brokers coverage ....who to believe ?

Brokers Coverage ... who to believe ?

Jan 2014, we see the release of SDL coverage thru 3 brokers, but do we understand their figures and interpretations ?

Points to note

1. Brokers came with their own assumptions and risk factors in valuation and we can't never expect their analysis and outcome to be identical, so we need to apply our own judgement...

2. Also PLEASE pay attention to discount rate (WACC) when broker apply DCF valuation, as they are not an exact science, it's just a guess ...Remember a high discount rate is applied for a high risk profile, but that can be changed when the company situation/status changed (funding approval, production, etc..)

More importantly look at the variation or "Sensitivity analysis" (re. Mac Bank table below) if they are provided, for example in case of Mac Bank (p5,fig 8 or table below), and so we can have an ideas about SP changed based on risk profile (link to WACC) and Iron ore price...

So from MacBank figures below , SDL SP can vary from $0.15 to $0.92

For example Mac Bank noted that "Reducing our WACC from 15% to 12% would nearly double our price target from $0.15 to $0.29 based on our long-term iron-ore price of US$90/t."

Note that MacBank used a very high discount rate for SDL : DCF @ 15% (compare to Patersons with DCF @ 10%)

I used DCF @ 11.3 for my different SDL valuations..

3. Interesting to note from brokers that we may have funding in plave by April 2014 ...
- "Finalisation of an exclusive agreement on the port and rail infrastructure in April 2014 (Patersons)"
- "It is now issuing tenders for the debt funding and development of the mine plant and associated infrastructure and expects this process to be finalised in April 2014 (Breakaway Research)"


Following are summary of assumptions and valuation methods used by SDL brokers:

I) Patersons (8 Jan 2014)

1) Valuation method and discount rate (i.e risk factor) = DCF @ 10% discount

DCF = Discounted Cash Flow

2)Price target and when ?

Price target = A$0.26/share
When = finalisation of an exclusive agreement on the port and rail infrastructure in April 2014

"We expect finalisation of an exclusive agreement on the port and rail infrastructure in April 2014 and we anticipate a major re-rating of SDL’s share price to more closely align it with our $0.26/share valuation.

We believe that the short-term catalyst for the stock lies in SDL’s ability to successfully finance the project using the balance sheets of significant engineering, procurement and construction companies and product offtake groups."

3)Valuation and assumptions
- "Our analysis indicates that there is significant value in SDL based solely on the high grade hematite project, without the need to factor in the potential of additional mine life from converting hematite resources to ore reserves or the potential cashflows of the itabirite
project, both of which could be significantly value accretive.

- We have run a scenario that assumes that the port and rail infrastructure is built, owned and operated by a consortium independent of SDL, whereby SDL signs up as a foundation customer. We have assumed that SDL pays a tariff to access the infrastructure of US$22/t, which is sufficient to derive a return to the consortium of c12-13%.
This leaves SDL with capex to fund of around $1bn, which we have assumed is sourced from bank debt (c$650m), iron ore pre-sales (c$200m) and equity, including the exercise of options (c$300m).

Based on this scenario, and at full production, the project derives free cashflow of around $330m p.a., which is less than the current market capitalisation of SDL.
Other assumptions made in the calculation of our discounted cash flow based valuation of SDL are:

1. We have only modelled the cash flow of the DSO hematite project, assuming detailed design commences in Q3 CY2014, construction starts in early 2015 and production
initiates in December 2017.

2. We have escalated capex from the DFS by c10%, while operating costs have been inflated by CPI from the DFS, which used December 2010 dollars.

3. We have applied a nominal valuation of US$0.20 per Fe unit in-situ for 76.5% of the Itabirite resource.

II) Mac Bank (19 Jan 2014)

1)Valuation method and discount rate (i.e risk factor) = DCF @ 15% discount

(discount rate very high!!! but when WACC is changed from 15% to 12%, SDL SP = $0.29)

2)Price target and when ?
Price target = A$0.15/share
When = initiating coverage

"We are initiating coverage on Sundance Resources (SDL AU) with an Outperform rating and
a A$0.15 price target."

IMPORTANT NOTE:
"Reducing our WACC (i.e risk factor) from 15% to 12% would nearly double our price
target from $0.15 to $0.29 based on our long-term iron-ore price of US$90/t.

"We believe that the short-term catalyst for the stock lies in SDL’s ability to successfully
finance the project using the balance sheets of significant engineering, procurement and
construction companies and product offtake groups."

3)Valuation and assumptions
- The key risk to our A$0.15 price target is the level of ownership dilution SDL will endure at the asset level to secure a funding solution.

Our price target is based on the sale of half its interest in the project for US$500m, which is sufficient to provide SDL’s equity financing requirement for the development.

- Our base case valuation assumes
SDL is able to secure a funding agreement in 2014 by selling 50% of its 76.5% interest in the project for US$500m. The sell down should remove the need for SDL to raise additional equity.

We don’t expect SDL to generate any meaningful earnings over the next five years as we do not expect production from the Mbalam-Nabeba project to commence until FY19. Our base case development scenario for SDL assumes the project operates as a standalone joint venture, with SDL’s share of earnings reported at the associate line in the company’s income statement.

We expect cash flow from the Mbalam-Nabeba JV to come in the form of dividends, although we do not expect dividend payments to commence until project debt has been fully repaid, which we forecast to occur in 2023. SDL will be required to make equity contributions to the Mbalam-Nabeba JV during the construction period; however we believe that the proceeds from the initial sell-down should be sufficient to meet SDL’s equity funding requirements.

Sensitivity analysis
We assume a 15% WACC for SDL, higher than for most other iron-ore development plays in our coverage universe. Reducing our WACC from 15% to 12% would nearly double our price target from $0.15 to $0.29 based on our long-term iron-ore price of US$90/t.

DYOR

III) Breakaway Research (Jan 2014)

1) Valuation method and discount rate (i.e risk factor) = Using EV/t method and based on peers.

"As the final financing and ownership structure is yet to be determined we have not carried out a DCF valuation of Sundance – the potential ownership scenarios give
significant uncertainty to a Company value. Instead we have used indicative rule-ofthumb methods to compare Sundance to a suite of comparable companies in West and
Central Africa to arrive at a current price target range."


2)Price target and when ?

Price target = A$0.16-$0.19/share
When = Short term (could be April 2014 ?)

Price target = +$0.50/share
when = successful project execution


"It is now issuing tenders for the debt funding and development of the mine plant and associated infrastructure and expects this process to be finalised in April 2014.

With successful funding and development we can see a long term potential valuation of +A$0.50 per share, with this
dependent on final funding and equity structures of the producing operation."


3)Valuation and assumptions

Our main method is a comparison of the relevant company’s enterprise value per tonne of contained iron (EV/t). This is calculated using the following:

- Enterprise value is the diluted market capitalisation plus net debt
- All figures have been converted to Australian dollars using the current exchange rate
- Contained iron is the tonnage of each resource multiplied by the grade, weighted by the company’s current ownership of each resource.

The general trend is one of increasing EV/t with project advancement, and three groups can be recognised using this metric. The higher value group includes the producers,
London Mining and African Minerals (average of A$0.94/t), the second group Sundance and Afferro (average of A$0.24/t), and the third group Zanaga and Equatorial (average of A$0.07/t).

Still confused ?

DYOR