SCE visited the Mbalam site in November 2010. The camp is well established with accommodation units for 200 people, maintenance and laboratory facilities to service the exploration program, and a sophisticated communications set-up.
Access is by road or air. Supplies from Perth are shipped in containers and arrive by road with a lead time of up to 6 weeks. Access has been established to the Nabeba deposit with a new border crossing just south of the Mbalam exploration base.
DCF is our preferred valuation methodology
Our valuation for Sundance is $1.09. This assumes SDL has an 81% and 76.5% share of cash flows from CamIron and CongoIron respectively, and carries the government’s 10% share of capex. Our valuation reduces to $0.77 in 12 months time, as we assume that a portion of the project is sold to an offtake partner at a discount to our valuation, and that further dilution occurs due to an equity raising.
The DSO component of the project has a higher contribution to the valuation as it is due to begin in 2014/2015, but the itabirite component begins much later in 2025 so the cash flows are greatly discounted.
Sensitivities and key variables
Our assessment of sensitivities is that the most important variable for the projects, like most mining projects, is the price. Therefore we give a valuation curve for SDL using the A$ iron ore price. At spot prices our $0.77 valuation rises to $2.43
Funding requirement
We expect that the Mbalam project will be funded in a similar fashion to GBG’s Karara project. The key elements were GBG reducing its ownership to 50% by forming a JV with a Chinese partner, Ansteel, which offered LOM offtake and arranged the debt financing at competitive rates. The capex was funded 70:30 debt:equity. We assume that a partner buys in to Mbalam at a price which covers the majority of SDL’s share of capex to be equity funded, but at a discount to our valuation. We also assume that a further US$250m equity is raised to cover the balance and contingencies. Overall our valuation is diluted to $0.77 next year, but still at a premium to the current shareprice. The itabirite project can be funded through cashflow in c.2024.
Earnings valuation methodology
When SDL reaches full production, it should be earning consistently >A$270m at long term prices (100US¢/dmtu) which translates into a diluted EPS of >$0.08.
We would expect a pure play resources exposure to trade in the 8-11x PE range, less than the diversifieds. This implies a price of $0.64 - $0.88 sustainable for the full production level. This is consistent with our valuation.
Peer comparisons
SDL will have the greatest production growth of the mid-cap producers. It is also the cheapest of the stocks under our coverage if we consider that it is trading at the greatest discount to our valuation
Rating and Target Price
We have set our price target at $0.77, underpinned by our diluted 2011 valuation, and set a Buy rating. Our analysis suggests that there is considerable upside once Mbalam begins production, or at higher prices, but with project financing and execution risk ahead, we have set a conservative target in the short term.
SDL underperformed the rest of the iron sector in the start of the year, but project progress throughout the year, marketing by the company, high iron ore prices, and M&A in the sector, have led to out-performance recently. We expect progress towards FID mid next year will drive the next leg of out-performance.
Company Description
SDL is an Australian developer with a plan to produce 35Mtpa of iron ore from its tenements in Cameroon and Congo. The project is in the final stages of a DFS, financing and offtake agreements, with construction scheduled to begin in late 2011. The project involves building a mine, simple crush and screen facilities, a 500km rail line, and a deep water port on the coast suitable for 300kt super capes. Hematite resources are capable of underpinning a 10+ year operation.
Beneath the hematite cap lies itabirite which can be beneficiated into a concentrate, adding a further 20+ years minelife to the operation. SDL’s infrastructure may attract 3rd party users which are currently stranded. It is estimated that the Mbalam project could be managing 100Mtpa of exports from the region.
Investment Strategy
We rate SDL a Buy. The project resources are world scale, and the potential to ship 35Mtpa, would place SDL in the top 10 iron ore exporters. High grade 62.5% Fe hematite, and low strip ratios makes the project high margin. There is a substantial budget for infrastructure, but at current prices we estimate a payback period of <3 years. We believe there is minimal resource risk, and current management can overcome financing and offtake risk. Country risk may be a concern for some investors, but the signing of the project convention early in 2011 should show the government’s commitment, and be a key catalyst.
Valuation
Our base case DCF gives SDL a valuation of $1.09. However we have assumed some dilution from selling part of the project at a discount to our valuation and raising some further equity sometime in 2011. Our 12 month valuation is $0.77 which forms the basis of our price target. Our 4 year valuation is $1.05/share.
We are using long term assumptions of 100US¢/dltu for fines and an 80¢ currency. Our 12 month valuation rises to $2.43 at spot prices.
SDL Price at posting:
37.0¢ Sentiment: Buy Disclosure: Held
