TD research Sep 28Lundin Mining Corp.
(LUN-T, LMC-N) C$3.64
Tenke Update -- Operations Smooth, Politics Still Unclear
Event
Lundin management held a Tenke information update session in Toronto on Friday afternoon.
Impact
Slightly Positive – Lundin will be hosting a visit to the Tenke Fungurume Mine (TFM) this week; in advance of the trip, management held an information session in Toronto. Management comments indicate that TFM is performing ahead of expectations with full production capacity is likely to be achieved during Q4/09. Discussions with the government regarding the ongoing license review process continue – LUN management noted that it has
not been officially notified of a 60-day period for the completion of the review negotiations as has been suggested in press reports
We are maintaining our BUY recommendation and C$4.50 target price.
Details
TFM production ramp-up
• Copper cathode production at TFM is expected to reach 100% capacity during Q4/09; the operation was running at 84% capacity in August.
• Copper recoveries and mine head grades are as per plan; cobalt grades appear to be higher than plan (management did not specify how much higher).
• The copper plant is expected to produce 320 tonnes per day of cathode; the operation has produced as much as 441 tonnes of cathode in a single day. LUN management believes that debottlenecking of the plant (at a
cost of several millions of dollars) could result in sustainable production levels 10-15% higher than the current nameplate capacity of 115,000 tpy copper and 8,000 tpy cobalt.
• Operating costs are still difficult to pin down due to the fact that the mine is in the initial ramp-up phase. Performance to-date suggests that power consumption could be less than expected but maintenance of the
surface miners has been above plan. Management remains confident that the feasibility target of US$85/tonne (including US$14/tonne in transport costs) is very realistic. This translates into approximately US$1/lb, excluding the cobalt by-product credits.
Expansion Opportunities
• Freeport is spending considerable time assessing potential expansion opportunities for the TFM project;
we believe that it is unlikely that Freeport would provide much in the way of clarity on possible
expansions until the license review process is complete.
• The challenge in assessing expansions for TFM is the large scale of the property and the very large
mineralized inventory. There are multiple options open for expansion, including the early development of
a sulphide mining operation (roasting or autoclave processing routes would be required).
• Drilling as deep as 2,000 metres below surface has intercepted sulphide mineralization – intercepts 10-15
metres thick grading 2.5-5.0% copper are not unusual.
• Freeport has targeted ultimate production of 450,000-500,000 tpy cathode copper production from TFM
within a 5-7 year time frame. Lundin anticipates that the first expansion would include a doubling of the
current production rate (to 230,000 tpy). Third and fourth stage expansions would take annual production
to 345,000 tpy and 460,000 tpy.
• LUN management believes that there is sufficient power available under its long-term supply contract to
support at least the Phase 2 expansion. Third and fourth stage expansions would likely require additional
power and rail infrastructure.
• Given the heavy infrastructure spending attached to preproduction capex, LUN expects that Phase 2
expansion capex should be less that US$6,000/t of production capacity, i.e. less than US$700 million.
License Review
• LUN management provided little insight into the ongoing license review process – management did note
that it is not aware of an official deadline for completion of the negotiations. Press reports have suggested
that a 60-day time frame has been proposed by government officials (which would expire on or about
October 8).
• Management indicated that during the construction process, TFM has paid the DRC government
approximately US$100 million in import duties, licensing fees and other payments. The mine is also
subject to a 30% corporate tax rate, 2% royalty and 1% export tax.
• Hilary Clinton, the U.S. Secretary of State, was in the DRC 2 months ago and the status of the TFM
license was discussed with government officials.
Cash Flow to LUN
• LUN management indicated that the overdraft facility provided by Freeport due to the cost overruns
experienced by the project totals approximately US$210 million and could rise to about US$220 million
(LUN pays a carrying cost of LIBOR+3.5%).
• LUN expects that the facility should be repaid by late-2010/early-2011 if the current copper price (i.e.
US$2.70-2.80/lb) is sustained. We are presently forecasting a US$2.40/lb copper price in 2010 and
US$3.00/lb in 2011 – our model suggests that the overrun facility would be repaid by mid-2011.
• LUN and Freeport will receive all free cash flow from TFM until project debt funding of US$1.7 billion
has been repaid.
• Expansion capex will be funded by Freeport and LUN on a pro-rata basis (70/30).
Net Asset Value vs. TFM Project Risk
• Our 12% discounted DCF for LUN’s interest in the TFM project is US$643 million, or C$1.36/share;
increasing the discount rate to 15% would reduce our DCF to US$476 million, C$1.01/share. Our
consolidated NAV for LUN is C$4.77/share; increasing the TFM discount rate to 15% would reduce our
corporate NAV by 7.5%. Using our base case 12% discount rate for TFM, the project comprises 28.5% of
our NAV.
• We believe that TFM faces a lower risk of DRC government intervention to the extent experienced by
First Quantum at its Kolwezi Project due to the presence of a large U.S.-based mining company as the
mine operator combined with the influence of U.S. government officials. As well, we have noted that
over the past several years, DRC government officials have taken a more conciliatory tone towards TFM
as opposed to the aggressive actions towards Kolwezi.
Valuation
Lundin currently trades at an EV/2010 EBITDA multiple of 4.0x and a P/NAV multiple of 0.8x, compared to
its intermediate-small cap. peer group average of 4.4x and 1.0x, respectively.
Justification of Target Price
Our target price is based upon an EV/2010 EBITDA multiple of 4.3x (60% weighting) and a 1.0x multiple to
our 10% NAV (40% weighting)
Key Risks to Target Price
The main risks facing the company include forecast, financial, technical and political risks. Among other
things, these include risks related to copper, zinc and nickel prices, input costs and fuel prices, the governing
fiscal and legislative regimes, the timing of key developments, market conditions, capital and operating costs,
foreign exchange rates, resources and reserves, operating parameters, permitting, environmental, and staffing
and key personnel retention. Lundin currently has a 24.75% interest in the Tenke Fungurume project in the
Democratic Republic of Congo. Companies operating in the DRC face heightened political risk. The company
is undergoing a mining license review that covers the Tenke project and any changes on its interest in the
project may have an impact on our estimates. Lundin's valuation relies heavily on new projects and
developments, which face cost overrun and development risks that are inherent in new mine construction.
Investment Conclusion
We are maintaining our BUY recommendation.