Morningstar's Recommendation: Gindalbie Metals...

Morningstar's Recommendation: Gindalbie Metals Ltd

Recommendation: Buy

GBG is building an iron ore mine in the Midwest region of Western Australia. Principal asset is a 50% stake in the Karara iron ore project, a joint venture with AnSteel, China?s second largest steel producer. Production of hematite ore started in March 2011 with magnetite concentrate production expected by the September quarter in 2012. Attributable iron ore production run rates should reach 4.5Mtpa by 2013. The Karara project is well developed putting GBG ahead of Midwest peers. WA state government desire to increase Midwest iron ore production provides good support. Single commodity focus and exposure to Chinese steel demand makes this a high risk play only suitable only for risk tolerant investors.

Event16-Feb-2012
GBG’s 1H12 financial result had little relevance as magnetite iron ore production does not start until the September quarter. In addition, the majority of assets reside within Karara Mining Limited (KML), a 50% owned company which is equity accounted. Construction of the Karara mine and associated infrastructure remain on track for completion by mid 2012. First magnetite iron ore shipments are due by the September quarter. Capital cost guidance remains unchanged at $2.57bn. The water pipeline and pump station have been commissioned. The rail spur and transmission line will be commissioned in the March 2012 quarter with port infrastructure commissioned in the March and June 2012 quarters. Production of hematite direct shipping ore was 670,000 tonnes in 1H12 with 278,000 tonnes shipped. An initial small trial shipment to Ansteel also occurred during the period. The strong Australian dollar means additional debt funding of $150-$200m will be required to fund Karara - a small percentage increase relative the total $3bn capital cost. Preliminary discussions have been held with the China Development Bank regarding an additional debt facility to cover the shortfall.

Business Impact: We were a little surprised at the $16m loss from KML. A $16m foreign exchange loss relating to revaluation of the US$ project debt facility was the cause but means the initial hematite operations only made a small profit. Nevertheless, at this early stage profits are largely irrelevant. Earnings will transform with the start of magnetite shipments in late 2012. The Karara project will ‘de-risk’ as the year progresses increasing investor appeal and analysts valuations. The share price already responded with a 29% rise this year verses a 54% slump in 2011. At $0.68 a share market capitalization is $842m. GBG has no debt but 50%, or $915m, of KML’s debt is effectively its own implying an enterprise value of $1,757m. Only 50% of production aspirations of 30m tonnes a year will be attributable to GBG. In addition, expansion beyond 5m tonnes a year (attributable) is dependent upon further feasibility studies and capital spending. The feasibility study for the Stage 2 expansion of Karara is expected mid year. Completion will provide more certainty regarding value accretion and could boost the share price. At US$140 a tonne (62% iron, CFR China), the iron ore price remains well above our long term forecasts. At current levels, GBG should be capable of strong cash flow generation. We increase our FY12 net loss forecast to $32m but stress that the result has little significance due to GBG’s largely pre-production status. The 1H12 report gives us no reason to change our valuation of $1.00 a share. At $0.68 a share our Buy recommendation is maintained.

Forecast Impact: --

Recommendation Impact: At $0.68 a share our Buy recommendation is maintained