Description

Soverign Metals discovered Kasiya, the world's largest undeveloped natural rutile (titanium) and second largest graphite deposit. Both titanium and graphite are designated as critical materials by the U.S. and EU due to supply shortages and china-controlled supply chains. Just this week, China even vowed to tighten exports of natural graphite in a blow to the EV industry ex China. However I think its the rutile (titanium) which most likely attracted Rio Tinto to recently become the largest shareholder in Sovereign Metals. Note this stock is a microcap development company and illiquid so only suitable for small PA, but I think represents an interesting investment considering no upcoming funding requirements and because its a big discount to Rio Tinto's entry price only a few months back.

Apple & Titanium

With the most valuable company in the world, Apple, now championing “Carbon Neutral” products, the direction of travel will involve bold steps in terms of materials. Notably, the new iPhone 15 Pro has a titanium design. Apple uses Titanium as compared to stainless steel, titanium is both lighter and tougher. It is 45% lighter than steel and twice as strong as aluminium.  It is more resistant to both corrosion and extreme temperatures. It can also withstand harsh chemicals much better and is much easier to anodise than steel. These are just some of the reasons why titanium is a preferred material used in advanced applications like aerospace and defence. Natural rutile-based titanium is also significantly more environmentally friendly than aluminium and even steel production.

Demand for Titanium

The Titanium market is around US$20bn and is forecast to grow at about 6%p.a. until 2030. Use in electronics coatings such as Apple’s new iPhone 15 Pro are a growing part of the demand for titanium. However, electronics are still small compared to TiO₂ (Titanium Dioxide) pigment used in the paints/coatings/plastics market. Rutile-based TiO₂ pigments are highly preferred due to the high scattering of light and superior properties including opacity, whiteness, and high refractive index. Titanium dioxide is a very white, opaque compound that absorbs ultraviolet rays and reflects 96% of light, so it has been a primary ingredient in products like paint, sunscreen, toothpaste, and cosmetics for over a century. These same properties are creating new applications that reduce carbon emissions – like paint used on buildings to reflect heat and reduce air conditioning energy consumption as well as battery and solar technology.

Increasing infrastructure investments in developing economies have been a dominant factor driving the demand for Titanium which is also key material for high-precision welding and the complex light weighting of alloys for aircraft, spacecraft, and rockets. Also, for the mundane manufacturing of iPhones, laptops, golf clubs and bicycles. Titanium is increasingly used in submarines, power infrastructure, solar panels, and desalination plant pipes. As titanium is lightweight, it can also help reduce fuel consumption, letting planes go farther with less impact on the environment.

Supply of Titanium

While demand for Titanium (TiO₂) will continue to grow, it is the supply of natural rutile, the most common form of natural TiO₂ (95% TiO₂) which is critical to the world economy as part of the “decarbonisation” solutions required to meet “Net-Zero” and other targets set by policymakers. Titanium has been classified as a critical raw material by both the US and EU due to a combination of scarceness and China-controlled supply chains. Current sources of natural rutile are in severe decline as several operations’ reserves are depleting with declining ore grades. These include depleted reserves after 50 years of mining from Sierra Rutile in Sierra Leone as well as Base Resources’ operations in Kenya. Global rutile supply is projected to decline sharply beyond 2023, following scheduled closures unless mine life extension is approved. There are no new deposits forecast to come online and no new major discoveries, and hence supply of natural rutile is likely to remain in structural deficit for the long term.

Due to no significant discoveries of natural rutile in over 50 years, Titanium industries (dominated by China) were forced to shift to less environmentally friendly titanium feedstocks such as ilmenite, titanium slag and synthetic rutile. As can be seen from the significant price differential of natural rutile ($1,400/t in SVM's PFS) versus ilmenite prices ($350/t), there is a shortage of natural rutile. These much dirtier energy and carbon intensive processes are used by major Chinese market participants to produce upgraded synthetic rutile and titania slag. Both methods use ilmenite (~FeTiO₃) as the raw feedstock and are essentially processes using coal and petroleum coke for the removal of iron oxide. The downstream pigment production process relies heavily on the use of these upgraded titanium feedstocks, each having an associated substantial environmental impact in terms of CO₂ emissions, power costs and waste.

Sovereign Metals’ Kasiya Rutile & Graphite Discovery

Natural rutile is the cleanest, purest, and most environmentally friendly form of TiO₂ with a genuine scarcity, pricing premium and no major new discoveries…until now. Julian Stephens, an Australian geologist with 20 years of on-the-ground activity exploring for graphite deposits in Malawi, hit paydirt when he found high-grade natural rutile accompanying the graphite.  Most of this sits in a blanket formation right at the surface within the top 10-15 metres of the massive resource and can be easily mined by high pressure water jets (hydro-mining). Natural graphite is also classified as a critical raw material by the US and EU due to its scarceness and China-controlled supply chains. Graphite is a key component required for anodes in EV batteries and regardless of the different battery chemistries, graphite makes up a significant composition of any battery used today. Why then has lithium captured investor interest over graphite when it only makes up a tiny fraction of the battery composition?

This again, is likely because China’s battery industry has developed synthetic graphite which has kept the embryonic EV growth market very well supplied.  That is expected to change in the future with general de-risking from China and increasing costs and emissions regulations which should drive a shift to more natural graphite demand from rising EV adoption.

Following the Auto OEMs closely and noting their direct attempts at vertical integration into EV supply chain participants, indicates the eventual progression towards higher proportions of natural graphite used in battery anodes. This is supported by its lower cost and superior environmental credentials. The environmental footprint of EVs will become an increasingly important market consideration as EV penetration accelerates, noting that synthetic graphite has a carbon footprint an order of magnitude higher than flake graphite because synthetic graphite is made from petroleum coke which is a by-product from oil and coal refining via a dirty and energy intensive process. Leading EV producer Tesla’s “Master Plan 3” outlines its proposed path to reach a sustainable global energy economy through end-use electrification and sustainable electricity generation and storage. In its plan, Tesla suggests that the world would need to produce 10.5Mt of graphite per year and estimates US$104 Billion of new graphite mining investment is required to achieve its target.

Kasiya, located in central Malawi, is therefore heralded as the largest global undeveloped natural rutile deposit and second largest undeveloped flake graphite deposit in the world. Sovereign is aiming to develop a low-CO₂ and sustainable operation to supply highly sought-after natural rutile and flake graphite to global markets. Kasiya has a geological benefit with both natural graphite and rutile hosted in soft, friable material at surface which can be easily mined, beneficiated, and purified with a considerably lower carbon footprint than hard-rock operations or synthetic graphite and synthetic rutile production.

Enter Rio Tinto

After spending months in due diligence and noting the quality of this generational scale discovery with predicted lowest-quartile costs and very simple metallurgy, Rio Tinto made an investment into Sovereign resulting in an initial 15% shareholding and options expiring within 12 months of initial investment to increase their position to 19.99%. Under the Investment Agreement signed in July, Rio Tinto will provide assistance and advice on technical and marketing aspects of Kasiya’s rutile for its Titanium division including with respect to Sovereign’s graphite co-product, with a primary focus on graphite for the lithium-ion EV battery anode market. This investment is highly aligned with Rio Tinto’s publicly stated target of reducing its scope 1 and 2 greenhouse gas emissions by 50% by 2030, with a 15% reduction by 2025.

For Sovereign Metals shareholders, the business now benefits from:

1. No dilutive rights issues and enough cash funding from Rio’s investment through to the end of DFS.
2. Rio’s technical mining design expertise.
3. Rio’s marketing channels and supply chains.

Importantly, Sovereign controls the timeframes and gets the right to match anyone who bids at the asset level up until the point Rio Tinto decide to bid for the entire company or to walk away. It’s that simple. Interestingly, Soverign has also signed MOU's for rutile offtake from Mitsui (large Japanese trading house wanting to secure rutile for its downstream titanium industries), Chemours (a large U.S. downstream TiO2 pigment producer) and Hascor (a large global titanium welding flux distirbutor). 

Rio Tinto’s Titanium Division

Rio Tinto’s interest in Sovereign Metals is most likely driven by their Titanium division which has three major operations in Canada, Madagascar, and South Africa. They have had some challenging issues at these divisions particularly with Transnet and Richards Bay in South Africa as well as incurring substantial costs to try and decarbonise their Canadian Quebec operations. They have committed to spending C$737m over 8 years in partnership with the Government of Canada to reduce the use of coal during their ilmenite processing.  While Rio Tinto have already incurred significant sunk costs, it makes sense that they would have a strong financial and “decarbonising” interest in the largest discovered natural rutile/titanium mine, Kasiya. It’s what Rio Tinto’s Eurocentric shareholder base increasingly demands from the company.

Originally Kasiya was a natural rutile project only. While the graphite co-product is undoubtedly new to Rio Tinto, titanium, and rutile (and mineral sands more broadly) are not.  Rio Tinto’s goal is to diversify away from iron ore sold to China and break into the EV battery market. In that respect, they have already done diligence to qualify and test the graphite product sourced from Kasiya at their recently opened battery materials lab in Melbourne. Following the setup of a Battery Materials division in 2021, Rio Tinto has been quick to sign global MOUs with Ford, BMW & Volvo to jointly develop supply chains for battery and low-carbon materials.

Kasiya has a 25-year mine life which only processes a mere 30% of their resource and has a LOM (Life Of Mine) total revenue forecast at US$16Bn at forecast commodity prices. This equates to 64% cash-margin (revenue/cash-cost 2.8x). Total build capex estimated at US$597m equates to just 23 days of Rio’s 1H23 FCF. Even at a 100% bid premium, this equates to just 12 days of FCF for Rio Tinto, for what could be the world’s largest rutile and natural graphite mine.

What is it worth?

Right now, in the current market malaise, the SVM share price is trading over 20% below what Rio Tinto paid a few months back for their initial stake and more than 25% below their further 5% option (July 2024) strike price of 53.5c. Given the project NPV remains many multiples of the current market cap, the bigger question really is whether there are any major impediments to the project being financed and moving ahead. Our independent due diligence focussed on the resource quality, power, rail and port facilities, water infrastructure and mining licence permitting. After consulting with independent mineral sands industry insiders, there appears to be no major concern besides some small village resettlements. However, there is still substantial technical design and optimisation work required over 2024 and into 2025. Using the modelled rutile and graphite prices which are below spot prices in the recently published PFS, the after-tax NPV at an 8% discount rate is US$1.6b. This is a 28% IRR with average annual EBITDA of US$415m and a total LOM revenue of US$16b modelled to only 25 years. Rio Tinto’s 4.9x EV/EBITDA multiple applied to Sovereign’s PFS LOM US$415m EBITDA implies a value of A$2.3bn with initial capex already netted off (>4x capex). What is clear is that while the initial upfront capex is meaningful, it is bordering on inconsequential since Rio Tinto has taken a financial interest in Sovereign Metals most probably seeing this as a multi-generational asset for their titanium division as well as their emerging battery anode ambitions.

Is Malawi a risk?

Africa generally may be tarred with the brush of “Sovereign” risk when it comes to mining development, but Malawi is a pro-mining jurisdiction where an increase in foreign spending for resource exploration is under way. Malawi, a landlocked country in Sub-Saharan Africa often described as “the warm heart of Africa”, has a government that views mining as one of, if not the main pillar of its economic revival. Perhaps the big perceived risk for Sovereign Metals is its location. Malawi is still one of the poorest countries in Africa and with limited industry of any kind. However, it has none of the country specific security issues like many de-stabilised countries in the north of Africa. Malawi is a member of the Commonwealth - a stable, peaceful, and transparent jurisdiction. In fact, the Malawi Government is a big supporter of Sovereign’s project because it can see the potential attractions to the Malawi economy with over US$2.7b (taxes & royalties) modelled over the first 25 years alone.

The Kasiya project therefore has very strong support from the Government of Malawi. After the Rio Tinto investment into Sovereign, the Government of Malawi issued an unsolicited press release applauding the timely investment by Rio Tinto and marked it as a milestone towards realising the country’s aspirations of growing the mining sector as a priority industry. With mining being one of the key pillars for growth under Malawi’s economic development strategy (Agriculture, Tourism, Mining) and the potential for Kasiya to be a project of national significance, the Malawi Government has gone as far as to constituting an Inter-ministerial Project Development Committee to work alongside Sovereign and Rio Tinto to assist with the permitting processes. So far, these are positive signs. It is clear Kasiya has the potential to deliver significant social and economic benefits for Malawi including fiscal returns, job creation and sustainable community development initiatives. But don’t take it from me, listen to Lazarus McCarthy Chakwera, President of the Republic of Malawi as he addressed the general debate of the 77th Session of the General Assembly of the United Nations in New York in September 2022. At minute 6:20, he even specifically called out Sovereign’s Kasiya project as Malawi having the largest natural rutile discovery in the world and that because of it, “Malawi’s rise is imminent”.  In some respects, I believe it may even be considered an advantage that Sovereign’s project is in Malawi as this project alone would mean a lot to the country’s future. Therefore, they will likely be bending over backwards to move the project ahead to eventually obtain their royalties and taxes.

The Group behind Sovereign Metals (SVM)

Ian Middlemas, company insiders and his combined investor group own around 10% of Sovereign Metals. His group has over 20 years of experience in various natural resources in Africa. He was a senior executive at one of Australia’s largest gold mining companies, Normandy Mining, for over ten years before investing across a range of Australian resource companies looking for mineral deposits outside of Australia.  His history is demonstrating solid commercial skills in finding good low-cost assets and then knowing when to sell rather than trying to operate the mines directly. His biggest wins have all been in Africa. First with a company called OmegaCorp which owned an undeveloped uranium deposit in Zambia which was bought by Denison Mines of Canada, one of the world’s biggest uranium miners at the time for US$170 million. Following that, came his biggest Uranium win in Tanzania when Russia’s state-owned nuclear energy company Rosatom bought Mantra for A$1.2bn. Subsequent to that, Mr Middlemas became the Chairman of Papillon Gold – a gold project in Mali that was bought by B2Gold for $615m. The game plan is always the same. Prove out a large world class resource, bring in the experts create strong local government relations, obtain permitting and then do all the technical work for a mining major to write out a big cheque. Currently, besides his gain in Piedmont Lithium where Mr Middlemas was the original Chairman, Sovereign Metals is his largest investment at cost and the one he views as his most prospective, even though he admits rutile and graphite are not your "household commodities". My point is this is not his first rodeo, and he has a strong track record in place to put together a team to do all the work to extract a substantial control premium out of Rio Tinto or another interested party. Time will tell.
 

Conclusion

Kasiya is a rare and unusual tier 1 titanium mineral deposit in a world where natural Rutile is scarce and highly prized as an important carbon neutral feedstock mineral. Rio Tinto’s A$40m financing follows months of examination and due diligence indicating potential for greater involvement going forward. While it is possible another TiO₂ producer might look to partner with Sovereign, we suspect Rio Tinto may ultimately seek to control the mine and as per the agreement, has an option to “become operator” of the mine within 180 days of publication of the DFS which is around 18-24 months away. Rio is not really in the business of operating mines on behalf of microcap junior partners and already has a significant presence in Titanium and a growing interest in battery-grade graphite anodes. Therefore, it is logical to expect a full takeover. The question then becomes can management extract an appropriate control premium like they have done in the past? Currently the share price of this small microcap is even well below Rio Tinto’s entry price, so unless Rio finds something they really don’t like and decides to write off this very new and immaterial investment, there is a decent margin of safety embedded in the current valuation for patient shareholders.

Catalyst

- Significant future shortage of natural rutile and absence of any major new discoveries

- Global de-risking from China controlled supply chains

- Titanium (rutile) and Graphite shortages ex China

- Growing focus on flake graphite for EV batteries

- Publication of final DFS, permitting, financing

- Rio Tinto takeover