Lepidico — Valuation update pending feasibility study

Since Edison’s last report (see Lepidico: Caesing the opportunity, published on 19 November 2019), Lepidico has announced a number of developments with respect to its Karibib Lithium Project in Namibia, which it acquired with its takeover of Desert Lion Energy in July 2019. The more significant of these recent developments are detailed below:

An analysis of the principal consequences and effects of these announcements is provided in the sections below.

Lepidico’s updated mineral resource estimate at Karibib, announced on 30 January, was based on 5,164m of additional diamond drilling at the two largest, lepidolite rich pegmatite deposits within the project area, namely Helikon 1 (where 35 holes were drilled) and Rubicon (where a further 51 holes were completed). The object of the drilling programme was specifically to promote resources from the inferred category into the measured and indicated categories for subsequent inclusion into the proven and probable reserve categories, rather than to increase the tonnage of the resource. Within that context, pit optimisations were undertaken for Helikon 1 and Rubicon that demonstrated that resources could be economically extracted at a cut-off grade of 0.15% lithium oxide (Li2O) with the result that the cut-off grade for the deposits was lowered to this level from 0.20% in the previous mineral resource estimate with the inevitable result that there was nevertheless some collateral increase in tonnage as well. A comparison of the mineral resource estimate at Karibib in January 2020 relative to that in July 2019 is as follows:

A number of features of the mineral resources upgrade in the table above are noteworthy:

Although Lepidico’s Karibib lithium grades are noticeably lower than those at Alvarrões (eg 0.43% lithium oxide cf 1.16%), one of its alternative sources of ore, it still comprises a massive lepidolite zone as well as lower grade mixed lepidolite-muscovite and muscovite zones. In addition, part of the reason for the lower lithium grades is the correspondingly higher by-product grades, as a result of which Lepidico expects to produce more, higher specification SOP as well as caesium and rubidium products.

The pegmatites at Karibib are characterised by a barren, coarse grained quartz core. Historically, this was surrounded by a petalite zone (sometimes on one side only) adjacent to the quartz core, although this has generally been mined out by historical mining operations that largely focused on the petalite itself for the ceramics industry. Around the petalite zone is a high-grade lepidolite zone (denoted the LEPZ zone), which also represents the main source of caesium in the orebody, and around that a low grade, disseminated lepidolite zone, which is layered and banded with albite and denoted the LEPZ-B zone. Surrounding the whole is the mica zone, which also contains varying concentrations of lithium. The ratio of the mica zone to the two lepidolite zones is approximately 2.5 to one. Management interprets the structures to be consistent with a tectonic gash filled with granite fluids that have then cooled slowly from the edges, concentrating the non-compatible elements (eg caesium) towards the centre of the structure.

The Rubicon and Helikon deposits are 7km apart. Rubicon has a 700m strike, while Helikon is 400m long, but bounded by a north-south fault at depth where there is a sharp boundary with a sandstone/shale unit. Discrete lenses are identifiable as the pegmatites pinch and swell. Historical underground workings confirm that the different zones may be distinguished visually, which will aid the distinction between the LEPZ zone and the LEPZ-B zones when mining, in addition to close grade control drilling.

Key to Lepidico’s success will be its ability to match production from the mine with processing rates at its plant. Greatly in its favour however is the fact that historical mining operations have effectively already pre-stripped the orebody for exploitation by Lepidico and much of the essential infrastructure is already in place including water bores and pipeline and haul roads.

The pit optimisations used for the mineral resource estimate at Rubicon and Helikon indicate that mining should start at Rubicon, which should be the source of the first 1Mt of LEPZ and LEPZ-B material at a grade of approximately 0.7% lithium oxide and a stripping ratio of 0.3 to one. In production year 3, mining is expected to move to similar grade material at Helikon 1, but with a stripping ratio of about two to one. Three years after that, Helikon 1 will move to the second of its two stages of development, during which both grade and recoveries are expected to decline, while the stripping ratio rises. Nevertheless, over the first 10 years of operation, c 4.0Mt of mineralisation will be prioritised from both Rubicon and Helikon 1 with an average grade of c 0.55% Li2O and a stripping ratio of only c 1.4 to one to supply concentrate feed to the planned Phase 1 L-Max chemical plant. Overall however, mining tonnages are extremely low, necessitating only a small fleet, comprising two excavators and two trucks. Haulage from Helikon 1, in particular, is expected to employ conventional road trucks.

Stage 1 feed will be dominated by ostensibly massive, augmented by some disseminated, lepidolite, initially at a rate of 40tph, or 330ktpa and with an expected recovery into concentrate of 85–90%. It is then envisaged that the Karibib concentrator capacity will need to increase by c 65% in production year 5 (when Helikon 1 moves into a lower grade zone – see above). Known as Stage 2, this will involve increasing throughput to 65tph (or 540ktpa) at a 79% recovery in order to maintain 60,000tpa of concentrate output from predominantly the mica zone feed, grading c 0.45% Li2O on average (but, in places, up to 3% over 5–6m). Stages 1 and 2 together are anticipated to account for the first 10 years of operations. As they stand, measured and indicated resources are estimated to be sufficient to support concentrate production for approximately 14 years, with a further two stages planned after the completion of stages 1 and 2. In addition, considerable surface stockpiles of massive lepidolite exist – a ‘waste’ product from historical mining. These are not currently included in the mine plan but could add significant value if resource estimates are undertaken.

Owing to Namibia’s arid nature, Lepidico will filter and dry stack its tailings and recycle c 80% of its water requirements (similar to the nearby Navachab Gold Mine). Moreover, on account of its unique technology and unique suite of products, Karibib’s tailings will be designated a waste management area, rather than a dedicated tailing storage facility. Finally, since the surface of its footprint is underlain by calcrete, there will also be no requirement for a liner, while Lepidico’s process’s production of silicates, rather than sulphates, means that neither its waste nor its tailings will be potentially acid forming. As a result, there will be no need to neutralise any waste products beyond the immediate products of its acid circuit.

In addition to that already delineated and upgraded, Lepidico has observed high-grade lithium mineralisation in old mine workings at Helikon 2, 3 and 4. These three deposits represent excellent targets for also promoting quality inferred mineral resources into the measured and indicated categories, as well as expanding the mineral inventory. A regional exploration programme to evaluate the lithium pegmatite potential within the >1,000km2 exclusive prospecting licence areas started in January.

In addition to lithium exploration, several gold occurrences have been identified within Lepidico’s block and it therefore makes eminent sense for the company to evaluate the potential of and explore for gold at Karibib, in parallel with lithium.

Lepidico’s operations at Karibib are fully permitted in the form of three exploration prospecting licences (EPLs) and one mining licence (no. 0204) on which both Helikon and Rubicon are situated.

The surface rights coincident with Lepidico’s mining and exploration comprise the Okangava farm, which was in private ownership before being sold to the Namibian government. As a result, the surface rights exist with the government, which has sub-divided the farm to a number of individuals (typically employed in professional services) on leasehold terms. The land itself is then occupied by tenant farmers and their cattle. Lepidico reports that it has good relations with these tenant farmers, to whom it provides water under its extraction permit for their livestock. Fences along the existing Helikon haul road and around the former Rubicon mine and processing infrastructure mean that easements for Lepidico’s planned operations are already in place.

All of the required infrastructure for the development of Karibib (eg water, roads, rail etc) is, to all intents and purposes, already in place. The local town, Karibib, has a population of c 10,000 and hosts rail infrastructure, an airstrip and road infrastructure that would not be out of place in Europe in terms of its quality, other than for the fact that, from the perspective of a European visitor, it is, by comparison, empty of traffic.

Lepidico intends to outsource its door to door logistics needs to a specialist freight forwarder. Initial haulage capacity of 250tpd (7,500tpm) will be met with 32t road haul trucks.

Once produced, the combined concentrate will then be transported to Walvis Bay on flatbed trucks. Walvis Bay’s principal function is as a bulk terminal. Since its output is relatively modest, concentrate will be shipped in 1.2t service sacks before being packed into 27t containers at the port for the six-week journey to Abu Dhabi. In the meantime, it intends to investigate any potential for cross-contamination at the recently expanded Walvis Bay container terminal in order to evaluate possible logistics cost savings.

Within the context of an arid environment overall (ie 150–200mm rainfall per annum vs London with 584mm pa), Karibib experiences short periods of intense rainfall, in relation to which Lepidico will be required to stabilise a small existing water course near the Rubicon pit.

Otherwise, process plant water will be sourced from existing water bores, which is reported to be ‘near potable’ and from which Lepidico has the right to abstract 207,000m3 of water per annum for seven years (see ‘Sensitivities’ section, below). In addition, Lepidico has the option to purchase water from the Namibian parastatal water utility, NamWater, which has a water line that crosses the Karibib property.

Namibia has three electricity generating power stations, but otherwise imports up to 70% of its power from neighbouring countries including South Africa (Eskom) and Zimbabwe (in particular, Kariba). The two most important power generating facilities in Namibia are the Ruacana hydroelectric power station on the Kunene River on the border with Angola with a capacity of 249MW and the coal-fired van Eck power station just to the north of Windhoek with a capacity of 120MW. However, while the profile of Namibian power production is currently relatively traditional, NamPower has a target of generating 80% of its power from renewables by 2023, including 330MW from hydro-electric sources and, to this end, is actively encouraging independent power producers (and particularly solar producers) into the grid.

Lepidico’s power requirement at Karibib will be 4.5MVA, which will be supplied via a 25km long 66kV line that will run down public roads from the nearest switching station at Marble Hill and enter the mine site at the same point as the NamWater line (see above). A power purchase agreement between Namibia’s electricity state utility, NamPower, and Lepidico has already been signed off on all technical matters and it only remains for the latter to now make an offer to the former regarding the commercial terms and, in particular, an appropriate power tariff in line with other commercial agreements in place. Nevertheless, a number of options pertaining to both the physical and commercial structure of the power purchase agreement exist. For example, Lepidico could own the 25km long transmission line to site, with a meter located at the Marble Hill switching station. Alternatively, NamPower could own the line, with the meter located at the mine site (which is Lepidico’s preference).

In the light of the above developments and our increasing knowledge and understanding of the Karibib project and its relationship with a Phase 1 L-Max plant – planned to be built in Abu Dhabi – we have made the following changes to the assumptions that supported our valuation in our last note (see Lepidico: Caesing the opportunity, published on 19 November 2019):

In addition, we have also refined our capital expenditure expectations, as follows:

We are also now assuming a peak debt:equity ratio of 60:40 rather than a nominal US$30m equity raise in order to finance the equity portion of the Phase 1 Project’s funding. Lepidico’s management reports that the company and project have had ‘good engagement’ from funding institutions and we expect that commercial banks could support a debt:equity ratio of 60:40. Offtake, prepayments or streaming agreements have the potential to increase this further to an 80:20 ratio. In due course it may also be possible to attract development agency type funding to the mining project on account of its location in Namibia, which could have the effect of lowering the interest rate on debt to as low as 8%. For the moment however, Edison is only considering an expansion of the debt:equity ratio to 60:40 with all of the other potential developments regarded as possible future value enhancers. All other assumptions remain unchanged.

In the light of the considerations discussed above, our valuation of Lepidico – based on maximum potential future dividends discounted back to present value at a rate of 10% per annum – has increased from 6.04 Australian cents to 7.34c per share and could be expected to rise further, to a peak of 10.81c, in FY26. A graph of our updated EPS and (maximum potential) DPS forecasts for the first 20 years of the Phase 1 Plant project life is as follows:

The individual components of the valuation change are shown in the waterfall chart below:

Note that this valuation is fully diluted in that it accounts for an additional assumed A$68.4m in equity issuance (at a share price of 2.9c/share) in order to achieve a maximum debt:equity ratio of 60:40 in FY22. Stated alternatively, an investment in Lepidico at a share price of 2.9c would yield an internal rate of return to investors in Australian dollar terms of 20.3% per annum for 22 years to 2042. By contrast, an investment in Lepidico shares now at the prevailing share price of 1.0c would yield an internal rate of return to investors in Australian dollar terms of 35.5% per annum over the same 22 years to 2042.

Lepidico had net debt of A$1.7m as at end-December 2019 (and reported, on 23 March, that it had A$3.4m in cash as at end-February 2020, after having raised A$10.8m in late FY19 via the issue of 372.9m new shares (plus warrants) at a price of 2.9 Australian cents in the form of one-for-nine renounceable rights issue). Gross debt of A$5.4m as at 31 December 2019 related to the liability component of a convertible note that Lepidico acquired when it acquired Desert Lion. The original note was convertible into Desert Lion equity at a price of C$0.20/share and is now convertible into 108m Lepidico shares at a price of approximately 4 Australian cents at any time prior to maturity on 10 December 2020.

In its 23 March announcement, Lepidico stated that its Phase 1 Project feasibility study is ‘very close to completion now’. Assuming that its Phase 1 feasibility study is completed on schedule in May 2020 and that the company makes a positive final investment decision shortly thereafter, we estimate that Lepidico will spend c A$193.4m (currently US$117.5m) in capital expenditure over the course of FY21 and FY22 before moving into production in FY23. That being the case, we estimate that it will have to raise an additional A$68.4m (approximately a two for one entitlement offer) in order to achieve a net debt:equity ratio of 60:40. This compares with our prior assumption that Lepidico would raise US$30m (A$49.4m at the prevailing forex rate) as the equity portion of its project financing.

Within the context of the above discussion, Edison’s valuation of Lepidico, above, is sensitive to at least seven specific factors – three of which are empirical and the balance of which are conceptual. These are considered in turn, below.

The most evident risk to Lepidico from the uncertainty surrounding the coronavirus pandemic are volatile capital markets in the short term and delays in the finalisation of agreements with third parties in the medium term. Otherwise, we do not believe that the coronavirus will have a material impact on long-term demand for lithium or the uptake of electric vehicles in preference to traditional petrol engine vehicles. In the meantime, the company reports that constructive discussions continue with prospective off-take partners for the planned products from the Phase 1 chemical plant and samples continue to be prepared and dispatched for analysis. Essential feasibility study and corporate functions are continuing, non-essential functions have been curtailed and cash resources are estimated to be sufficient to sustain the business into late calendar 2020.

As a part of its acquisition of Desert Lion, Lepidico acquired a convertible note that was originally convertible into Desert Lion equity at a price of C$0.20/share and is now convertible into 108m Lepidico shares at a price of approximately 4 Australian cents at any time prior to 10 December 2020. Our valuation, above, implicitly treats this convertible note as if it were conventional debt. However, in the event that it were to be converted in full, then our valuation of Lepidico falls very fractionally to 7.28 Australian cents per share (cf our ‘base case’ valuation of 7.34c/share).

Edison’s long-term lithium prices are based on an assumed benchmark lithium carbonate price of US$12,000/t, which equates to a lithium hydroxide monohydrate price of US$14,021/t. Variations in our valuation of Lepidico with respect to the lithium hydroxide monohydrate price are as follows:

Edison’s financial model assumes that Lepidico will raise A$68.4m in the relatively near future in order to achieve a future, maximum net debt:equity ratio of 60:40 and that it will raise this equity at a share price of 2.9c. Exhibit 5, below, demonstrates the sensitivity of our valuation to the price at which future equity funding is conducted:

As a matter of interest, readers should note that the non-diluting price of future equity funding (ie the price at which Edison’s post-funding value is the same as the funding price) is 9.99 cents per share.

In our mining sector report, entitled Gold stars and black holes, published in January 2019, we calculated that the average company enterprise value (EV) for companies at the pre-feasibility stage of development was 9.9% of attributable project NPV. This rose to 30.9% for companies at a bankable stage of development. Taking the non-diluting price of future equity funding of 9.99c to represent project NPV on a per share basis, Lepidico’s share price of 1.0c is in line with the average for companies at PFS stage (albeit Edison has had to vary its financial model to reflect changed circumstances since the original PFS). On completion of a bankable study (scheduled in May) on substantially the same terms as the PFS however, we would expect Lepidico’s shares to re-rate to something close to 30.9% of 9.99c, or approximately 3.1c per share – ie close to our assumed price of future equity funding of 2.9c (see pages 7–9).

In addition to its in-situ resource, our site visit to Karibib also revealed clear evidence of a surface stockpile of broken massive lepidolite ore, being a legacy of former petalite mining at Rubicon, where it was considered waste. To date, this has been excluded from Karibib’s formal mineral resource estimate (Exhibit 1). However, management estimates the size of the stockpile to be in the order of 700kt at a grade of c 0.9% lithium oxide with c 20kt in excess of 1.1% (cf an average grade of 0.40% Li2O at Rubicon – see Exhibit 1). This being the case, we estimate that the stockpile could represent a material circa two years of feed to Lepidico’s Phase 1 L-Max plant, from which c 100–150kt of lepidolite concentrate could be produced.

Lepidico also has access to 69.4kt of slimes at Rubicon, at an elevated grade of 0.95% Li2O, being the flotation tailings related to former petalite mining at Rubicon. While these require mineralogical test-work to be performed before their compatibility with the L-Max process can be determined, they nevertheless represent an additional potential source of material for Lepidico. Utilisation of the slimes would also qualify as tailings disposal/remediation for environmental, social and governance (ESG) purposes.

According to Lepidico’s first optimised production schedule of by-product volumes, the Karibib resource has the ability to support production of c 1,400tpa of rubidium sulphate, equivalent to 1,368tpa of rubidium formate. While the use of rubidium formate as a completion fluid for high pressure, high temperature oil wells is not as developed as that of caesium formate (see our note, Lepidico: Caesing the opportunity, published on 19 November 2019), with chemical and physical properties typically lying in a range between those of caesium and potassium, there seems little reason why it should not develop a function in this role.

While caesium’s crustal abundance of 3ppm is instrumental in conferring upon its formate salt a price in the order of US$37,000–50,000/t (see Exhibit 6, below), we estimate that rubidium’s higher crustal abundance of 90ppm would confer upon its formate salt a price in the region of US$7,158/t. Nevertheless, on this basis, 1,368tpa of rubidium formate at a price of US$7,158/t could potentially generate a very similar (or even greater) revenue to 210tpa of caesium formate at a price of US$37,000/t (see Exhibit 3).

Desert Lion’s business plan was based around a concentrator throughput rate of 2.35Mtpa and its water abstraction rates (which Lepidico has inherited) are consequently similarly based upon this rate, which is materially in excess of Lepidico’s initial throughput design rate of 330ktpa, rising to 540ktpa. As such, Lepidico’s right to abstract 207,000m3 of water per annum is sufficient to at least support a doubling of production capacity to 11ktpa of lithium hydroxide monohydrate and potentially more if it applies for additional water rights, either from further water bores close to the mine or by application to NamWater. As such, Lepidico’s business plan at Karibib has expansion potential in addition to duplication potential and the potential for a large-scale Phase 2 plant.

Three other initiatives that have the potential to augment the economics of Lepidico’s mining plan at Karibib include 1) the possibility of steepening the walls of the proposed open pits; 2) mining the footwall mining zone at Helikon, in particular, which has returned grades as high as 3% lithium oxide over 5–6m in exploration drilling; and 3) the potential for gold exploration success.

Finally, Lepidico’s environmental and social impact assessments point to the following benefits at both its mining operation at Karibib and its lepidolite chemical conversion plant in Abu Dhabi: