Syrah Sell-Off Overly Panicked?

This story features SYRAH RESOURCES LIMITED. For more info SHARE ANALYSIS: SYR

The managing director's resignation has sent Syrah Resources stock plunging but brokers are sticking to their belief in the company's graphite opportunity.

-Resignation unlikely to be the preface to bad news but considered poorly handled
-Mine scheduling and budget confirmed on track with update on spherical graphite in a month
-Balama project still considered the top high-grade advanced graphite project
 

By Eva Brocklehurst

All was going swimmingly for graphite producer Syrah Resources ((SYR)), until the announcement of the managing director's resignation sent the stock plunging. Tolga Kumova has announced he will step down from both the management position and the board to devote more time to develop the spherical graphite business.

Brokers, in the main, understand the reason for the move but question the timing of the announcement. Moreover, without further explanation, suspicions arise that all may not be going so well on the graphite front. Mr Kumova remains full time with the company and chairman Jim Askew will assume an executive role until a replacement is recruited.

Credit Suisse is one broker who believes the resignation from the board needs further explanation and that the poorly managed announcement has left the market convinced there is some bad news to follow. Mr Kumova was always expected to step aside as the company evolved but such a precipitous change at a critical time for the company is a concern.

Morgan Stanley wonders why the ongoing transition to producer from explorer needed such a sudden change in management. The broker notes a mention of some challenges in achieving the company's battery strategy, which is expected to be elaborated in the next quarterly production report, due soon.

Still, the company states it is on track in moving to a product that could eventually be used in electric vehicles. Morgan Stanley retains an Underweight rating.

To Credit Suisse the announcement raises a “red flag”, one that is typical of many companies where the MD resigns stating the business is in good shape, and then the incoming MD identifies undisclosed issues and re-bases expectations lower.

In this case, the broker does not believe there is undisclosed bad news pending and accepts the chairman's explanation that Mr Kumova recognised his skills were more appropriate to building the business rather than running it.

Deutsche Bank, too, acknowledges the reasoning behind this view, noting Mr Kumova stated he did not have the appropriate skill set to take the company into commercialisation and beyond. He can be credited, nonetheless, with taking the company to the development phase of the world's highest grade graphite project. The broker is surprised at the sell-off in the stock and considers it a strong buying opportunity.

Still, with Mr Kumova having made the decision to exit the MD role, it appears to Credit Suisse the board viewed it as a material disclosure, hastily releasing a statement that has confused the market and added new risk. The broker accepts that having a prior MD on the board might be potentially unworkable for a newcomer but this decision has been made with inevitable market consequences.

Moreover, replacing Mr Kumova's five years of experience, knowledge and credibility in the graphite industry by an external recruitment will be difficult and his retention as a consultant appears to the broker to be a tenuous hold on a valuable resource.

The company has confirmed that its mine is on schedule and budget and the spherical update would be released in around a month. Recently, results from pilot plant testing at Balama indicate graphite can be upgraded to higher levels of total graphitic content.

Macquarie observes that achieving higher grades is a positive step but understands that purification costs are not that simple. To reach the very high levels of purity required by battery applications it is necessary to remove contaminants, and the process becomes more expensive as higher and higher purity is demanded.

The increased grade will lift the price of the company's product but without more technical details, Macquarie is inclined to leave estimates unchanged.

Morgan Stanley has carried out some channel checks with Chinese battery producers and deduces that synthetic graphite typically trades at an average price of US$7,000/t and can trade up to US$14,000/t for the highest quality product in China. In comparison, the average price of natural graphite is US$6,000/t with high end products being sold up to US$8,000/t.

In the broker's view, therefore, with average prices only US$1,000/t apart, the cost saving benefit of switching to natural from synthetic appears limited. The broker also notes that industry sources advise that lower end battery electric vehicles (BEV) use a blend of synthetic and natural in order to balance the power/range paradigm. High end electric vehicles seem to be using anodes composed of synthetic graphite only.

Credit Suisse adds a final observation that the market will no longer tolerate further surprises from the company, which could mean disclosures become even more vague than what brokers have had to contend with.

While the company does have intellectual property which needs to be protected the broker points out that investor decisions are based on more rigorous study than just thematic stock picking of exposures without earnings to audit and suspects the board does not fully appreciate this.

The broker believes the board can recruit a good candidate and the company's transition momentum is strong, which should drive demand growth for anode material. Moreover, there is no other high grade advanced graphite project which has emerged as a near-term anode supply alternative.

There are three Buy ratings on FNArena's database with one Sell (Morgan Stanley). The consensus target is $6.36, suggesting 80.2% upside to the last share price. Targets range from $3.75 (Morgan Stanley) to $7.80 (Credit Suisse).
 

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