Looking ahead at Horizonte Minerals

Coming soon after my piece on Emmerson’s likely funding for it proposed Moroccan potash mine, the just announced full and final funding package for Horizonte Minerals’ Araguaia Brazilian nickel project adds more insight to the likely state of funding for others. I imagine Emmerson’s advisers will be looking closely at the details.

Private investors will be advised to as well. Most have been disappointed with the 7p share price set for Horizonte. That wasn’t unexpected. PI’s tend to set rosy expectations based on large looking NPV’s. Institutions set it lower. But for HZM they seem to have set them even lower than usual, and have extracted quite onerous terms.

However, it’s not all private investors’ fault. Having been led to believe until quite recently that the capex for Araguaia would be around $440m (up nearly 10% from the 2018 feasibility study, due to steel and other price rises) what HZM has just raised is a staggering 46% higher even than that, at $633m.

Perhaps that unforeseen cost is why the funding institutions are being cautious and, instead of the 70%/30% split between debt and equity many expected, we have a funding package that is 55% bank debt and the rest mostly equity but with a convertible loan element. Belt and Braces is afforded by an agreement by Glencore to take the first ten years of Araguaia’s production, although at what true cost isn’t clear.

The $65m convertible loan is only 10% of the funding but (unless repaid at $91m in three years time) has the potential to add another 20% – or 782m shares – to the 3,888m shares in issue after this fund raise. That will take the total to around 4,670m shares, 3.2 times the number a year ago when I had made my own forecasts and considerably more than anyone bargained for.

All these extra cost elements chip away at the value per HZM share most investors were going for. In my own latest update in October last year I said I did not expect the fund raise to be at the 10p per share most observers were hoping for.

And on top of it all, private investors always buy too early. Stage one won’t even begin to earn the $250m cash to pay for stage two until at least five years from now. Which means the full stage two rate of production and therefore the availability of cash free to pay dividends and on which the market will price the shares, won’t happen until 2028 at the earliest. Discount 7 years at 8%, and the NPV investors see now (and a sensible share price) is only 60% what it is stated to be once that cash starts to flow.

Even ignoring that, let’s see how value for shareholders has panned out compared with the expectations in my coverage (starting in 2016, ten years after HZM came onto the market at over 30p, and well before it bought Aruaguia cheaply from Teck Resources) when it was still valued at only around £30m. I flagged it subsequently as one of the few early stage miners likely to become large, due to the key position it is building in world-wide nickel production. So what should investors do, now that the fund raising has been made at a disappointing price but which means the project is definitely happening, while the lower price (which I think will be maintained for some time) ought to offer better value.

(Note that HZM has meanwhile added another, separate, project – Vermelho – which will start considerably later if ever, and is not included in these calculations or in this funding except to a very small extent for preliminary work. If it happens it promises to be much more profitable than Araguaia)

Araguaia, the project now funded, will be in two stages, the second starting three years later and doubling capacity (but output and profit only between 45% and 65% more) to be funded by $250m of the cash flow from stage one, so shouldn’t need a further raise. But it, has not been studied in detail, and although included in the company’s projections, has probably not been given much credit by the institutions, yet adds a variation which will confuse private investors as to which stage, at what assumed nickel price, is supposed to be being valued by the shares here and now.

It doesn’t help that because the nickel price has been rising strongly (and currently is at $19,500/tonne) HZM has provided three valuation scenarios, at $14,000; $16.800; and $26,450/t with enormous implications for long term value. It is likely the institutions are relying on the lowest while, of course, private investors will go by the highest. Most seem to be going by what HZM says is the market ‘concensus’ of $16,800 which is what I will assume and is near the ‘long term consensus’ HZM was assuming only last February.

I first made a serious stab at how the finances would pan out for Araguaia stage one in October 2019 (where I also set out how HZM had arrived there) – just after the shares had doubled to around 5p, after Indonesian export bans had doubled the nickel price and, more important, when soon after that, the first major institution had come aboard. That was Orion Mine Finance, whose $25m up-front payment to kick start preliminary work on Araguaia was in return for a 2.25% royalty on its first stage nickel production of 462,000 tonnes. At a $16,800 nickel price that will pay Orion $5.75m pa, worth an NPV of $68.1m (which will deduct 8.3% from the $740m project NPV). Nice work for Orion, and the first big chip off value to shareholders..

One of HZM’s advisers said then that the deal was the equivalent of having raised equity at 10p per share. But as I said in my article “- a simple calculation will show why I don’t believe the institutions will pay that (the nickel price, and any subsequent revised feasibility study, staying equal)

At the time those were, respectively for stage one, $14,000/tonne and a $410m NPV, at an initial $433m capital cost, whereas HZM now quotes $16,800/tonne and a $740m NPV. The capital cost is the same, but with contingencies and working capital amounting to a staggering $225m added, which is being met within the new $633m fund raise.

I updated my figures again in October 2020, after the shares had doubled again to 8-9p on the signing of a deal with major banks to raise up to $325m towards the full capital cost. (They are now providing $346m). At the time the nickel price was again recovering strongly, but I still thought that (on the basis of my calculations of the year before) the 10p which many were still saying would be the eventual equity capital raise price would still not be achieved. That was in the face of broker Cantor Fitzgertld only months later projecting a share ‘target’ of 23p.

To recap why I have never thought such prices feasible, and why NPV’s (on which they are based) always mislead, note that Araguaia’s takes in all estimated earnings over a very long 29 year mine life. Why would any investor pay more and more for the larger and larger NPV that is thrown up by taking in earnings further and further into the future? Ten years is the maximum I think institutional investors assume

A more reliable forecast of share value would be based on the expected annual cash flows, which in the early years will bear the costs of repaying the funding, as also the ‘hidden’ costs of the streaming offtake and the royalty payments. For the latter for example, what Araguaia loses is not just the 2.25% of top-line revenue, but also the cost of extracting the product which, for stage one at a $16,800/tonne nickel price, amounts to 64% In other words the real loss to the company is 3.65% of profit, and therefore 3.65% of the NPV.

So to sum up all the factors that will produce a ‘true’ PV at start of production, and a ‘true’ annual cash flow for HZM shareholders on which I believe they should value the shares, they are as follows: (figures based on the $16,800/t ‘consensus’ nickel price and the stage one plan)

• The $346m bank loans look complicated, but, to simplify, incur repayments over ten years at between 2.5% and 5.5% (at current low 0.7% LIBOR, which might increase substantially over the next ten years) I estimate average annual repayments will be $42m with an NPV of $460m (to be deducted from the project NPV)

⦁ The $65m convertible loan is at an eye-watering 11.75% which if rolled up will need repaying at $91m in three years time or buy 782m extra shares..

⦁ The original 2019 Orion royalty deal which I estimate takes $68m away from the NPV

⦁ A new $25m Orion finance loan for early work at Vermelho in return for a 2.1% revenue royaly from its future production. This doesn’t impact Araguaia

⦁ An agreement by Glencore to take the first ten years Araguaia stage one production. The company says ‘at market prices’.

⦁ The whole financing package replaces the upfront $433m capital cost which the stated project NPV will have deducted from the gross NPV after production start, so can be added back

⦁ This means the true ‘adjusted’ PV at start of production in 2025 will be $740m-$68m+$443m-$460m = $655m

⦁ Per the 4,670m shares then in issue, that equals 10.5p per share.

⦁ If stage two is added from production year four, the combined life-of-mine NPV becomes $1,179m and, per share, will be 18.9p

⦁ However, this NPV totals the whole 29 year life and is not a logical price to pay

⦁ A more appropriate figure will be the net cash flow, which with stage two at $16.800/t will total $4,033m over 29 years – ie £1.05m pa – or 2.2p per share per annum.

⦁ What will the market pay for that ? I would suggest not a lot more than 10p. Or if nickel remains at its current $19,000/t (which could be a short term bubble due to current production constraints) maybe 15p.

But how do I know how investors will behave? In the short term they might be dazzled by the ‘potential’ should nickel get to the ‘high’ $26,000/tonne ?

But the benefit of that won’t flow through until at least 2028, so I think realism will keep the shares at current or even lower levels for some time yet.