Australia | Oct 08 2010
By Chris Shaw
Discovery Metals ((DML)) is an emerging copper play in Africa. The company is currently developing the Boseto project in Botswana. Interest in Discovery is growing, with both Goldman Sachs and UBS today initiating coverage on the stock with Hold and Neutral ratings respectively. (For more on recent initiations of coverage in Australia see this week's Weekly Insights "It's A Two-Tiered Share Market")
The Boseto project has an expected production scenario of three million tonnes per annum, producing 36,000 tonnes of copper and 1.19 million ounces of silver per year. Cash costs are expected to be around US$1.39 per pound, while the project has an estimated mine life of 15 years. First production is expected in the first half of 2012.
Longer-term there is potential for the project to develop underground operations as well, though as UBS notes, these underground reserves still need to be delineated. Exploration results are expected to be positive and this sees UBS factor in an 18-year mine life compared to the official 15 years currently indicated by the company.
In the view of UBS, some of this production upside is now being factored into the Discovery share price. The other issue for UBS is Discovery is likely to soon raise equity, with the capital raising likely to be a significant one at around US$100 million on the broker's numbers.
Goldman Sachs notes Discovery intends to use as much debt as possible in developing the Boseto project, though there will still need to be an equity raising of anything between US$78 and US$121 million depending on the final level of debt assumed.
Another important point for Goldman Sachs is while Discovery's Boseto project has a better copper grade than most similar projects, there are lower by-product credits and a materially higher strip ratio. This means the project will be in the upper 3rd quartile of the cost curve.
Copper is a preferred base metal for Goldman Sachs, so the stockbroker has factored in a relatively positive pricing outlook. Discovery is quite sensitive to actual copper prices, UBS estimating a 10% move in the copper price would impact on earnings per share by as much as 34% in FY12 and 25% in FY13.
Production at Boseto is expected to commence in FY12, so earnings will be immaterial until that time. In FY12 Goldman Sachs is forecasting earnings per share (EPS) of 6.9c, rising to 50.4c in FY13. UBS is somewhat more conservative, forecasting EPS in FY12 of 5c and in FY13 of 20c.
Longer-term Discovery is likely to become less reliant on copper, Goldman Sachs pointing out the company also has 85.3% of the Dikoloti nickel project, also in Botswana. This project remains in the early stages but currently has a resource of 4.1 million tonnes at 0.7% nickel and 0.5% copper. Further exploration work is planned before any further economic studies are commenced.
Based on current expectations, UBS values Discovery at $1.27 per share and sets its price target at $1.35. While Goldman Sachs has a valuation range of $0.91 to 1.20, GS has set a higher price target of $1.50.
Both targets are more aggressive than those of RBS Australia and Macquarie, the other brokers in the FNArena database to cover Discovery. RBS has a target of $1.25 and Macquarie of $1.00, though both brokers rate the stock as a Buy in contrast to the Hold ratings of Goldman Sachs and UBS.
Shares in Discovery today are slightly weaker and as at 11.00am the stock was down 3c at $1.245. This compares to a range over the past year of $0.42 to 1.345 and implies downside of a little more than 3% to the average price target in FNArena's database.
