Three junior potash picks

With potash juniors continuing to enjoy the limelight, Mining Markets asked a few fertilizer analysts for their picks in the sector and came up with three companies that stood out.

In a nutshell, they identified three criteria that should rank high on investors’ checklists when looking at potash juniors: the stage of a company’s project(s), the capital costs of development, and the company’s ability to attract partners with deep pockets. Three analyst picks — Western Potash (WPX-V), Amazon Mining (AMZ-V) and Allana Potash (AAA-V) — all exemplify one or more of these attributes.

Stage of development

If you’re looking for potential takeover candidates in the potash space, the stage of development of the junior’s project can be crucial.

Sid Rajeev, head of research at Fundamental Research Corp., says investors should be looking at advanced plays, because that’s what potential buyers — the majors — are looking for.

“They make the juniors do all the hard work delineating the resource and (developing) some idea of the economics,” Rajeev says.

Potash One (KCL-T), for example, received a friendly $434-million offer from Germany’s K+S Aktiengesellschaft in November, just one month after completing a feasibility study for the project, and less than two weeks after getting the project permitted.

But now that Potash One is off the table, the easy pickings are gone, says Joel Jackson, an analyst at BMO Capital Markets.

“All the other potash developments, with the exception of Mag-Industries, their projects are either drill-stage (exploration) or they just have a scoping study, so these projects are a couple years at least behind Potash One in having a full feasibility study,” Jackson says. “A lot of potential transaction partners would prefer to see a feasibility study that fully characterizes the risk of a particular project before they advance in. And if they don’t have that type of study, they certainly would want to pay, I imagine, a much lower price to acquire that project.”

Jackson isn’t currently recommending any of the potash juniors he covers (although he points to Americas Petrogas’s [BOE-V] Gro-Max potash project in Peru as “interesting”).

Rajeev, however, believes that Western Potash is advanced enough at its Milestone project, in Saskatchewan, that it could be the next takeover target in the sector, and compares the project to Potash One’s Legacy.

“Both have very similar projects, they’re in the same area, similar resource estimates, same type of mining method. It’s just that Potash One is a year ahead of Western Potash,” he says.

The company recently announced a financing of up to $40 million, he notes, which will take it through a prefeasibility study or feasibility study.

“I think within a year, they can get a prefeasibility study done, at which point it will be much more attractive,” Rajeev says.

Jaret Anderson, an analyst at Salman Partners, recently upgraded the company to a speculative buy from a hold rating, and raised his 12-month target to $1.30 from 85¢, writing that K + S’s takeover bid for Potash One raises the value of Western Potash.

“We believe Western now offers scarcity value as one of the few remaining viable greenfield solution potash projects in Saskatchewan,” he wrote in a Nov. 23 note.

Anderson adds that the Milestone project’s location in the Prairie province is a big advantage because that’s where buyers have focused their attention. K + S’s offer follows BHP Billiton’s (BHP-N, BLT-L) failed bid for Potash Corp. of Saskatchewan (POT-T, POT-N), as well as its successful $341-million takeover of junior Athabasca Potash earlier this year.

“I think it’s going to take Western at least 18 months before they can publish a feasibility study,” said Anderson in early December. “But the sector is attracting a lot of interest so I do think they have some upside from here.”

Western Potash shares are currently trading at around $1.04 in a 52-week range of 36¢-$1.23. The company has 109.3 million shares outstanding.

In September, the junior released a scoping study that showed Milestone could produce 2.5 million tonnes of potash annually for 40 years with a capital investment of $2.51 billion. The study estimated the project’s net present value (NPV) at $5.22 billion and its internal rate of return (IRR), after taxes and royalties, and at a discount rate of 10%, at 27.3%.

Milestone is also a solution mining project — which Rajeev favours over traditional underground mines.

“They have a significant capital cost advantage over conventional underground mines,” he says, estimating the capex of solution mines at about half that of traditional mines.

Capex

With a greenfield potash mine costing upwards of $2.5 billion to build in Saskatchewan, capex is among the most important considerations for investors looking to cash in on the buzz around the fertilizer.

Capex is also one of the key reasons why a lot of eyes are on Amazon Mining and its Cerrado Verde ThermoPotash project, in Brazil.

Cerrado Verde is not a solution-mining project, but a scoping study of the project, released in October, predicted that it would only cost about US$269.4 million to build an operation producing 2.2 million tonnes of ThermoPotash per year.

“It’s a unique project in that most of these projects in Saskatchewan, you’re looking at sticking a shaft about 1,500 metres below surface and… at a salt-based deposit,” says Salman Partners’ Anderson. In contrast, Cerrado Verde is a slate-based deposit (the mineral is glauconite) that outcrops at surface and could therefore be mined by open pit.

“The concentration of K2O (potassium oxide) is significantly lower than what you see in Saskatchewan but it’s very attractive in terms of being very easy to build (with) very low capital costs,” adds Anderson, who rates Amazon as his top pick in the sector. Whereas he doesn’t see any new production coming out of Saskatchewan until 2016, Anderson thinks Cerrado Verde could be online years sooner — by 2013.

The scoping study estimated the project’s NPV (at a 12% discount rate) at US$652.6 million, its IRR at 40.2%, and operational costs at US$36.36 per tonne. Cerrado Verde has an inferred resource of 105 million tonnes grading 10.3% K2O, but the resource was defined on only a very small portion of Amazon’s property, so there’s still much room for expansion.

Anderson also lists the project’s location in Brazil as a significant advantage — potash consumption has increased at a compound annualized growth rate of 5.5% in Brazil in the past 10 years compared to the global rate of 0.6%. Despite lower grades (about one-third to half of the potassium chloride or KCl content of Saskatchewan and Russian deposits), he says that there is potential for the project to be economic based on the shipping cost advantage. Anderson estimates it costs Saskatchewan producers about US$150 per tonne to ship potash to Minas Gerais state.

However, there is one caveat. The product that Amazon would produce, called ThermoPotash, is entirely new. ThermoPotash contains lower K2O content than conventional KCl (8.5% vs. around 60%), but the product does have certain advantages. It contains significant limestone (which farmers in Brazil use to counter the high acidity of the soil), contains more micronutrients, and is a slow-release fertilizer that is less likely to be washed away by heavy rain.

It’s difficult to predict how much the product will fetch, but a scoping study used a price of US$133 per tonne.

On Nov. 23, when Amazon Mining shares closed at $3.80, Anderson has a 12-month target on the stock of $5 (which it exceeded on Dec. 7, trading as high as $5.30). At press-time, it traded at $4.80. The company has 28.4 million shares outstanding.

Financing/partners

Because of the large price tags of most greenfield potash projects, the ability to attract strategic partners
or an outright buyer are key to the success of a potash junior. Even Potash One, whose chairman is legendary financier Robert Friedland, chose to shop its Legacy project around for a buyer rather than find the over US$2.5 billion required to build the project itself.

If financing doesn’t come soon enough, a junior can face big problems. Take MagIndustries (MAAT), MAAT), for example. Despite having an advanced-stage project, where a feasibility study was completed before the credit crunch, the company has been unable to advance its Mengo potash project (formerly called Kouilou) in the Republic of Congo in west-central Africa.

The company has come close to signing an agreement with Complant, under which debt funding would be made available in return for a majority share in the MagIndustries subsidiary that holds Mengo. However, Complant’s largest shareholder, the Chinese government, has not yet signed off on the deal — which was expected to be concluded in August. MagIndustries is now reassessing its options, including with other potential partners.

The US$1.4-billion project is smaller-scale than its counterparts in Saskatchewan. Mengo has reserves of 33.5 million tonnes of KCl, which would last for 28 years at an initial production rate of 600,000 tonnes for the first two years, followed by 26 years at 1.2 million tonnes annually.

It does have other attractive attributes: it’s a solution-mining project, enjoys access to low-cost natural gas, and is situated only 22 km from a deep water port. The feasibility study gave the project an NPV of US$1.2 billion (at a 12% discount rate) and an IRR of 19%.

“That being said, virtually every mining and potash company has looked at Mag’s project… and to date Mag has not been able to attract a partner with which to move forward,” Anderson says. “Mag’s got an interesting project but I think there are lower-risk ways to participate in the sector.”

Anderson has a “sell” rating on the stock and a target of 25¢. It recently traded at 30.5¢ in a 52-week window of 28¢-59¢ (its shares peaked at over $3 in late 2008/early 2009). One of Mag’s problems is that it has become heavily diluted as it struggled to keep afloat during the financial crisis while waiting for talks with potential partners to bear fruit. The company has 456.8 million shares outstanding.

By contrast, Allana Potash, which holds the Dallol potash project in Ethiopia, on Africa’s east coast, has had the luxury of turning potential partners away, despite having a relatively early-stage project.

Last year, the company backed out of a proposed joint venture with China Co. after finding it had better offers from other investors. (The deal would have seen $4.5 million invested in the company in return for just under 20% of Allana’s shares and 70% of Dallol’s capital costs paid for.) The company recently raised $12.4 million through a private placement with Liberty Metals & Mining Holding (a subsidiary of Liberty Mutual Group). The money means the junior is fully funded to the end of a feasibility study.

Last November, China Mining United Management put $2 million into Allana. The company can secure 20% of production from a mine at Dallol if it picks up 35% of development costs, estimated to be around US$280 million.

Dallol holds an inferred resource of 105 million inferred tonnes grading 20.8% KCl. BHP, Anderson notes, has a significant plot of land next to Allana.

Dallol is a comparatively shallow deposit, with mineralization starting at less than 50 metres depth (against 1,500 metres for Saskatchewan deposits). That means potentially low-cost production by solution mining. Allana is also investigating solar evaporation as a low-cost processing method. Infrastructure, however, including roads, electricity and water are limited or non-existent.

“While the asset presents some challenges based on its location in Ethiopia, the potential for solution mining and interest expressed in the company by Chinese suitors makes it another candidate for consolidation,” Anderson wrote in a Nov. 23 research note.

He has a “speculative buy” rating on Allana with a 12-month target of 90¢ a share. It’s recently traded as high as 81¢, though it’s since come back down to about 66¢.

Robert Winslow, an analyst at Wellington West Capital Markets, has a “strong buy” rating on the stock and a target of $1.20.

The company has 96.5 million shares outstanding and a 52-week range of 29¢-81¢.

— The author is editor of The Northern Miner’s investment magazine Mining Markets, www.miningmarkets.ca