Western Areas Tucks Cosmos Into Its Nickel Belt

This story features BHP GROUP LIMITED. For more info SHARE ANALYSIS: BHP

-Nickel price trajectory a trigger
-Potential for quick re-start
-Exploration critical to scale up
 

By Eva Brocklehurst

Western Areas ((WSA)) has swooped on the mothballed Cosmos project, picking up an asset at a time when prices are depressed, with a view to add scale and potential to its nickel portfolio.

The company will acquire the Cosmos nickel project for $24.5m from Glencore Xstrata in deferred cash payments over 18 months. Cosmos historically produced 127,000 tonnes of nickel but was placed on care & maintenance in 2012 at a time of low nickel prices and a high Australian dollar. Now, Western Areas will conduct work on the Odysseus prospect, which has potential to become the third operating nickel mine within its portfolio.

JP Morgan is keen on the exploration potential of Cosmos because there has been limited step-out drilling to date and the project is located within a well known nickel district. The project is 28 kilometres north-west of BHP Billiton’s ((BHP)) Leinster mine in Western Australia. The asset was originally acquired as part of Xstrata’s bid for Jubilee Mines in 2008. The broker takes account of the prospect in modelling but, regardless, considers the demand for nickel remains anaemic. Chinese stainless steel production in the first four months of the year increased by 4.0% as opposed to 10.0% over the same period last year.

Moreover, there is amply supply with the quality of ore imports from the Philippines improving. Without further curtailments to supply, or improved demand, JP Morgan believes the risk for the nickel price in the second half of 2015 is skewed to the downside. Given current fundamentals, the broker remains more comfortable with a US$10,000/t nickel price than one projected at US$17,000/t. JP Morgan has the one Neutral rating for Western Areas on the FNArena database. The remaining six are Buy ratings. The consensus target is $4.71, which suggests 26.7% upside to the last share price. The dividend yield on FY15 consensus forecasts is 2.3%, rising to 5.6% for FY16.

With the promise of increased leverage to higher nickel prices, Deutsche Bank retains a Buy rating. The potential re-start of operations based on the Odysseus deposit and exploration upside from a prolific nickel belt, signals less emphasis and reliance on the company’s Forrestania project to deliver incremental upside. Assuming no success from further exploration, Deutsche Bank calculates a re-start of Cosmos will require a nickel price above $12.00/lb to deliver a 15% internal rate of return.

There are several exploration targets within the project. While sufficient lower grade mineralisation has been defined at Odysseus, significant success will come from targeting the small, high grade ore, such as that previously mined at Cosmos and Cosmos Deeps. Several targets have been defined to the north of Odysseus which will require follow up. Deutsche Bank notes the depth from surface and small size of the targets means drilling will be expensive and need to be highly accurate. Development of a drill drive off the existing underground infrastructure may prove the easier alternative.

In the meantime, Macquarie considers the acquisition a positive step and a near-term catalyst. The broker observes the resource base at Cosmos is significant when placed in context with the company’s current base. Grades are well below the Flying Fox and Spotted Quoll deposits but are higher than the New Morning and Diggers South deposits at Forrestania. A scoping study conducted on Odysseus previously suggested a development producing 12-14,000tpa over 7-8 years and the company will review this work and complete a pre-feasibility study over the next 12 months. Of importance, there is significant infrastructure in the purchase, with a 450,000tpa nickel concentrator, accommodation village and potential for gas-fired power established.

On simple resource metrics the deal appears inexpensive to Morgan Stanley. This could be another example where a non-core asset of a major miner is better off in the hands of a smaller operator with a specific focus. Based on the Odysseus deposit alone, the transaction equates to 6.0c/lb compared with the company’s current metric of 80.0c/lb on Forrestania. Approving a nickel development would be challenging in the current market but the broker observes the existing infrastructure could aid the economics overall.

The advantage in UBS’ view is the potential for a quick entry into another mining operation. The broker expects cost deflation will unlock immediate value. The broker likes Western Areas for its operational stability, low cash costs, net cash position and consistent dividend stream. UBS believes, as the last of the Forrestania development debt is soon to be re-paid, investors are probably wondering what is to be the next item on the agenda. The announcement underscores a measured approach to regional growth and, should the nickel price rally on the back of de-stocking of high grade stockpiles in China, the value of Cosmos could be unlocked quickly in the broker’s opinion.
 

Find out why FNArena subscribers like the service so much: “Your Feedback (Thank You)” – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms