Re: KZL - Kagara Zinc
I have obtained the following from Newjo's posting on HC....
Huntley's Recommendation: Kagara Ltd
Recommendation: Reduce
The Mt Garnet plant in Qld sources ore from a number of small, high grade deposits to produce zinc, copper, lead, silver and gold. Thalanga’s late 2006 start-up makes copper the dominant metal. The Mungana base metals mill at Chillagoe, similar to Mt Garnet, was postponed in 2008. It was to start April 2009. Red Dome and Mungana may support a combined low grade gold/copper development. KZL’s Lounge Lizard is a promising exploration project adjoining Western Areas’ (WSA) Flying Fox nickel mine in WA. Admiral Bay is a large but low grade and deep zinc, lead, silver deposit with significant option value. Speculative and only for those seeking upside from exploration and development with a tolerance for mining and commodity price risk. KZL has no moat with cash costs near the industry average for zinc but in the highest quartile for copper.
Event
06-Feb-2009
Much has changed in the past five months. When we reported on the FY08 result in August copper was US$3.44/lb and zinc US$0.81/lb. KZL’s margins were healthy. Copper is now US$1.45/lb and zinc US$0.49/lb. The balance sheet has weakened substantially. Spending was relatively heavy in 2008 with capital directed to the mothballed Mungana Basemetals plant and exploration – both now pared back to a minimum. As at June 30, 2008, cash was $15.8m and debt $100.0m – receivables and payables broadly balanced. Cash at end December 2008 was $31.7m but debt was approaching $200m. Payables have blown out to exceed receivables by more than $70m. Provisional pricing payments of $34.5m received from smelters in 1Q09 are to be repaid in 3Q09 due to the steep fall in the copper price.
Business Impact: We have slashed our valuation to $0.54 a share in response to the worsening financial position, dilution from the placement and severely reduced near term earnings. We cut $150m from Admiral Bay, Lounge Lizard and the Mungana/Red Dome gold copper – all projects now valued at zero given the weak balance sheet and considerable development hurdles. The valuation assumes survival and no further discounted equity raisings. That’s appears a best case scenario now. Our forecast FY09 loss of $9.8m assumes $34.5m of provisional pricing losses, US$1.97/lb copper, US$0.59/lb zinc and an A$/US$ exchange rate of 0.70. Our modest $7.7m FY10 forecast assumes US$1.58/lb copper, US$0.55/lb zinc and an A$/US$ exchange rate of 0.64.
Forecast Impact: --
Recommendation Impact: With combined net debt and negative working capital of $250m, leverage in the face of weak operating cashflow is uncomfortably high. The company needs asset sales or improved commodity prices and survival is not necessarily assured. Despite trading at a discount to our valuation, risk dictates a downgrade in recommendation to Reduce.
Event Analysis
Much has changed in the past five months. When we reported on the FY08 result in August copper was US$3.44/lb and zinc US$0.81/lb. KZL’s margins were healthy. Copper is now US$1.45/lb and zinc US$0.49/lb. The fall in the copper price is the most worrying for KZL. Our forecast revenue over the next decade – based on Mt Garnet, Thalanga and Mungana Basemetals is split approximately 51% copper and 37% zinc with lead, silver and gold all minor contributors. Gold could represent a larger slice if a dedicated gold plant is built to service the Mungana deposit and Red Dome but would require additional capital. The zinc business has some competitive advantage. Cash costs of US$0.53/lb in calendar 2008 place KZL in the middle of the industry cost curve. At current prices, margins are slim but the business by itself would likely survive. By contrast, there is no real competitive advantage in copper. Cash costs of US$1.34/lb in calendar 2008 are deep inside the highest cost quartile. Copper investment was good as capital costs were low and quickly repaid. These mines will lose money sometimes though. Margins aren’t defencible and a debt laden balance sheet can be deadly. The balance sheet has weakened substantially. Spending was relatively heavy in 2008 with capital directed to the mothballed Mungana Basemetals plant and exploration – both now pared back to a minimum. As at June 30, 2008, cash was $15.8m and debt $100.0m – receivables and payables broadly balanced. Cash at end December 2008 was $31.7m but debt was approaching $200m. Payables have blown out to exceed receivables by more than $70m. Provisional pricing payments of $34.5m received from smelters in 1Q09 are to be repaid in 3Q09 due to the steep fall in the copper price. By end December 2008, the company had fully drawn down its $100m corporate facility with NAB as well as a $50m facility with Westpac established in the 2Q08.A further $22m of $25m is drawn under a guarantee facility and $20m of $40m under a leasing facility. The Westpac facility matures March 2009 – it was just short term to cover stocks built in advance of the wet season. The copper hedge book was closed out in January 2009. It was $25m out of the money at the end of December. To shore up its balance sheet, KZL raised $10m through the placement of 25m new 40c shares. Shareholders as at February 2 will be able to participate in a share purchase plan to buy either $2,000 or $5,000 of new 40c shares. The offer closes February 18 with a maximum of 64.9m shares to be issued for $26m. We’re not convinced the $10m placement will be sufficient capital to ease balance sheet pressures. Asset sales may be needed with Lounge Lizard and Admiral Bay the obvious options. KZL says it is progressing early stage expressions of interest in Admiral Bay but just what price these assets can fetch in this market is uncertain. We have had to slash our valuation to $0.54 a share in response to the worsening financial position, dilution from the placement and severely reduced near term earnings. We cut $150m from Admiral Bay, Lounge Lizard and the Mungana/Red Dome gold copper – all projects now valued at zero given the weak balance sheet position and considerable hurdles to development. Our forecast FY09 loss of $9.8m assumes $34.5m of provisional pricing losses, US$1.97/lb copper, US$0.59/lb zinc and an A$/US$ exchange rate of 0.70. Our modest $7.7m FY10 forecast assumes US$1.58/lb copper, US$0.55/lb zinc and an A$/US$ exchange rate of 0.64. With combined net debt and negative working capital of $250m, leverage in the face of weak operating cashflow is uncomfortably high. The company needs asset sales or improved commodity prices and survival is not necessarily assured. Despite trading at a discount to our valuation, risk dictates a downgrade in recommendation to Reduce.
NJ