SVH Tracker - March 17, 2017: The importance of SCY positioning itself as a downstream Al-Sc master alloy producer
Scandium International Mining Corp made an announcement on March 2, 2017 whose importance was overlooked during PDAC week when the principals of Scandium Investments LLC showed up at SCY's PDAC booth to take the pulse of the audience and check out what else the junior resource sector might have on offer. The SIL principals did not hide their presence nor did they make a show of it; in private discussions they indicated that no decision had yet been made about whether they would convert their 20% Nyngan/Honeybugle project interest into an SCY equity interest that could end up as high as a 20% stake prior to project financing, which would be worth $24 million based on 225 million issued and a $0.43 stock price, or stick to a 20% project interest which would require them to invest an additional $25 million or more to end up with a 10-20 year annuity. Given that their initial $2.5 million investment already has an implicit 10 times MOIC (multiple of invested capital) in hand, provided SCY raises CapEx at current or higher stock prices, it is hard to imagine the comparative desirability of chasing an ROI (return on investment) by putting up an additional $25 million so that $27.5 million is at risk through a 20% interest in an Australian operating subsidiary whose revenues will not be guaranteed by an off-take agreement until the mine is producing as expected. Especially when one considers the implications of SCY's announcement of an MOU (Memorandum of Understanding) with Weston Aluminium for an alliance to develop the ability to produce aluminum-scandium master alloy.
Weston is an Australia based recycler of aluminum waste streams, which include scrap and smelter dross, which processes about 20,000 tonnes of aluminum waste annually. Weston's facility is based in New South Wales. According to SCY's CTO Willem Duyvestyn, Weston will provide the space and aluminum while SCY will provide the know-how for production of aluminum-scandium master alloy, which consists of 2% scandium and 98% aluminum. Assuming SCY wishes to convert all its 40 tonnes of scandium oxide output at the DFS proposed full production scale into master alloy, this would require about 1,300 tonnes of aluminium (divide the scandium oxide amount by 1.534 - the oxygen gets blown off when the scandium oxide is "melted" into molten aluminum - to get 26 tonnes of scandium, and divide by 0.02 to get the amount of aluminum needed to make Al-Sc master alloy at 2% Sc). The addition of an Al-Sc master alloy division thus displaces only a fraction of annual recycling capacity.
The method for making Al-Sc alloy from raw aluminum and scandium oxide is common knowledge, though there are tricks of the trade that enable some producers to do a better job than others. One of the tricks is to know what impurities are undesirable and which are trivial ones that float off as slag. Master alloy producers like to insist on 99.9% purity in scandium oxide because at that purity the harmful elements will be below problematic thresholds. This makes sense because currently Al-Sc master alloy producers source their scandium oxide from many small and different sources, making quality control a headache. In its DFS SCY gets away with collecting $2,000/kg for 97%-99% purity scandium oxide because it knows that the impurities that remain from processing Nyngan ore are trivial (the $2,000/kg price refers to contained scandium oxide, not the total weight of the white powder in the drum). Fabricators of Al-Sc based products such as Alcereco, with whom SCY already has an offtake agreement for 7.5 tonnes of scandium oxide annually, would prefer to purchase Al-Sc alloy ingots to feed into molten aluminum in just the right amount to achieve the customer's desired scandium percentage, of which 0.1% scandium is currently the lowest level before the special properties scandium bestows on aluminum disappear. (Patents held by Ford and Boeing allow for a lower percentage of 0.05-0.06% scandium with the help of zirconium, an abundant low cost input, though I am not aware that this patent has been commercialized, likely for the obvious reason that there is no reliable scalable supply at a stable price.)
SCY has conducted R&D on making master alloys involving scandium, aluminum, and magnesium and in 2014 applied for related patents. In some quarters SCY is perceived as simply a future hole digger with a chemical plant that spews out buckets of whitish powder in the style of juniors that own a rare earth deposit. The company is also a metallurgical innovator about which it does not say much because until a primary, scalable supply of scandium oxide emerges, any such innovations and their potential patents have no commercial value. But unlike any of the other innovators in the scandium space, SCY through its Nyngan development plan controls the commercial destiny of its metallurgical intellectual property.
The Weston MOU is important because traditionally intermediaries such as KBM Affilips have purchased scandium oxide by-product and converted it into Al-Sc master alloy before selling it to customers of their choice at prices based on their own profitability calculus (ie volume required and reliability of customer). They have never had the luxury of dealing with a primary, scalable supplier of scandium oxide, and would no doubt be delighted to be the primary wholesale buyer while controlling the end-user market. By moving downstream from selling $2,000 kilo buckets of white powder to making the Al-Sc master alloy SCY is cutting out the middle-man and accomplishing two key objectives.
The first key objective is that SCY controls the purity of its scandium oxide output and can adjust the master alloy production process to handle whatever the purity of Nyngan output may end up being. Metallica and Clean TeQ have both been jerked around by demands for 99.9% scandium oxide purity which is only relevant for electronics applications such as the electrolyte in the solid oxide fuel cells of Bloom Energy. At the moment Bloom's scandium oxide needs appear to be taken care of through supply from Chinese titanium dioxide waste stream recyclers, and there is no evidence yet of a runaway success for Bloom Energy that would cause Bloom's scandium demand to blossom as I imagined a couple years ago. Future demand for scandium will come mainly through Al-Sc alloy based applications where strength, corrosion resistance, weldability and fabrication efficiency are the relevant features bestowed by scandium. These applications require Al-Sc master alloy, not buckets of oxide powder. Through its alliance with Weston SCY will be in a position to offer scandium to the world in a consistent and standard form.
The second key objective is that SCY will be in a position to price its Al-Sc master alloy according to the needs of the customer and to what extent the customer's adoption of Al-Sc alloy material will drive future demand from that customer. An intermediary will only be concerned about the difference between what it pays to the scandium oxide producer and the best price it can get from customers. This makes sense when the producer generates scandium oxide as a by-product whose supply cannot be scaled up as demand rises. The current drum-beat from Bay Street is "show me the guaranteed off-take and we are all over you". This attitude causes head-shaking among the SIL principals who would write the entire CapEx check personally if what Bay Street wanted became reality. In fact, it is very unlikely that SCY will have disclosed off-take deals in place for 100% of its production; quite likely it will end up with a large number of end-users purchasing small amounts of Al-Sc master alloy for testing purposes. Many of these end-users will insist on anonymity because they will not want their competition to know they are working on a better, possibly cheaper product. Some of the end-users will be intermediaries for defense departments, not necessarily including the United States. Others could even be acting for Chinese interests; China has no interest in the anti-science path to self-stupidification its chief rival is veering towards. During the initial ramp-up year Nyngan will produce only 18 tonnes of scandium oxide which will be parcelled out to a large number of end-users, with committed order from full scale production allocated on a first come first serve basis.
That first year of partial production will accomplish two goals: 1) it will give end-users a meaningful amount of material to play with, and, 2) it will demonstrate to the end-users that SCY has indeed figured out how to supply scandium oxide from a scalable source at a stable price with sufficient profitability that Nyngan will be a long-lived producer of scandium. The Bay Street clucking about offtake is hilarious given how much money it pours into projects that require a higher metal price to be viable. SCY's operating subsidiary will set the price of scandium oxide at $2,000/kg, which will ensure a healthy return on investment for the Australian sub's shareholders. SCY the parent company, however, will participate 100% in any downstream markup it could collect from the sale of Al-Sc master alloy. The market has undervalued SCY's potential because it perceives SCY as a peddler of buckets of white powder whose profit margin will be squeezed by downstream intermediaries.
Many people think SCY's stock price move during PDAC week was connected to my BNN appearance during which I emphasized SCY as my top pick. The more likely truth is that non-retail investors understood the implications of the Weston deal and Clean TeQ's recent shift to making nickel-cobalt sulphate production for the battery market its priority. Those implications are that SCY is taking steps to become an Al-Sc master alloy supplier to a very broad range of end-users and is emerging as the only primary scandium supply game in town until at least 2020. Often being the first mover is a disadvantage because the followers benefit from all the problems the first mover encounters. But when the first mover has the technical talent on board to appreciate what is required to develop a market for its product, many potential problems will be anticipated and those that are not will be quietly solved through internal resources. Once SCY has demonstrated that Nyngan can profitably deliver scandium oxide at the price promised in the DFS, end-users with serious needs will be talking to the first mover well before considering the johnny-come-latelies who will get a good stock market valuation on the coattails of SCY's success but not the long term commitments that justify scaling up production capacity.
SCY will also be in a position to develop special relationships with researchers working on innovative applications involving scandium, which, in a world of 10-15 tonnes of non-scalable by-product supply would have been done for academic rather than commercial reasons. It is quite possible that in 5-10 years SCY is making more money through its facilitating role in downstream applications than it is as a producer of scandium oxide even after ramping up to 100 tonnes plus annual output. The move to secure the Al-Sc master alloy segment of the supply chain will enable Wall Street to see Scandium International Mining Corp as potentially much more than an easily valued miner whose chief output is a commodity that is more likely to go down in price than up over time. One has to wonder how many scandium based R&D projects like Hydrogen fuel for thought are lurking in university closets waiting for the day of unlimited scandium supply at a stable price. The Weston master alloy deal is a major step in turning the sky blue for SCY's upside above and beyond producing a metal. My target price for SCY of $1-$2 over the next two years, and $3-$5 per share 2-5 years from now is based simply on 5-10 times future cash flow multiples based on successful execution of the DFS and its subsequent expansion; it does not include the possibility that Wall Street will end up perceiving SCY as a facilitator of transformational innovations involving abundant supply of scandium at a stable price.
*JK owns shares in Scandium International Mining Corp