Some work I did over the weekend. Still sort of in draft form. Personal musings, not advice.
1. HOMBRE MUERTO WEST Updated Preliminary Economic Assessment from 9 December 2021 Variables: - Average Li2CO3 selling price: US$18,594/t - Royalty: 3% - Average annual operating cost: (US$3,518/t) - Production volume tonnes p/a: 20,000 - Corporate tax: 35% - Sustaining capital: (US$116,000,000) across 40 years: (US$2,900,000) p/a [Required upfront capital expenditure: US$439M / A$627M]
Entering the variables into a basic model therefore predicts free cash flow per year of US$185,836,340 per the image below. The HMW revised PEA has this figure at US$190,000,000 so near as bang on to my napkin-model. Converting this to AUD at an AUD/USD ROE of 0.70 equates to free cash flow of A$265M. Divided by the number of shares on issue, that means at normal operation, based on the metrics provided by the updated HMW PEA, each single current share of Galan could in future produce $0.87 of free cash flow. At the current share price of $1.18 this is an unheard-of yield of 73.9%. Don't get excited yet. A few obvious qualifiers. Clearly the yield will not remain this high. It will drop down considerably as a) the GLN share price increases towards production and b) the number of shares on issue increase, whether that is through further capital raises, or performance options being issued etc. Important side note: diversified, stable giants like BHP and RIO trade at a historic FCF yields of between 9-15%, sometimes as high as 17-18% in a bumper year. There is really little point owning a speccy that does less than that, might as well stick with the safe giants. So you want a FCF yield above what the majors are offering, since you are taking on a lot more risk. Ultimately you want these miners to be returning earnings generated to shareholders via dividends, so the higher the yield the more attractive the stock. They are not there to take over the world like a tech company, their purpose is to mine their resource as efficiently as possible and give the profits to shareholders. Additionally, the above model makes a number of large assumptions, namely:
that Galan will get HMW to production. Lots of adverse things could happen - a buyout, a key person dying, the host nation nationalising the industry, EV market weakness, trouble getting finance, market oversupply, etc.
that shares on issue will not increase, which will certainly not be the case as various performances options will vest, and at some stage in future further capital will most likely be raised (even if just smaller amounts to support debt funding).
that Galan will be able to hit expected production volumes (20,000 tpa for HMW). Also unlikely, discussed why further below.
Finally, as the project comes closer to production one would expect the share price to naturally rise. So I can't go 'all-in' on this thinking "at these prices, I'm buying a 74% FCF yield, this is free money". Some further tweaks need to be made. For example, plugging in the 52WH share price of $2.34 reduces the HMW free cash flow yield down to 37%. Simple maths ($0.87/$2.34) - the project is estimated to produce A$265M free cash flow per annum. If the shares on issue remain at current levels, then the cashflow per share will always be $0.87. So as the share price goes higher, that yield reduces. If the yield falls below what I can earn holding a larger, safer company (like a major) - why would I bother with a speculative developer? I could bank my big capital gains, and cycle the profits into something paying a far better yield. So, yield matters. This is not a point I had given enough thought to in the past. If we suggest (just for illustration - this may not be realistic) that by the time Galan reaches production: - there are an additional 15% of shares on issue (350,059,266 in total) - share price is A$3.00/sh (market cap is A$1,050,177,799) - free cash flow is still A$265M per the PEA Then the FCF per share is $0.76/sh and divided by $3.00/sh = a FCF yield of 25% (which is extremely good - better than I can get holding the majors).
There is a slightly more bullish view. Earlier on in the project's life, the Li2CO3 price may be higher than US$18,594; recall that figure is an average price estimated across the period from 2025-2040 (per the updated PEA). Let's suggest in the first few years of the project the lithium prices are at the US$25,000 range. So long as other variables remain unchanged (royalties, cost base, taxes and sustaining capex), at those higher lithium prices, HMW would now produce A$380M free cash flow p/a for those earlier years of the project. So taking the same variables as before: - an additional 15% of shares on issue (350,059,266 in total) - share price is A$3.00/sh - free cash flow is A$380M Then the FCF per share is $1.09 divided by 350M shares = a FCF yield of 36%.
Once we know how much free cash each share is producing, we could use an 'acceptable' FCF yield to reverse-engineer what the share price would be (so long as we have correctly estimated 1. free cash flow, and 2. the future number of shares on issue). For example, if the market is happy to buy and hold Galan at 20% FCF yield, then using the variables above, $1.09 / 20% = A$5.45/sh. If the traditional majors were all struggling along only doing say 7-8% FCF yield, and the market was happy to buy/hold lithium companies at 15% FCF yield, then $1.09 / 15% = A$7.26/sh. Not predictions, just illustrations. To me this approach seems to make more sense than just doing EBITDA multiples. The above is for one project.
2. CANDELAS Preliminary Economic Assessment from 30 November 2021 Variables: - Average Li2CO3 selling price: US$18,594/t - Royalty: 3% - Average annual operating cost: (US$4,277/t) - Production volume tonnes p/a: 14,000 - Corporate tax: 35% - Sustaining capital: (US$99,000,000) across 25 years: (US$3,960,000) p/a [Required upfront capital expenditure: US$408M / A$582M]
Entering those variables produces a FCF of US$121,248,538 which is close enough to Galan's US$126M in the Candelas PEA. Again converting this to A$ at ROE 0.70 means annual free cash flow generation of A$173,212,197. Thus on its own (if it reaches production) based on current shares on issue Candelas would produce A$0.57 of free cash flow per share (a yield of 48% based on the current share price of $1.18). Using the same variables as noted earlier (350M shares on issue, $3/sh), the yield drops to 16.5%. You can see that because this project has a much lower FCF than HMW, as the share price increases the yield drops away. Given that the upfront capex required for Candelas (US$408M) is similar to HMW (US$439M), assuming no difference in overall chemistry between the projects, it makes sense to progress HMW and produce far higher volumes for more free cash flow.
3. COMBINED Lastly, combining the two projects' economics. Personally I think this is a stretch as a junior like Galan is highly unlikely be able to fund/develop two projects concurrently (far too much execution risk - the market would freak and so would I). So they'll likely go for HMW first and only when that is successfully generating returns, then later try to fund/develop Candelas, the smaller operation (or perhaps they will sell one to help fund the other). This is just my opinion of course. However if we were to combine the two projects then we get the following: - 34,000 tonnes per annum (maximum/ideal) production volume - EBITDA of US$483M - Free cash flow of US$307M or A$439M With 350M SOI and $3/sh this is free cash flow of A$1.25/sh or a yield of 42%.
Again, if both projects were running concurrently and the market was happy to buy/hold lithium companies at 20% FCF yield, that'd mean $1.25 / 20% = A$6.25/sh. But with two projects running I think you'd have to estimate SOI were much higher, i.e. >400M, from large capital raises required to help with the capex. So that would drop the FCF per share down to $1.09, so at a 20% yield that's a share price of A$5.45/sh.However for reasons stated above I think that Galan would look to execute projects separately, more likely sell one to finance the other. It is also worth remembering that there is plenty of operational risk, i.e. the model above is assuming that Galan will produce exactly the tonnes per annum the PEA's suggest (20,000 and 14,000 respectively). Anyone who follows producing miners (lithium or otherwise) know this is never the case: bad weather, accidents, machinery breakdown, staff shortages, pandemics... you name it, stuff conspires to result in production guidance being missed. So to be realistic you'd need to carve off decent percentages to account for production volume misses, etc.
4. SUMMARY These are just my own attempts tinkering with the economics from the two PEA's to try and get a feel for what sort of cash returns the project(s) will be generating - should they get to production - if they are achieving the variables set out in the two studies. I think it is self-evident why Galan are focusing their time and money on HMW. I have not included Greenbushes South as that is a totally speccy - it's just a bonus on the side that may or may not deliver. But what I think this approach does show is that people calling for a $10/sh either may not have run the numbers, or must believe the Li2CO3 price is going to absolutely moon right as we get into our first few years of production. Because based on the figures in each PEA (principally, the annual FCF generated by each individual project), if Galan had a $10/sh price when they hit production, the free cash flow from HMW would be yielding just 7.6% and Candelas would be 4.9% (and remember, those figures would be even lower if there were more shares on issue). As for $15/sh - that would be yields of 5.1% (HMW) and 3.3% (Candelas). In either case here, at $10/sh or $15/sh, there would be almost no point owning the company when better cashflow yields could be garnered by owning much larger/safer/diversified companies like BHP or RIO. In fact, even a term deposit would be better in the latter case.
I think a better way to determine a future share price assuming Galan get to production is to estimate how many shares on issue will be floating around, decide on what sort of FCF yield the market would be satisfied with (i.e. a good deal higher than what the majors offer) and work it out that way. For example, I could imagine a scenario like the following:
Galan progress HMW to development and to help with this, sell Candelas
They raise the necessary capex via a combination of equity (capital raised), cash from Candelas, and debt funding
By the time the company reaches production, there are 380M shares on issue (i.e. another +25% issued)
HMW is slated to produce A$265M of free cash flow (but debt interest repayments would drop this down a bit)
Lithium prices could well be stronger early on, so I estimate FCF of ~A$350M (Li2CO3: US$23,500) once they're a few years into production and have ironed out production issues
Divided by 375M shares on issue that's generating $0.92 per share
A satisfactory FCF yield could be anything above 20%- So $0.92 / 20% = $4.60/sh.
Again, not a price target, just an illustration.This exercise was useful for me, perhaps it is for others. My key takeaway is that at the end of the day, the most important numbers are a) the annual FCF generation per project and b) shares on issue. That will determine future EPS (so look out for companies that are constantly issuing options to directors, friends and consultants as they are diluting your future earnings per share, which is really what matters). Happy to hear any feedback or necessary tweaks to the approach/model. Tagging @HOOPZ who I recall has done some valuation work too.
GLN Price at posting:
$1.18 Sentiment: Hold Disclosure: Held
(20min delay)