Description

Western Areas is being acquired by IGO by way of an agreed scheme of merger, at A$3.36 per share. The stock is trading at a small premium at A$3.42.

We believe that the agreed price undervalues the company and therefore recommend investors buy the stock in anticipation of an improved bid. The current price is underpinned by the agreed merger price, so investors are effectively paying a 2% premium plus the time value of money on the purchase price as a de facto Call Option on any upside.

Andrew Forrest’s Wyloo has steadily increased its position to 6.29%. Wyloo recently won its bidding war for Noront against BHP, suggesting IGO’s scheme is unlikely to proceed without some improvement in the terms.

Most mining majors are heavily weighted to traditional commodities like iron ore, coking coal, thermal coal, manganese, zinc, lead, platinum group metals and diamonds, while being underweight in what BHP refers to as “future facing commodities”.

These cash flush majors have under-invested in exploration since the GFC and are short of reserve replacement, and growth projects that can structurally rebalance their portfolios for the green future.

The following slide shows BHP’s assessment of the relative growth prospects of Nickel compared to its traditional portfolio.

Nickel is a $50bn p.a., exchange cleared commodity that fits much better into a major’s portfolio than the forward-facing minor metals and exotic commodities such as Lithium, Cobalt, Rare Earths or Graphite. Wood MacKenzie expects primary nickel demand to almost double from 2.5m tons to 4m tons over the next 20 years. Under such a scenario, prices could surprise to the upside. The $50bn market should therefore gravitate towards an annual value of $100bn or more in real terms. That makes nickel an essential building block for the majors.

Western Areas operates 2 high grade nickel complexes in Western Australia. The producing Forrestania complex lies 400km east of Perth, while the Cosmos complex is being brought into production near Leinster, 375km north of Kalgoorlie. Cosmos is in close proximity to BHP’s Leinster mine with BHP’s Mt Keith and Cliffs mines just 100km further to the north. The map below shows Western Areas’ Cosmos in light blue, BHP’s mines in olive green and Norilsk’s exploration assets in light green. Since the date of the map, BHP has acquired Norilsk’s remaining 50% stake in these tenements.

Western Areas sells 10,000 tons of contained Nickel in concentrate to BHP per year, with the balance of the concentrate sold to Jinchuan. 

We believe that there are significant synergies that can be extracted through a merger of Cosmos and BHP’s Nickel West operations.

1. Forrestania Complex (400km east of Perth)

Forrestania produced a combined 16,180 tons of Nickel in concentrates from its Flying Fox and Spotted Quoll underground mines in the year to June 2021. These mines are extremely rich, with the ore grading at 3.2% Ni. This resulted in low cash costs of US$3.69/lb, despite seismic problems early in the financial year. The problems were quickly rectified by a change in mine support to paste fill.

1 a) Forrestania : Flying Fox mine

Flying Fox produced 5,739 tons of contained Nickel.

On paper, the mine has a short Ore Reserve Life of 1 year, but in reality it has very significant Indicated as well as Inferred Resources. In addition, it is sourcing the majority of its production from the Lounge Lizard area at a 3.5% ore grade. What is remarkable is that Lounge Lizard doesn’t have a formally declared Ore Reserve, just a 0.8% Indicated Resource of 36,000 tons of contained Nickel. The group’s ore reserve calculations thus appear to be exceedingly conservative, especially if one considers how rich the ore is.  

1 b) Forrestania : Spotted Quoll mine

Spotted Quoll produced 11,073 tons of contained Nickel.

The mine has a short formal Ore Reserve Life of 3 years, but again the tiny reduction in the Ore Reserve year-on-year of 2,800 tons paints a much more robust picture.

2. Cosmos Complex (375km north of Kalgoorlie)

This new complex is fully funded and will produce 14,600 tons of Nickel in concentrate per year. First concentrate will start to flow by December quarter of calendar 2022 from the Odysseus North and South underground ore bodies. What is exciting is that a third underground area, AM6, has been delineated south of Odysseus South. This area holds a further 47,100 tons of contained Nickel Reserves, in addition to the Ore Reserves of 164,520 tons at Odysseus North and South. The Cosmos area also hosts a further 263,733 tons of Indicated Resources.

The growth from Cosmos will position Western Areas as a 30,000 ton p.a. high grade producer of Class 1 feed Nickel of good provenance, based in a tier 1 jurisdiction.

The Cosmos complex was shrewdly acquired during 2015 and recent surface exploration in the region has yielded promising results over a wide area.

3. Panoramic Resources (19.9% shareholding)

The investment in Panoramic was another inspired call. The stake was acquired 18 months ago for A$28.6m and has since appreciated to A$114.3m. The company is restarting production at the previously mothballed Savannah Nickel mine, 100km south of Rio Tinto’s defunct Argyle diamond mine in the remote north of Western Australia. Panoramic also has significant exploration tenements that are already yielding promising results.

4. Other tenements and assets

In addition to the group’s Ore Reserves of 281,000 tons, the brownfields tenements contain further Measured & Indicated Resources of 759,000 tons of contained nickel with a theoretical turnover value of $15.8bn at spot. As discussed above, the group is extremely conservative in its declaration of ore reserves. Under normal circumstances that would be a virtue, but in the context of a take-over bid it penalizes the sellers and makes it almost impossible to accurately estimate mine life and NPVs. That may explain why IGO spent so many weeks on its due diligence of the group.

The group also owns vast greenfields tenements of great promise. The principal asset is Western Gawler in South Australia consisting of outright ownership and a 75% earn-in stake on contiguous tenements owned by Iluka. The tenements cover ~12,000km2 over a strike length of 250km. The first 2 projects at Gawler - Sahara and Firefly - host shallow nickel, copper and cobalt resources, with potentially very low mining costs.

Other group assets include the exceptional BioHeap bacterial leaching solution that can function in temperatures of up to 95 degrees Celsius and in water with a salinity of up to 200ml salt per litre (6 x sea water). That places BioHeap in a category of its own compared to other providers of bio metallurgical solutions. In contrast to a metallurgical patent with a finite life, the ownership of the bacteria is similar to breeding stock and can therefore deliver very significant profit and royalty streams over the long term.  

The Noront playbook

The bidding war between BHP and Andrew Forrest’s Wyloo Metals for Noront Resources culminated in a final price of C$1.10 in December, compared to Wyloo’s initial bid of 31.5c in May. With first production from Eagle’s Nest potentially more than a decade away, the fierceness of the bidding demonstrates that the market is willing to pay a hefty premium for good nickel projects in sound jurisdictions.

While BHP walked away from Noront in remote Ontario, Western Areas is an existing supplier of concentrate on BHP’s home turf.

Eagle’s Nest looks great on paper, but has endless permitting and first nations hurdles to cross before metal starts flowing. Forrestania is a well established high grade producer and Cosmos will start delivering concentrate by year-end.

An acquisition of Western Areas will instantly slot into BHP’s existing operations giving them greater critical mass and delivering synergistic cost savings. At the margin, these savings translate into lower cut-off grades, fewer sterilized ore blocks and unlocking more metal. It would leave BHP’s Nickel West owning more than 100km of uninterrupted tenements from Leinster in the south to Honeymoon Well in the north. It would also guarantee ownership of 100% of Western Areas’ concentrate feed, once the group’s non-BHP supply agreements run to term.

For IGO and Wyloo, Western Areas represents an attractive portfolio of high quality nickel assets. But for BHP, it’s about much more. We therefore believe that a bid from BHP for Western Areas is imminent. If the BHP bid materializes, there will be at least 2 bidders for Western Areas. If not, there is still a chance that Wyloo could either launch its own bid, or that it will extract a premium from IGO.

Catalyst

Continuing strength in the nickel price vs. a static cash takeover price.

Likely competing bids from BHP and Wyloo.