Savannah Resources v Bacanora Lithium

I hope that folks have enjoyed the rise on Savannah in the past month. As my last blog clearly mentioned when in the 5s and 6s, Savannah was a screaming and safe buy, the rise up to the highs of 16-17p was both dramatic and fully expected. Understanding the mining cycle, having patience and investing are key on AIM. Jumping around from share to share, “trading” is a game with winners and losers, particularly over time.

For the record Savannah Resources has really just started its journey. Achieving a 100m Market Cap, has been a form of “coming of age” for the company, it should allow the company to fulfil its dreams, deliver on its projects and become a serious midcap miner. All 3 of its projects have sufficient potential to deliver 500m-1bn of MCAP each, once into phase 2 or 3 of their product. Due to this and the excellent management of the company it will remain a very strong buy and sit pride of place as the bedrock of my investments. There remains strong share growth at the 3, 6, 12 month and beyond targets.

Whilst researching Savannah this year though I have continually come across an old favourite of mine, Bacanora Lithium. I was a fan of this company when it was just on the Canadian Exchange, I followed its admittance into AIM (and invested). Under Colin’s stewardship it was an example of how to identify good projects and explore them. I argued on this blog how toxic having David join the board would be, Colin and Cordy did not want any of the article changing and the ensuing lack of share price growth is a helpful indicator of how toxic this has been. Colin’s death was a blow to the company and a very sad piece of news, his ability to pick a path through difficult waters has been missed.

The company in the last 12 months has made a number of unforced errors, the arguing of the royalty payments to Cordy and family, left me angry as this was Colin’s inheritance for creating the company. He was the explorer who found the world class lithium project that will define Bacanora and to try and rob him and his family after his death was a low even for an AIM company. The decision to finance through Nextview capital was stupid on so many levels, thankfully the appointment of an experienced CFO and bolstering of the BOD post this debacle should help to ensure it doesn’t happen again. That a company would want a shady private Chinese company as a partner shows a total lack of directorial oversight.

Despite this, not everything has been doom and gloom at Bacanora. The company has quietly been progressing its Mexican Lithium project, concluding a feasibility study, finalising construction plans, getting the support of the local authorities and refining the complicated process of extracting the lithium from the clay. Aim however doesn’t like quiet and is slow to forgive bad decisions, so the share price is actually lower than the original admittance to AIM all that time ago. Despite the lithium price increasing from 5500 to 17000 over that time.

  

Comparison.

Both companies have considerable expansion on their lithium prospects.

	Savannah Resources*	Bacanara Lithium**
NPV	$356m	$1253m ($1380m)
IRR	63%	26.1% (31%)
EBITDA	$72m	$229m ($254m)
LOM(length of mine)	$1555m	$3206m ($3450)
Profit Margin	60%	63% (70%)
Capex	$109m	$420m
Production	2020 Q1	2020 Q1

*Savannah Resources figures are based on a scoping study with a higher degree of uncertainty.

**Figures are updated from the Dec 2017 Feasibility Study to take into account the lithium price increase and the lithium forecast figures used by Savannah for comparison purposes.

Production is planned to commence relatively quickly, Bacanora is considerably more advanced than Savannah, however Savannah’s project is far more nimble, smaller and simpler. Bacanora has published its final feasibility study and despite already having a start ceremony will be finalising its design in July 2018 prior to ground breaking. I fully expect both to slip a bit to H1 2020.

Both companies have a fantastic profit margin, both are exceptionally low cost compared to similar competitors. Savannah has a much lower cost than for example European Lithium’s Spodumeme, whereas Bacanora is lower than many of the proposed new Argentina brines. Both projects would be considered low cost(lowest 10% of lithium projects globally) and profitable even by Morgan Stanley’s hatchet job earlier this year, as well as comparable to the great Chilean lithium deposits of SQM.

The LOM (length of mine) and EBITDA are both very respectable. On the plus side they should be considered starting figures, as Savannah will undoubtedly increase their resource by at least 100% prior to production and Bacanora have already planned phase 2 to double production. The resources for Savannah and Bacanora, should have a true LOM of at least 30 and 50 years respectively, giving estimated figures of $3.3bn and $30bn. These figures should start to be recognised by the market as we get close to production start.

One of the most useful ways of looking at a project’s profitability and particularly its attractiveness for obtain funding, is a companies IRR (Internal rate of return).  This is how quickly the projects capex will pay for itself. For example if the LOM is 10 years, it would make very little economic sense to have an IRR of 10%, as it would take 10 years to pay back the cost of the capex. It’s easy to see then that the IRR is also going to be impacted by the capex.

Generally an IRR of 30-40% is considered good. This is a rule of thumb only though. A certain small cap company a few years ago had an IRR of 40%, however the LOM was only 5 years and the EBITDA was only for 35m. The mine in question had a very low capex and was designed to maximise a small vein system of gold. Over the 5 years any profits for the mine were quickly eaten up by BOD salaries and further pointless exploration. Unsurprisingly the MCAP of the company never went over 30m.

Given the above example, a better rule of thumb would be less than 20% and the mine, except under extraordinary circumstances, would not be developed. 20-30% is only really acceptable if the capex is above 300m and the mine has a long life span. For a short life span mine less than 10 years ideally you would want an IRR of 40-50%.

If we look at a few IRR of other Lithium companies, European Lithium has an NPV of 263m and IRR of 21%, needless to say they are looking to improve this. Far resources has an IRR of 30% and Frontier Resources 38%, both of which have been deemed good enough to continue.

Savannah Resources will undoubtedly have a Length of Mine of over 15 years by the time the go decision is made. With an IRR of 63% and low capex it fits into the higher bracket of potential lithium producers. Indeed it puts it in a far more profitable position than the vast majority of small to medium lithium producers.

Bacanora Minerals with an IRR of 26.1% on the face of it doesn’t seem great. However it is worth remembering that even with a 20% discount to current lithium values its recalculated IRR is already just over 30%. For a higher capex mine this is respectable. The IRR for Bacanora is more complicated than this though. Phase 2 of the project is due to double output, some of the original capex and so IRR is forfeited for a cheaper phase 2 entry. When you factor in the incredible length of mine confirmed at 50-100 years by the company as recently as this weekend, a payback of only 3 years moves from respectable to highly respectable.

Of course the elephant in the room for both of these projects is how, with comparable MCaps of around £100m, can the two companies fund the capex’s already discussed?

The answer partly lies in the figures above. The healthier the figures the more likely the funding will be found. The better the figures stack up against other industry similar potential lithium assets the easier it will be attracting the funding.

Funding

Once we’ve established that a project has sound and healthy financials and will be attractive, we can assess funding and its implications. A mix of funding options are usually used, they include selling shares in the company, bonds, some kind of tiered structured loan facility backed by the asset used as collateral, funding secured against future offtake agreements or straight forward payment for future lithium sales.

Just like a mortgage to buy a house, financiers will often want the company to have some skin in the game. This is commonly around 25%, the table below shows how this should be accounted for as a percentage of the company.

Using Exchange rate of 0.75 pounds to 1 dollar.

	Mcap £	Capex £	Share of Capex £	Share Fundraising £	Share Fundraising % of company
Savannah Res	90m	81.75m	61m (75%)	15m	17%
Bacanora Lth	111m	315m	220m (70%)	55m	50%

Fundraising of this kind commonly concern 1-4 companies, funds or financials. The shares are unlikely to enter the market until the company goes into production.

Now that we have an educated guess of how much dilution might occur, we can address the rest of the fundraising for the two companies. I would expect funding against future offtakes to account for as much as 50% of the Capex. Particularly for Bacanora who already have an offtake agreement with an entity who is a major owner of the company. For Bacanora I would suggest the most likely option for the final 25% is probably a bond offering. Funding for Bacanora should be announced in the next 6-8 weeks.

For Savannah, the funding will likely be entirely offtake related (obviously with the equity component). Due to the low risk, pay back, this will be achievable.

Conclusion.

So where does that leave us? Which company should you invest in? Which company is better?

As always the purpose of this blog isn’t to tell you who to invest in. I just want people to think and research for themselves. I want investors to invest.

AIM has always been a gambling den, traders who like to pretend, frankly fools who invest on momentum and spikes and the next big thing. It’s always been assumed that long-term investment on AIM is for mugs. This philosophy is completely the wrong way round. I know that 90%, if not 95% of AIM companies never make money. This is where researching and choosing companies that are likely to go into production and make money, seems to me to be an intelligent way of investing. The mining cycle shows that companies often have a weak share price after a lengthy news wait for licenses and feasibility studies. Larger low-risk appetite corporate investors will often invest when the company is very likely to begin construction on a low risk project.

As a smaller invest, it seems to make sense for me to research projects, find projects that will likely enter production and make money. Then enter these companies when the share is unloved, just prior to the corporate investors.

Savannah resources fit this nicely when I used a new fund to buy shares at 5-6.5p. As expected the share price is nicely responding and production (at least to me), seems very likely. I have little doubt that the company will be considerably higher, in 18 months time, than its current share price, taking into account the share dilution. Being strongly up, I can relax, hold the share and probably make a return over the 2 years of at least 300-400%. If I wasn’t invested, I would still buy the shares, over the coming month or two. With a view of seeing considerable share growth as the corporate funds move in and important announcement de-risking the lithium project are made. There will also, in my opinion, be announcements on other Savannah projects that will drive share growth.

Bacanora is slightly different, it’s still in the unloved phase prior to any project unlift. As discussed above this is due to factors such as management mistakes, however I still believe that the project will go into production. Bacanora is currently valued at around 10% of its discounted NPV, even allowing for past management problems (which are hopefully behind us) and share dilution at 50%, there seems to be scope for the 100-150% share increase that Savannah has recently enjoyed. The catalyst for this will likely be the fund raising announcement for the project. Once the project has been fully funding and construction started, approx. August/Sept, the share price should gradually rise to meet 60-70% of the NPV prior to first shipment.

Savannah is a fantastic share in my opinion for a low risk, longer term investment.

Bacanora has a higher risk/reward ratio, mainly concerning director decisions and funding mix, but is a risk I am happy to take considering its closing in on production and its potential.

However both companies should delivery very good returns for investors, for those happy to shy away from the momentum chasing, gambling, stock chasing of more run of the mill shares.

For transparency, I have several holdings in Savannah Resources and have recently been building a holding in Bacanora Lithium.