fairfax still bullish

Discovery Metals* (LON:DME)? More value to come
We note that since the financing and move towards construction Discovery Metal?s share price has been languishing. We suspect that in part this is due to perception that the company is moving into that traditionally less exciting box ticking phase of development until cash starts flowing from production. However, Discovery has an exciting exploration portfolio and is pushing ahead with identifying potential new resources. Following Indaba we went to site and were impressed with the rapid progress with both development and exploration.
? Boseto is now fully financed and scheduled to start producing around 35-36ktpa of copper starting from next year with commissioning planned for the first half of 2012. Management has systematically de-risked the project and has been focused on developing its first mine and proving up sufficient resources to support this asset.
? Now that the financing is complete, construction underway with market conditions much stronger as copper prices trade close to records, the company is able to increase efforts in regional exploration.
? Discovery Metals has a well established exploration camp in place which we visited, with a growing number of people as activities pick up. The company has 100% of 9,656km2 of tenement packages under license along the Kalahari copper belt (including Boseto). We flew over some of the tenement package on a recent site visit and it really is a vast area that runs over 300km. The company has identified 1,300km of favourable geology that hosts the potential for copper silver mineralisation. Only 400km of this prospective horizon has been tested by the soil sampling programme, of which only 70km has been drill tested. Considerable work is going into understanding the geology to help identify other possible resources.
? A number of targets have been identified for follow up drilling including the Ophion target where a 75 hole programme is underway and due to be completed in the coming month or two. This is one of 10 named targets amoungst others Additionally there is along strike potential at the current resource base that sits across the Plutus, Petra and Zeta ore bodies (Plutus and Petra are contiguous).
? We expect exploration work at and around Boseto to add value through the delineation of resources away from the current Boseto mine that could support a standalone operation potentially doubling, or more, the planned output. Additionally, exploration around Boseto could add further resources to warrant up scaling the current 3mtpa operation that is being constructed. Underground potential at Zeta could also allow for expansion potential.
? In addition to the exploration potential on the Kalahari copper belt, Discovery Metals has tenements in Southern Botswana that are prospective for manganese as well as a JV with JOGMEC on the Dikoloti nickel sulphide project in the East of the country.
? Valuation: We value Discovery Metals at 94p/share using an NPV on Boseto with a 9% discount rate adding in cash and US$20m for exploration. We updated our numbers to reflect the A$142m equity financing of last year, year end cash position, and the US$180m debt financing package using the latest copper forward curve for 50% of the first 2.5 years of production as we would expect from the debt package. Our copper price assumption starts at 340c/lb next year falling to 250c/lb by 2018. We have modelled a ramp up from 0.75mt ore milled in financial year ending June 2012 rising to 3mtpa from the open pit that then goes to 1.5mtpa from 2016 as the underground is phased in. Total capex modelled amounts to around US$300m over the next 3 years which includes around US$170m for plant and mine, US$70m on the fleet and US$40m (funded from cash flows in 2013) on a mini coal power station with the remainder on working and sustaining capital. Cash costs from the open pit are around 125c/lb rising to 170c/lb once the underground starts up, although we note that the underground could be considerably lower cost if higher grade zones (1.5% currently assumed) are mined, and the work from the DFS could better optimise the mine plan and reduce costs.
Conclusion: With a mine now fully funded and the fundamentals for the copper price remaining robust as consultants forecast deficits for the next few years, Discovery should get its first mine up and running in a strong environment that will see very substantial cashflow generation. To add to this, the exploration programme is now well funded and picking up pace as this could add very substantial value through the delineation of another stand alone project. Such a development in the same region should be relatively straight forward particularly now that the company has considerable expertise to draw upon from its experience with Boseto. Furthermore Boseto has the potential to expand with further drilling. Another Boseto sized asset would put the Botswana copper assets firmly into being a mid tier copper asset. We see additional value coming from a number potential sources, and the recent share price weakness presents an excellent buying opportunity. Management?s methodical and structure approach to the development of this project also gives us confidence in the team?s ability to deliver a mine.