JP Morgan Initiate Coverage on GXY - Overweight - Target $4.00

JP Morgan have initiated coverage on ASX lithium sector as 'value emerges through the cracks'.

Sell-off creates opportunity to buy into quality assets
The Electric Vehicle thematic is emerging at an unprecedented rate. The shift
towards auto electrification continues to receive positive tailwinds as global
auto manufacturers release new hybrid and full electric models along with
global sales targets.

Positive sentiment towards the lithium market and listed equities has driven
up asset valuations and forced attention from industry players, downstream
customers and global money managers.

Spot lithium pricing remains close to record highs and despite recent supply
announcements and a subsequent re-basing of equity valuations, we believe
the lithium market will remain tight in 2018. Capital flows towards upstream
projects need to continue.

We initiate coverage of Mineral Resources, Orocobre Ltd., Galaxy Resources
and Kidman Resources with Overweight ratings, and of Pilbara Minerals at
Neutral. Our sector pick is GXY, trading on 0.7x P/NPV & 7.5x EV/EBITDA.

GALAXY RESOURCES
Summary
GXY operates the Mt. Cattlin hard rock project located in Ravensthorpe, Western
Australia and is progressing its flagship asset, the Sal de Vida lithium brine project
located in Argentina. GXY also owns the James Bay hard rock project in Canada
which is in study phase. Mt. Cattlin is the only operating asset and driver of current
year earnings, but the catalyst for GXY is an investment decision on Sal de Vida,
which we expect will come in 2018. As the major lithium brine project yet to be
locked into offtake, we believe there is strong corporate appeal for Sal de Vida.
GXY is one of the few global companies that owns a producing project selling into
the current deficit market, and as the only independent source of lithium concentrate
supply importing into China, the company plays a key role in setting 'contract'
pricing for 6% spodumene concentrate with third party converters.

Mt. Cattlin
The Mt. Cattlin lithium operation is 100%-owned by GXY following its successful
takeover of its partner General Mining (GMM.AX) in 2016. The asset is located 2km
north of Ravensthorpe, so noise pollution is a consideration during night operating
hours. Mt. Cattlin was originally developed by GXY in 2010 with an A$100m capital
budget, with first concentrate shipped in March 2011 to GXY's conversion plant in
China (which has since been divested). The operation was put on care & maintenance
in July 2012 due to poor market conditions and disappointing plant recoveries. The
project was restarted in September 2015 (in partnership with GMM) and concentrate
shipments recommenced in January 2017.

The Mt. Cattlin operation consists of an open pit mine developed on a flat lying
pegmatite ore body. Conventional drill & blast is used along with a load & haul fleet
to feed the 1.6Mtpa processing plant. The plant consists of four-stage crushing with a
concentrator circuit (classification screens and three-stage Heavy Media Separation
cyclones). Coarse waste is removed and sent to a waste dump while the cyclone
underflow is sent as a 6% spodumene concentrate to Esperance for shipment. The
plant is designed to produce 160ktpa 6% concentrate but GXY is considering further
expansion options.

Sal de Vida
Salar de Vida is located on the Salar del Hombre Muerto in the Puna region of northwest
Argentina. The project neighbours FMC Lithium’s El Fenix lithium operation,
which was built in 1999/2000. GXY acquired Sal de Vida in July 2012 when it
merged with TSX-listed Lithium One Inc. GXY released a Definitive Feasibility
Study (DFS) on Sal de Vida in 2013 and updated this study in 2017, delivering a
US$1.04bn asset valuation based on a 10% real discount rate and US$376m capital
cost estimate.

The revised DFS proposed a 25ktpa lithium carbonate operation with 95ktpa of
potash produced as a bi-product over a 40 year mine life. The DFS assumed a 3 year
production ramp up to full operating rates and potash production ramping up 12
months after the lithium circuit is commissioned. Operating costs have been
estimated at US$3,369/t LCE prior to potash revenue credits, and US$2,959/t LCE
including credits.

With Mt. Cattlin now operating and going through an optimisation phase, unlocking
the value of Sal de Vida is the major focus of the GXY management team. The GXY
team have a number of funding options available to them, including bringing a
strategic partner into the project to form a joint venture. This is a model that is
becoming more common in the upstream lithium market, where companies holding
the upstream asset need access to capital and security of offtake to continue
progressing a project towards development.
Strong corporate appeal with Sal de Vida

Sal de Vida is the only greenfield brine project in the world that has studies &
permitting completed and is now in the Final Investment Decision (FID) stage.
Greenfields brine projects have a 3-5 year profile from FID to full operating
activities, and investment in Sal de Vida will not change the lithium supply &
demand outlook until 2021 at the earliest. However, we believe that Sal de Vida will
i) produce 100% battery grade material, ii) have significantly lower operating costs
than hard rock and iii) has further expansion potential will be attractive to a potential
downstream player (either converter, cathode maker or battery maker) who is looking
to secure a sustainable, long-term solution to its lithium supply issues.

Valuation
We assume Sal de Vida is approved by the end of CY18 and first production occurs in
Sep Q 2021. We have assumed a 10% capital increase in the project (to remain
conservative given the long lead time and currency risks) and include 10% higher
operating costs than forecasted by the revised DFS. We assume a 40-year operating life
and arrive at an A$1.0bn asset valuation. Our base case assumption is that GXY
sources capital through debt markets to fund Sal de Vida, but the potential for a
strategic partner to inject equity into a joint venture to help fund Sal de Vida is highly
likely, in our view.

James Bay
James Bay is a hard rock lithium project located in Quebec, Canada. The spodumene
ore body outcrops at surface and the mineral resource was recently increased to
40.8Mt at 1.4% Li2O. Feasibility studies are progressing on the project, and GXY is
engaging First Nation groups as well as submitting a Project Notice to the Federal
and Quebec State governments for determination.
James Bay screens as a quality hard rock deposit, and its grade is higher than average
Australian pegmatite operations. We await the outcome of feasibility studies before
getting more constructive on the project. In our group valuation, we ascribe a
notional A$100m value for James Bay but we do not assume the project is
progressed as GXY will instead focus on Sal de Vida development.