However, large-scale Chinese iron ore production has not undermined the long-term iron ore price or the strong demand/supply fundamentals. I believe increased Chinese nickel pig iron production will prove no different. However, the disappointing Minara result highlights the risks for the high cost HPAL laterite producers with the recent fall in the spot price.
Consequently, I recommend investors rotate to the sulphide producers and the lowest end of the nickel cost curve. In this regard I strongly recommend Western Areas (WSA) with average production costs of $US3 a pound, yet with a share price down 40% from its recent highs.
Bottom of the cost curve: the place to be
Why is Julian Hanna, chief executive of Western Areas, smiling in the photo below? It is because he is holding a piece of drill core containing massive nickel sulphides, grading 10% from the company's recently discovered Spotted Quoll deposit in Western Australia. That is certainly enough to make any geologist smile and it is for a very good reason. High grades equate to low costs and it is this characteristic that has Western Areas positioned at the bottom of the nickel cost curve globally.
I recently visited Western Areas’ operations in Western Australia and also hosted meetings for the company in Sydney and Melbourne. The good news is that the Western Areas story continues to develop at a fast pace and appears on track to deliver on the company's ultimate goal of producing at 35,000 tonnes a year of nickel by 2011 from the Forrestania Nickel Camp. If Western Areas SA is able to deliver on the stated objective of 35,000 tonnes by 2011 then it will make it Australia's second largest nickel producer behind BHP. In a fast consolidating industry the company will have scale. Importantly, that will be at the highest grades and lowest cash costs in the industry. Globally, the only orebody with lower cash costs than those expected from Western Areas are at Norilsk, which is facilitated by high platinum and palladium product credits. This is demonstrated in the chart below.
The slide below is quite critical. It shows that Western Areas already has the assets within its portfolio to deliver on the stated objective of 35,000 tonnes by 2011. Over the past five years the company has delivered a dramatic lift in resources, and while exploration remains a key focus, the company will be in development mode. Importantly the Forrestania nickel belt remains under-explored and there is good potential for further high grade discoveries. The company has a strong financial position with $145 million in cash which should be adequate to fund the stated growth objectives.
From our site visit there were a couple of key takeaways:
The Streeter Decline has reached the top of T3 and is on schedule and budget. The water problem at the T1 fault appears to have run its course and the mine is now effectively dry. The pumping system is now only required to operate at about 20% capacity. Ground conditions are very good. We inspected mining at T1, where grade is about 6% and the mineralisation was 20 metres wide – very impressive! Construction of the concentrator is well advanced. The flotation circuit has been installed and the old Outokumpu feed bin has been refurbished. One of the next steps is to install the SAG mill. They are investigating sinking a shaft at the Flying Fox mine to increase production from the deeper ore bodies. This will cost around $65 million; however a raised bore ventilation shaft, costing $15 million, will be necessary as the decline gets deeper, so the capital cost of the haulage shaft (which would double as a ventilation shaft) is effectively $50 million. Work is progressing of Diggers South and Spotted Quoll, which are critical to the 35,000 tonne target. Spotted Quoll drill section on display was spectacular: 18 metres at 10% nickel.
The following slide shows the development timetable for the six projects that company has slated. I view it as aggressive yet achievable.
In summary, Western Areas remains a preferred nickel exposure. This is driven by the extremely high grade profile of the orebodies, which in turn drives a low-cost position on the cost curve. I see Western Areas as a growth stock with the ability to self-fund from here.
As cash flow continues to ramp up over the next six months, I would expect the company to announce and pay a maiden dividend in February. Our price target is $8.80 a share and Western Areas is the safest way to play a nickel price recovery as marginal producers shut down production.
Something's gotta give in the nickel industry and it will be the closure or placing on "care and maintenance" of some marginal laterite producers. The sulphide producers, with their significantly lower costs and processing risk, are very well placed to benefit from the nickel price bottoming as the marginal producers withdraw from the market.
I see Western Areas as a low-risk buy at current levels; with the risk determined by its place at the bottom of the cash cost curve. I had plenty of success recommending Jubilee (JBM) before it was eventually taken out by Xstrata. The key to the Jubilee recommendation was backing its very high sulphide grade and place right down the cash cost curve. Western Areas has many similarities with Jubilee and its fate may well be similar as it ramps up production and cash flows. Never underestimate the defensive and offensive power of grade.
WSA Price at posting:
0.0¢ Sentiment: Buy Disclosure: Not Held
