Ann: Restructure of Lithium Offtake Agreements, page-123

Here is my view of the announcement for anyone that is interested.

What's happened:

Burwill’s JV lithium plant is taking far longer to ramp up than they expected, and they have been getting dangerously close to outright breaching their offtake agreement for not taking product fast enough. This flows through to an issue for A40, as they were about to have concentrate building up at the dock and not be earning any money for it.

A40 have acted to renegotiate the deal, giving themselves freedom to go elsewhere

As any good negotiation needs some give and take, there are ups and downs for both. A40 has lost the guaranteed US$880/t pricing, but gained the freedom to expand at a faster pace than the lithium plant. Burwill has been freed from a commitment to buy product they’re not in a position to use yet.

I’m surprised by the agreement to freeze the repayments on the prepayment. I suspect Burwill might be using some accounting trickery there to make their operating costs look better. For example, the $US880/t price becomes US$750/t if you ignore the 15% repayment of debt. Instead of having accounting entries for having paid $880/t and then a credit of US$130/t to the outstanding debt, they can just say they have spent US$750/t.

I also suspect A40 wouldn’t have moved on pricing if they didn’t freeze the repayments.

So to me, this isn’t by any means a game-changing announcement, or even a great announcement. It shows that the offtake partner they signed up with wasn’t up to scratch to meet the commitments they have made. The board have identified the issue and dealt with it, but it does create more uncertainty about the company. After all, they have gone from having (supposedly) 100% guaranteed sales, to now only 50%.

The theoretical advantage is they’re free of the exclusivity and right of first refusal clauses that prevented them from spreading their offtake risk around. This episode has demonstrated why that is important.

In terms of next steps, the deal confirms a shipment of 18,000t to be made this month, which has already appeared in the shipping schedule at Esperance, and another 10,000t to follow next month. It is unlikely that the Burwill JV will be willing to take another 10,000t in March, and, as a rule of thumb, A40 need to be making monthly shipments of that much to make money.

So, sometime in the next 4-6 weeks I would expect another offtake agreement to be signed. According to this interview: https://www.youtube.com/watch?v=4SnlO7Dk2rg and this article: https://www.reuters.com/article/australia-lithium-supply/update-1-singapores-alliance-minerals-reframes-lithium-supply-deal-seeks-new-customers-idUSL3N1ZF1VZ that is exactly what is going to happen.

Based on the operating costs seeming to sit around $30m per quarter (which has included costs for the merger, but very little exploration. Hopefully soon we see no costs for the merger and plenty of exploration), then the two shipments already scheduled would put the company close to being cash flow positive, and a third in March would put them over the line into profitability. Certainly, if both are made, they're not at risk of financial implosion.

Also, as the first shipment under the new arrangement is scheduled for February, we will need to see an announcement regarding the pricing they have agreed on in the next few weeks. Remembering that US$750 without repayments is the same as US$880 with them, and we can use that as a benchmark to see if the pricing is better or worse for A40.

So, over the next month I will be watching for the announcement of further offtake agreement(s) and what pricing is being settled on.

Moving on to the production update provided at the bottom, there is more here that I’m glad they included today rather than dumping into the quarterly report in a few weeks. Total production for July to December came in at about 51,000t, 7% less than the 55,000t - 60,000t range of their already downgraded guidance for the second half of the year. The original guidance was 60,000t - 75,000t, so they fell short of that by 15%.

It’s not a great look to fall short of the guidance you had already lowered. They did flag they were going to have issues, which is why the guidance was lowered, but clearly things didn’t go to plan.

They’re reporting that the last 5 weeks of operation have been averaging 410t - 420t per day of production, which would be on track for somewhere around 73-75kt for the first 6 months of the year if it can be maintained. We’ll have to wait for another production update to know more, and we should get some info in the December quarterly in a few weeks.

Given the targets they’re setting for production and trying to sign new deals, there isn’t a whole lot of room left for more delays or excuses, so this is also something to keep a keen eye on.

Which brings us to the Stage 2 upgrade to the plant, with adding a fines circuit and boosting total production. According to the revised mining schedule, they’re targeting 180,000t this year (as a minimum, according to the MD in that video). Based on the production from the fines circuit commissioning in September and hitting full scale in October, and they would need to be doing 700t per day to reach that target, which is in line with the projected rate of production for next year (240,000t). So it’s possible, but they can’t have any more delays like have happened last quarter.

The last point I’ll raise is the assumed costs in the announcement; they look a little too neat and a little fat to be realistic to me. $800/t for 180,000t is exactly $144m for 2019, or $12m/month. $550/t for 240,000t is exactly $132m for 2020, or $11m/month.

Those are some extraordinarily round numbers to me, and a little odd when the operations so far have been $9.7m - $10.3m per month so far. Obviously there will be an increase in processing costs as they move more material, but there should also be a decrease in mining costs as they handle less waste. Will need to see how December’s costs unfolded and what the forecast is for the March quarter when we get the report in a few weeks.

But right now, that looks padded to me. If it isn’t, they’re going to be on very tight margins this year.

Lastly, the repeated point about the amount of pre-stripping they’re doing is demonstrated in the difference in stats from 2019 to 2020; 46% drop in total dirt mined, 33% increase in total production, result in costs dropping 31%. If it happens, it will be a very sudden jump in profitability. If that guidance for 2020 is met, they're talking about a profit of $80m+.

Just have to see if they can get there.

Cheers