers.”

Cash-rich Mosaic Co. (MOS-N) could be interested in Arianne Resources, Goldberg outlined in a research note in early August,  after the fertilizer giant’s chief financial officer, Lawrence Stranghoener, reportedly said during a conference in July that the company’s second priority was making strategic investments such as new rock mines or acquisitions or joint ventures.

Goldberg reasons Arianne would be a good fit for Mosaic for a number of reasons. For a start it would offer a cheaper source of material over imports from Morocco and would extend the company’s reserve life, which the analyst estimates currently stands at about 9.5 years for its operating mines. And it would also increase security of supply by presenting an attractive alternative to the problems it has faced in central Florida where all of its wholly owned phosphate mines are located.

Permitting challenges at Mosaic’s South Forte Meade mine extension in the state have been a huge headache for the company, for example. Goldberg points out that it took Mosaic more than eight years to complete the permitting process, only to find that it then faced litigation challenging its federal wetlands permit. That challenge resulted in a preliminary injunction that forced Mosaic to cut its production capacity at the mine by 22% and hiked its pre-tax production costs by about US$200 million annually.

“Mosaic incurred total litigation cost of US$13 million before receiving judicial approval of its settlement agreement in March 2012,” he explained in an Aug. 2 research note. “While environmental and permitting issues have been resolved for the time being in the area, adding mines in other politically stable regions would help mitigate this risk in the future.”

In terms of other sources of supply of phosphate in North America, he continues, Agrium’s (AGU-T, AGU-N) Kapuskasing mine in Ontario, which feeds the company’s MAP fertilizer plant in Redwater, Alberta, is nearing the end of its mine life. Agrium has said on the record that its phosphate reserves at the Kapusakasing mine will not last much beyond 2013, Goldberg says.

In May Arianne Resource released initial findings of its enhanced prefeasibility study for the project, about 200 km north of the town of Saguenay in the Saguenay-Lac-St-Jean region of Quebec. The EPFS envisioned a 17 year mine life with a production scenario of 3 million tonnes per year of phosphate concentrate and a capex of US$795 million with a payback period of 3.8 years. The study outlined a pre-tax net present value at an 8% discount rate of US$1 billion and an internal rate of return of 23.7%. (The company did not provide after-tax figures.) The study was based on measured and indicated resources of 348 million tonnes grading 6.50% P2O5, or phosphate, but excluded inferred resources of 114 million tonnes grading 5.46% P205.

On Sept. 5 Arianne released results from drilling completed in April on the project’s Paul Zone. The 15-hole drill program expanded the length of the phosphorous and titanium mineralization in the zone by an extra 700 metres — bringing the total strike length to 2.7 km. Drill results from the last nine months will be folded into a resource update and a bankable feasibility study that is scheduled for completion next year. The Paul Zone remains open at a vertical depth of 400 metres.

One of the interesting things about the Lac a Paul deposit is that it is an igneous deposit rather than the more common sedimentary-style deposits. Goldberg notes that while igneous phosphate ores “are often lower in grade in the ground, they can be upgraded through beneficiation to extremely high grade concentrates and generally sell for much higher prices.” He also notes that sedimentary deposits, which make up the bulk of world phosphate production, contain much higher concentrations of heavy metals like cadmium.

In terms of infrastructure, the project can be accessed by a network of logging roads and is about 30 km away from a settlement called Chutes-des-Passes, where the company can access a 160 kilovolt power line.

Goldberg has a twelve-month target on the stock of $2.50 per share. At presstime Arianne was trading at 88¢ within a 52-week range of 80¢-$2.48. The company has about 67 million shares outstanding.