What's Nevsun worth? ~ Seeking Alpha May 14th 2018 Growth at reasonable price, natural resources, base metals, investment advisor
Summary
Shares of Nevsun Resources have run up in recent weeks on speculation that it could be acquired.
Nevsun's one producing asset, Bisha, is barely profitable and located in a terrible jurisdiction.
My financial analysis confirms that the market has priced in the value of the development of its Upper Zone deposit located at its Timok Project in Serbia.
This idea was discussed in more depth with members of my private investing community, Industrial Minefinder.
Introduction To The Nevsun Situation
Nevsun Resources (NSU) has been in the news recently regarding a failed acquisition attempt by Lundin Mining (OTCPK:LUNMF), I spent some time analyzing the company in detail and creating a financial model. In this article, I will highlight my findings.
Nevsun has run up strong in recent weeks on speculation that it could be acquired. The following 3-year chart of the stock shows this:
NSU data by YCharts The Nevsun story is all about its Timok copper project in Serbia. The recently released pre-feasibility study ("PFS") results bill the 100% Upper Zone portion of the project as having an after-tax net present value ("NPV") of $1.8 billion (8% discount rate) and an 80% internal rate of return ("IRR"). The prior released (2017) preliminary economic assessment ("PEA") had the after-tax NPV at around $1.46 billion. The PFS study achieved a higher value on paper through a lower capital expenditure ("CAPEX") estimate, a higher copper price ($3.15 lb.), and a condensed mine life. A detailed comparison of the two studies can be found here.
[Note: for those not familiar with NPV and IRR - NPV is an estimate of the value of a project at its inception derived from discounting future net cash flows (discount rate). IRR is the discount rate that makes the NPV of all the project's net cash flows equal to zero.]
The economically robust nature of the Timok project and the future exploration potential it holds (including a joint venture with Freeport-McMoRan (FCX) on the Lower Zone) is why Lundin (and others) want the project.
Bisha
Nevsun currently has a producing asset through its 60%-owned Bisha project in Eritrea. Eritrea is a country where they will imprison you in a shipping container and torture you just for being a Christian. Lundin's offer has them only acquiring Timok because Bisha is a poor asset in a terrible jurisdiction.
Bisha produced roughly 80,000 tonnes of zinc and 7,000 tonnes of copper last year in a higher zinc price environment and still lost money. I modeled the remaining mine plan for Bisha which winds down in 2021, and I basically have it breaking even (adding together 2018 through 2021) at $3,100 per tonne ($1.40 lb.) zinc. Because the remaining depreciation (~$400 million) is a non-cash expense, Bisha may produce about this much in cash flow over its remaining life that Nevsun is no doubt targeting for reinvestment in the upfront CAPEX requirements of Timok.
The initial years of the Bisha mine, when it produced gold and copper, were helpful to Nevsun because it threw off cash flow that helped them to eventually acquire the Timok project through its acquisition of Reservoir Minerals. At this point, the only value that I give to Bisha is from the remaining cash flow. But really, in my mind, from a strategic investment standpoint, it is worthless. Nevsun needs to wind this thing down in 2021 and get out, however, they keep mentioning more exploration and the potential for other future development. Eritrea's 38% income tax and the 5% royalty on the project does not help matters either. Either way, the jurisdiction clearly presents a major obstacle for me when it comes to considering this stock.
Timok
I reviewed the 2017 PEA technical report for Timok and modeled out the financials to tie closely to the estimated NPV. It is interesting what you find when you look under the hood. The Timok Upper Zone has 27.1 million tonnes of probable reserves grading 3.3% copper and 2.1 g/t gold which comes out to roughly 4.7% copper equivalent. However, the overall high grade is driven by only about 1/3 of the deposit having exceptionally high grade (e.g., 7% to 9% copper equivalent). If you are a gold bug, don't get too excited about the gold in the deposit though because gold recoveries in the copper concentrate are only going to be in the 27% to 34% range.
Nevsun's plan is to mine the highest grade part first. The high cash flow levels in the early years goose the NPV and IRR numbers. There is about a 4-year window (2022-2025) when the Upper Zone could generate almost $2 billion of cumulative free cash flow. The risk here for Nevsun is that a cyclical downturn hits during the 2022-2024 timeframe and they do not realize the value from this phase of the project that they had hoped. Once you get past 2025, there is nothing exceptional about the project's economics. As it stands, the Upper Zone is not a long-life project (e.g., 20+ years) that will consistently produce high levels of free cash flow.
The economics of the Upper Zone project also get a boost from a 10-year initial tax waiver available in Serbia, however, the PEA does not really make it clear if this is included. Based on my modeling, I think this tax reduction is included in the economic assessment and it is a factor in boosting the NPV.
Finally, one risk to the project that stands out is the high level of arsenic in the deposit that results in smelter penalties. Nevsun is not concerned about their ability to place the concentrates with smelters and the charges are included in the economics.
Valuation
I prefer to use a minimum discount rate of 10% for mining projects and a bit lower copper price than Nevsun used in the PFS. This puts the NPV for the Upper Zone project in the $1.5 billion range. The starting point for the project to be producing close to capacity is about 3 years from now. Discounting the $1.5 billion NPV back to today at 10% gives me a value of $1.13 billion which is almost exactly the current market capitalization of Nevsun. This is also about the price of Lundin and Euro Sun's (OTCPK:CPNFF) total offer of CAD $1.5 billion.
Perhaps Lundin's management is thinking:
- Pay close to full price for the Upper Zone at current copper prices and hopefully profit from even more upside from higher prices in a major copper bull market next decade.
- Get the exploration and growth upside for free.
I know they don't want Bisha, so there is no reason to speculate on that aspect.
$1.1 billion is essentially the value I would place on Nevsun at present. You are paying full price for Timok, but it comes with quality, long-term growth potential. The Eritrean operations are not worth anything to me. I would not be willing to pay extra for exploration growth potential because I can get that elsewhere much cheaper.
Nevsun wants a potential acquirer to take the whole package and pay more for it. I suppose Lundin would consider making a higher offer if they could, at the same time, arrange for someone to take Bisha off their hands.
Strategic Conclusion
Perhaps the market agrees with me that Nevsun's Eritrean operations (and potential future options there) are worthless. The stock is now pricing in the value of the Upper Zone project at Timok but probably not the exploration and expansion potential from the company's joint ventures at Timok (with Freeport at the Lower Zone and Rio Tinto (NYSE:RIO) elsewhere). (To be clear, I have not studied the exploration potential at Timok and the joint venture arrangements, I am just reaffirming consensus.) I am sure there are a lot of investors, like me, who simply do not want the Eritrean baggage.
It is unlikely that Bisha is going to generate enough free cash flow for Nevsun to finance the upfront CAPEX requirements at the Upper Zone project at Timok internally. Assuming they can avoid shareholder dilution by securing debt financing for the project, I see the shares of Nevsun as currently priced just about right.
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Industrial Minefinder™
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