SVH Tracker - January 17, 2017: Recommendation Strategy for Scandium International Mining Corp
Scandium International Mining Corp has positioned itself to become the world's first primary producer of scandium from a resource whose output can be scaled to over 100 tonnes of scandium oxide annually for more than 20 years. The stock posted a gain of 86% from its $0.15 price on December 31, 2015 when it was rolled over from the SVH 2015 Edition to the SVH 2016 Edition from which its was rolled over at $0.27 on December 30, 2016 into the SVH 2017 Edition as a Good Absolute Spec Value Buy. Shortly after SCY received a New South Wales ministerial development consent which sets the stage for a mining lease some time in Q1 of 2017, I published SVH Tracker November 11, 2016 which provides a cash flow multiplier valuation framework for both the mining plan described in the 43-101 DFS published in April 2016 and a speculative expansion scenario I developed which sees output doubling in the fifth year of production and again in the tenth year. A major concern for the market has been the price at which the USD $88 million in construction capital will be raised and the impact on the upside potential for the stock should the scandium mine perform as projected. My analysis showed a 3 year price target of $1.08 on a 5 times EBITDA multiplier basis and $2.16 at 10 times if 80% of the CapEx is financed at $0.40. It also indicated a target range of $1.54-$3.09 if the financing were done at $1.00 per share. The price targets are the same whether SCY stays at 80% project interest or goes to 100% if Scandium Investment LLC converts its 20% project interest into a resulting 20% equity stake in SCY prior to project financing. The importance of this analysis is that it shows that funding the CapEx all the way to $1 per share makes sense for institutional investors seeking substantial unleveraged returns well above what they can hope for from market indices.
SCY is not like a gold story where the existing resource is put into optimal production with a mine life that depletes the economic resource, with additional upside contingent on finding additional ore or the metal price heading higher. The future of scandium is not about getting a higher price than $2,000 per kg scandium oxide; if anything the future portends a lower price as more deposits come on stream. However, given the ground-breaking nature of supply from recently discovered deposits with an unprcedented grade, one can expect economies of scale and fine-tuning of recovery processes to preserve the profitability of future scandium production. The DFS operating scale depletes only a fraction of the Nyngan scandium deposit, and does not even touch the nearby Honeybugle deposit found in 2014 which is physically bigger and potentially richer than Nyngan. The scandium story is about developing the offtake market for scandium from its current 10-15 tonnes per annum from by-product sources that cannot be scaled up to accommodate demand growth by turning into reality a primary scalable supply from a nearly unlimited resource. SCY is a growth story with a first mover advantage which justifies envisioning an output expansion scenario and valuing the stock in terms of that growth potential; if my expansion scenario, which is funded by internal cash flow, is assumed to represent this growth potential correctly, and the initial construction cost is financed at $0.40, the 3 year price target becomes $2.23-$4.45, and $3.18-$6.36 if financed at $1 per share. This makes it more like a technology story than a mining story where greater than projected upside for a deposit can only come from a higher metal price or the discovery of additional ore. The speculative question is to what extent the market will price the future value potential well ahead of 3 years from now when SCY will have demonstrated its success. The price targets I have set for SCY are for 3 years from now; the market may not wait for confirmation to price success into the stock, especially given SCY's potential as first mover to broaden supply from multiple sources and expand downstream. The answer will depend on the degree that the mainstream media discovers and propagates the transformational implications of "unlimited" availability of aluminum-scandium alloy at a stable price.
After a 3-5 year demonstration period where SCY shows the viability of primary, scalable scandium supply and diversity of supply is provided by other deposits coming on stream, offtake demand will grow exponentially toward an ultimate annual market of 1,000 tonnes scandium oxide worth $2 billion. The scandium story has market bubble valuation potential because, unlike the rare earth bubble which required displacement of dominant Chinese supply and renewable energy related demand growth, it facilitates cost savings regardless of energy source and creates demand from latent usage simply by making supply available at a stable cost from recently discovered deposits with a breadth and degree of scandium enrichment the world has never seen. The scandium story is ideologically neutral and positively forward-looking, unlike other metals such as gold for which enthusiasm demands an apocalyptic outlook most people prefer not to hold. Scandium is a feel-good story. During 2017 SCY will get its mining lease, likely secure a Wall Street experienced family as the largest equity stakeholder, raise in excess of $100 million to fund development, and start construction of a mine that starts commissioning in late 2018.
A definitive feasibility study for a 240 tpd open-pit mining operation that would produce 36-42 tonnes of scandium oxide was completed in April 2016. A development consent was received from the New South Wales Minister of Planning and Environment in November 2016, and a mining lease is expected to be granted in early 2017. Once the mining lease is granted SCY's 20% partner Scandium Investments LLC will have 30 business days to decide whether it will fund its 20% share of the projected US $87.4 million capital cost, or negotiate conversion of its project interest into an SCY equity stake. As SCY does not have any other easily quantifiable assets, it will likely issue up to 25% of its current issued 225 million issued shares, which would make SIL the dominant shareholder with 56 million shares representing 20% of the issued stock. SIL is owned by 3 family members, one of whom is a former Wall Street investment banker who is retiring as CEO from a NYSE-listed company that he built up over the best decade to annual sales approaching $2 billion, and the other is a hedge fund manager who built a fund to $20 billion in assets before selling out his founder's stake. These are young people my age I doubt want to spend the rest of their lives loafing around in the trough of philanthropy. But even if that is their goal, ponying up $20 million of their own cash for their share of a scandium mine will send a strong signal to the market. Once the capital cost is raised, construction will take about a year, followed by a two year ramp up to full production capacity. The missing piece of the puzzle is an offtake agreement with a party with a recognizable capacity to purchase the output at the proposed USD $2,000/kg of scandium oxide and a clear use for scandium oxide. SCY already has an offtake agreement for 7.5 tonnes with a private Ontario company called Alcereco and is in advanced negotiations with more visible parties for additional offtake agreements. Announcing a deal with a recognizable party for most of the remainder, even though it is not of the take or pay nature typical of existing specialty metal markets, would create a stampede for SCY stock.
Most people have never heard of scandium, but soon they will. Scandium is an element that is the perfect alloying agent for aluminum, making it stronger, corrosion resistant, and amenable to welding. Aluminum-scandium alloy is ideal for anything that moves such as aircraft, trains, cars and trucks, boats and trains because the ability to achieve functional and structural goals with a light-weight material translates into fuel savings. The ability to lightweight transport vehicles is relevant to the goals of reducing fuel costs and carbon dioxide emissions. Aluminum-scandium alloy has an advantage over other aluminum alloys in that it allows easy fabrication and repair, especially in the Series 5 aluminum-magnesium alloy. The properties of aluminum-scandium alloy emerged during the sixties when the Soviets extracted scandium from seams in an underground iron mine in the Ukraine and used it for military aircraft such as Mig fighter jets. The Americans, who did not have access to scandium enriched ore, developed titanium based alloys for their aircraft. Despite the widely known usefulness of aluminum-scandium alloy, only 10-15 tonnes of scandium oxide is produced annually from by-product sources such as the Bayan Obo rare earth mine in China, uranium in situ leaching operations in Russia, and titanium dioxide waste stream stripping operations in China. About half the scandium output is consumed by Bloom Energy for its solid oxide fuel cells which have a critical dependence on scandium. The small supply is due to lack of scalable physical supply, not demand, a concept a surprising number of poeple find difficult to grasp.
Commercialization of aluminum-scandium oxide has not happened because scandium is a dispersoid which has a high crustal abundance of 22 ppm but which, unlike lead which has a lower crustal abundance of 14, does not easily concentrate in rock formations. Ironically, it is this dispersoid nature which is key to the properties it bestows on aluminum as an alloying agent. The high cost of extracting scandium in large amounts from low grade deposits has prevented widespread adoption of aluminum-scandium alloy. A similar problem afflicted niobium until the sixties when the world-class Araxa niobium deposit in Brazil was recognized and developed; niobium, which is a steel strengthening alloying agent, now has an annual market worth about USD $2 billion, most of it supplied by Araxa. In contrast, the value of current scandium supply is only $20-$50 million. A similar game changer occurred during the 2000's when scandium enriched laterite deposits were discovered in Australia's New South Wales that ran grades in excess of 300 ppm, well above the 100 ppm grade of the Ukrainian mine which shut down after the collapse of the Soviet Union. Nyngan is one of these deposits and is the most advanced in terms of metallurgical research courtesy of the SCY management team whose chief technical officer, Willem Duyvestyn, has extensive experience with processing laterite deposits. At a grade of 300 ppm or better it is feasible to profitably produce and sell scandium oxide at $2,000 per kg. Nyngan is also the most advanced in terms of the development cycle. The nearest competitor is the Syerston deposit owned by ASX-listed Clean TeQ Holdings Ltd which recently shifted its focus to developing the adjacent nickel-cobalt resource which would have scandium as a lower grade by-product (see SVH Tracker Oct 11, 2016). This substantially larger scale by-product operation would come on stream 3-5 years after Nyngan achieves commercial production, assuming Clean TeQ's commercially unproven ion exchange separation technology works at commercial scale.
Once SCY has secured the mining lease and raised the construction capital it will enjoy a first mover advantage. The market has been slow to embrace the SCY story because of skepticism that a market will evolve to absorb a quadrupling of global supply. The potential large scale end-users such as the aerospace and automotive industries have been reluctant to endorse aluminum-scandium alloy as a desired material because until somebody has demonstrated that profitable scalable primary supply at a stable price in the style of niobium is a reality, they will not commit to the engineering and certification cycle required to adopt aluminum-scandium alloy. The initial demand will come from more mundane sources where less effective substitutes are available and the manufacturer's product line is not vulnerable to the failure of Nyngan to perform as projected. But once the viability of scalable scandium supply has been demonstrated, demand will snowball, and could achieve 1,000 tpa a decade later. As the first mover SCY is positioned to dominate the development of additional scandium mines as well as develop downstream alloy related businesses. In the latter department SCY is more than a future producer of a white powder called scandium oxide; it is conducting R&D in dropping the scandium content of aluminum alloy below the current 0.1% minimum threshold to as low as 0.02% scandium. Should such a metallurgical innovation succeed, it would drop the incremental cost of alloying scandium with aluminum as much as 80%, which would explode the potential demand by opening up price sensitive applications, the ultimate demonstration of Jevons' Paradox. Scandium is an extraordinary resource sector story, more so because it is driven by juniors such as Scandium International Mining Corp in whose success ordinary investors have a chance to participate while substantial gains remain possible.
*JK owns shares in Scandium International Mining Corp