Broker Note

Interesting points made by one of the supporting brokers -- thought it may be of interest here.

This is the one a lot of clients have been waiting for.  I had hoped that if I held off long enough, I could include the good news that Atrum have finally received the Bulk Sample Permit, alas, we continue to wait.  Having said that, let’s recap where things are at for Atrum, what is outstanding and what is coming near term that are catalysts for a re-rating.

The background
Atrum listed in July 2012 at 20c a share.  They have a high and ultra high grade anthracite coal (for more detail on HG and UHG anthracite refer here) asset in north-western British Columbia, Canada (around 800km north of Vancouver) called the Groundhog Anthracite Project.  Groundhog covers an area of over 800km², and comprises 46 granted coal licences and 37 coal licence applications.  It is likely that the ultimate overall resource will significantly exceed the 1.6 billion ton JORC resource announced so far – however, the quality and quantity of the resource haven’t been the issue for Atrum recently.

For some time, Atrum was able to defy the pressure being felt by most small cap resource stocks with the share price touching $2.10 in Sept of 2013.  Since that time, the shine has really come off Atrum and they have suffered as much as any small cap miner trying to move from explorer to producer as the environment for resources has deteriorated and investors’ appetites for the space have faded.  Given this macro backdrop (particularly for coal projects – even the highest of quality coal) it has been unfortunate that a lot of Atrum’s undoing can be attributed to self inflicted damage.  Without wanting to re-hash the situation that played out last year with two former directors and ongoing disappointment on missed targets/promises, Atrum is now in the process of moving on with significant changes at management and board level ushering in a new era for the company.

I have faith that the team and structure that is now in place is perfect for taking Atrum into production, however, Bob Bell (Executive Chairman – see attached for bio) has inherited a frustrated shareholder base, who have grown tired of broken promises and missed deadlines.  Fairly or unfairly, he cannot afford to miss a beat as he will be given a very short leash to get the business back on track.  From my recent conversation with Bob, he appears focused and very clear about the direction the company needs to take from here.  The team Bob has in place, who are now almost exclusively Canadian based, have the expertise and experience to ensure the company can get this project off the ground (an example of this was the appointment of Ann Marie Hann, refer to attachment for her credentials).

Numbers remain intact
With all the negative talk surrounding coal, it would be easy to lump Atrum into the “too hard” basket as well.  I have no doubt a lot of investors have done that already, however, that would be a mistake given the growing demand for the product as global anthracite supply begins to dwindle (refer to Supply and Forecast Demand of Anthracite below) while demand for the product strengthens.  Anthracite pricing has remained robust, with recent bulk pricing for high-grade anthracite lumps around $150 a ton in Japan and Europe.  


With upgrades to the Pre-Feasibility Study in relation to increased yields at Groundhog, the cost of production will further reduce (cost of production now estimated to be around $68 a ton FOB) ensuring that Atrum’s margins when in production will remain attractive – roughly $80 a ton.  This implies that on the basis that Atrum achieve production of 1mtpa by mid 2017, they will have free cash flow of $80m a year.  With the likely production increase to 3.5mtpa, free cashflow would jump to $280m a year.  Assuming that Atrum are able to secure JV partner(s) at a project level for a 30% stake, this number would reduce to $196m per year of free cashflow for Atrum.  These are back of the envelope numbers, but I am highlighting them as a reminder that the economics of the project(s) remain compelling and haven’t diminished substantially despite all the doom and gloom for resources and coal particularly.

Next steps and near term catalysts
Everyone is waiting for the Bulk Sample Permit (BSP) to be approved.  As mentioned previously, the shareholder base has become frustrated and this is one of the key causes of that frustration.  Bob and the team have been working hard to ensure this permit is approved as urgently as possible, they have done everything required of them and answered all queries and questions from the regulators.  Currently, the application is with the Mining Development Review Committee (MDRC), they’re assessing the comments from externals and finalising a report for the Statutory Decision maker.  It’s important to note that ongoing support for the project from First Nation communities in the region continues to be strong.  The company is unprepared to commit to a timeline for approval given previous promises, however, be assured that the process is drawing to a close and the approval is imminent.

Negotiations and discussions have taken place regarding equity stakes in the project, largely revolving around the big Japanese conglomerates, however Bob indicated they have had substantial interest from non-Japanese parties, which hints that there will be some competitive tension when the time comes to finalise deal(s).  I expect this to occur within 3-6 months following on from the approval of the Bulk Sample Permit.  The positives from this will be as follows:

• Provides a look-through valuation for the project and by default, the entire company
• Provides much needed funding for the progress of the project and the ongoing business
• Will almost certainly involve off-take agreements securing the long term sale of future product
• Will add substantial credibility to the project (assuming the calibre of the JV partners are of the ilk of those companies that have previously signed non-binding Off-take Marketing MOU’s)

Risks/headwinds
The current share price tells us there are significant risks/headwinds for Atrum to confront in the short to medium term.  A summary of the major risks/headwinds is below:

Risks

• Permitting – despite ongoing assurances, until the permitting has come through, this remains a significant risk
• Cash – without a JV partner for the project (i.e. successful sell-down of an equity stake in the project), the company will run out of cash unless they come back to the market again to raise capital – the shareholder base will have no appetite for this in the current environment, particularly with the implication that would come from this outcome – i.e. no interest in the product
• Capex to get the project up and running is significant and a partnership of some kind remains critical to this funding (refer to point above)
• The demand and pricing for ATU’s product mirrors that of the mainstream coal markets – nothing suggests this is likely, but it is an ever present risk with any bulk commodity

Headwinds

• Ongoing macro environment for global equities, particularly players in resources with exposure to coal (obviously this has been a headwind from day 1 of the company’s listed life); or another credit crunch that cripples debt markets and global growth
• The overhang of the two ex-director’s shares – who remain no.2 and no.3 largest shareholders on the register – there appears a resolution is in place with a syndicate of investors keen to take on the cornerstone investment, however until this is resolved it remains a concern and a drag for the share price
• Disruption from previously mentioned ex-directors who are potentially looking to white-ant the company and generally cause trouble

Summary
Atrum still has a lot to offer, but the plans and strategy to get Groundhog into production need to be focused and well executed. Fortunately, Bob Bell is the man to achieve the outcome that shareholders desire, with the BSP acting as a near term catalyst for interest in the stock and a re-rating of the share price. This should also be a stepping-stone for Atrum to then proceed quickly with a sell down of equity in their project, which as highlighted previously, will provide substantial upside on a number of fronts and should see Atrum return quickly to price levels we have seen in the past (i.e. > $1.00).

The valuation for Atrum is tricky to accurately assess given the outstanding risks they currently face, however, using conservative numbers and significant discounts to account for risks, a valuation of 80c-$1.20 is easily achievable near term.  Clearly, if Atrum are able to hit near term milestones successfully, the longer term price target will escalate rapidly.