infrastructure cost implications

Here ya go....guess who

ATLAS IRON LIMITED
Third party infrastructure makes the most sense (Amended)
Atlas Iron Limited (“Atlas”, “AGO”, “Company”), in line with management’s low-capex philosophy, has always expressed a desire for significant infrastructure requirements to be funded by third parties and was unlikely to pursue build-own-operate. We have previously modelled build-own-operate scenarios though because AGO has better development control and it’s more conservative for valuation.
We have increased our assumed build-own-operate infrastructure capex to achieve >40mtpa from ~$3.5b to ~$6.3b due to higher assumed rail costs and port costs given AGO may need to over-invest in the port if partners do not participate. Note that we prefer to be conservative on capex and it’s possible our assumption is too high.
The higher capex reduces our NPV under a build-own-operate model, but is still NPV positive when AGO achieves the full >40mtpa. However, the critical change is the assumed new capital requirement for AGO in a build-own-operate scenario. With our revised estimates, we estimate AGO would require ~$3b in new capital, which in our mind becomes a risk. Therefore we believe a build-own-operate scenario for AGO is unlikely.
Consequently, our base case is no longer build-own-operate, and we now assume third party infrastructure. This change in assumption has increased our base case valuation for AGO, however it also increases the execution risk as AGO is now more beholden to the whims of third party infrastructure providers. To be clear, we are not saying that a build-own-operate scenario is uneconomic using our higher capex forecasts, we are saying that the amount of capital required to be raised by AGO (debt and/or equity) would be a stretch in current markets. A better capitalised company may still look to take the AGO business plan and fund it all internally.
Third-party cost assumptions
We assume that a third-party infrastructure provider requires an 8% post tax return of assets and earns a 20% EBIT margin. We estimate that if AGO, as a foundation customer, entered a take-or-pay contract for 35% of the infrastructure, it would cost AGO $870m pa ($19/t @46Mtpa), for 50% take-or-pay cost $27/t and for 75% would cost $40/t. Additional operating costs borne by AGO would be mining + processing + shipping (let’s say additional $30/t). The key here is that we take a slightly different approach looking at the infrastructure. We look at AGO’s ability to afford/underwrite third party infrastructure rather than their ability to fill the capacity and is consistent with our central theme for AGO: “they are in the iron ore business; they will develop iron ore projects”. We believe that AGO’s ability to afford infrastructure is high given the low processing costs (most of the product is true DSO). In our model we assume AGO has a take-or-pay for 50% of infrastructure usage charges, but believe the risk is skewed toward a better outcome for AGO.
Maintain Buy recommendation
We have an AGO valuation of $4.18 including ~$0.25 of MRRT tax liability. At spot iron ore and fx prices we have a valuation of $6.39. We have a Buy recommendation and a twelve month price target of $5.21.

Hartleys