Tropicana To Transform Independence

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-Tropicana to transform earnings
-BHP plans at Long concern Credit Suisse
-Short mine lives also a concern
-Improving copper grades seen at Bentley

By Eva Brocklehurst

Diversified miner, Independence Group ((IGO)), is accomplishing just that. Diversifying its resource base. This is increasingly seen as standing the company in good stead on the rocky road of earning a crust from resources.

The Tropicana gold project is expected to transform the earnings outlook and first production is due this month. The early signs of the production ramp-up are encouraging and hitting target production rates is a key catalyst for the stock over the next 6-12 months. Macquarie has Tropicana at 68% of its valuation for Independence. Credit Suisse finds all the company's operations are performing well and should be profitable at current prices. Independence has minimal debt and has the best near-term outlook within the broker's nickel coverage. That said, the stock is up 65% from lows two months ago and, for Credit Suisse, it's starting to look fully priced. Hence the broker decided to downgrade to Neutral from Outperform after the FY13 results.

There are two Buy ratings and four Hold on the FNArena database. The consensus target price is $3.98, suggesting 0.2% upside to the last share price.

The FY13 results were firm with headline net profit of $18.3m just 2% below Macquarie's expectations. Earnings were was actually 10% higher than the broker had anticipated with operating cash flow also coming in 9% ahead of estimates. Macquarie materially upgraded earnings forecasts for FY14. The upgrade reflected a much stronger gold contribution from Tropicana in the first half. Independence expects Tropicana to deliver 120-160,000 ozs in the December half. BA-Merrill Lynch notes that, despite depressed commodity prices and the strong Australian dollar, FY13 profitability was helped by improved production from both the Long (nickel) and Jaguar/Bentley (copper/zinc/silver) mines.

Macquarie's forecasts had assumed that the majority of production in the first FY14 was capitalised, with only 40,000 ozs of output contributing to income for the half. Incorporating much stronger guidance has driven a 79% uplift to FY14 earnings forecasts. Countering this is lower guidance for Long and Jaguar and slightly higher cost assumptions across all three projects. This has resulted in a 9% cut to the broker's FY15 forecasts. Macquarie assumes Tropicana to be at full production in FY15.

IGO still looks reasonable on price/earnings ratios of 7-8 times from FY16, as Credit Suisse's forecasts for nickel, copper and zinc turn more positive. However, the real issue for this broker is the short mine life for all operations. Further upside is most likely to come from successful exploration drilling around Tropicana, with the Havana Deeps pre-feasibility study due in the December quarter.

The question is: Can Independence really be counted fully as a nickel play when the company's key asset is now a gold project? Admittedly Independence is the junior partner, with 30%. AngloGold Ashanti has the remainder. The JV was established in 2002 and approved development of Tropicana in 2010. Previously, Independence was a nickel play, having bought the Long nickel mine from BHP Billiton ((BHP)) in 2002. The company's main projects are the Victor/Long nickel mine, the Jaguar/Bentley copper/zinc mine (acquired 2011) and Tropicana, all in Western Australia.

The Tropicana stake makes up around 70% of Deutsche Bank's discounted cash flow valuation. The broker thinks the large land holding is highly prospective and resources will continue to grow and add further value over time. Tropicana has an 11-year reserve life, although there will be substantial variability in production performance over the life of the mine. During the first three years of operation, Tropicana is expected to produce 470-490,000 ounces. Over the 11 years of operation, the average goes down to 330-350,000 so, in Credit Suisse's evaluation, the decline is considerable.

Tropicana's resource is 7.89m ozs, which includes the 3.91m ozs in the gold reserve base. The bulk of the remaining resource is from Havana Deeps which can only feasibly be exploited as an underground mine. Deutsche Bank is bullish on the resource growth potential at Tropicana, through depth, lateral extensions and satellite discoveries. The Havana Deeps' underground option is likely to be taken up in the broker's view.

The Long nickel project has about four years reserve life and 7-8 year resource life. What concerns Credit Suisse is that  BHP may still decide to shut down its loss-making Nickel West concentrator as it does not view the nickel price outlook favourably. IGO would then be left without a customer for its ores. There may be partial compensation if this does happen because the contract is in force until 2019. Credit Suisse models Long until 2021, in line with the resource estimate.

Deutsche Bank has recently visited the Long mine and views the exploration potential favourably. In the last quarter 5% of tonnes were sourced from Long, 28% from McLeay, 13% from Victor South and 54% from Moran. Moran has been recording the most impressive grades, above 4% for FY13, and the broker thinks this area has greatest potential. Deutsche Bank has not changed nickel production assumptions but has incorporated new nickel price forecasts into estimates.

Jaguar/Bentley is similar to Long in terms of a short mine life, in Credit Suisse's opinion. It has a five-year reserve life and six-year resource life. At the moment, only Bentley is being mined but this is where the bulk of the reserve is located. On this project, Deutsche Bank assumes that higher zinc grades persist in FY15, while over time the zinc grade should fall and the copper grade should rise with depth. Merrills believes Jaguar/Bentley fortunes can improve significantly as the production performance lifts in FY14. This broker estimates zinc and copper revenues to contribute over 40% of Independence's total revenue in FY14 and, excluding Tropicana's gold contribution, this would rise to 50%.

Stockman (copper/zinc/silver) and Karlawinda (gold) are two exploration assets which have been put on the back burner because of poor economics. Credit Suisse does not assign any value to either. Deutsche Bank includes $150m for these assets in forecasts.
 

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