--------------------------------------------------------------------------Summary - We are initiating coverage on Formation Metals Inc., a Canadian junior
mineral exploration and development company, whose key assets include a 100%-
owned cobalt property in Idaho and a 100%-owned hydrometallurgical complex
situated approximately 200 miles from the cobalt mine site.
Cobalt is classified as a critical metal by the European Union and deemed a strategic
metal by the United States Government. High purity cobalt is vital to the aerospace
industry and used in the manufacturing of rechargeable batteries and as catalysts for the
petroleum and chemical industries. Approximately 76,000 tons of refined cobalt was
produced globally in 2010, representing an estimated market value of US$3
billion. Two grades of cobalt have quoted prices: 99.3% and 99.8%. High purity
cobalt exceeds 99.99%, with extremely low impurities, and is very difficult to produce.
Formation will be the only cobalt producer in the U.S.A. and one of a handful of highpurity,
superalloy grade cobalt producers in the world. The U.S.A. accounts for
approximately 60% of global high-purity demand.
Valuation
We are initiating coverage on Formation Metals Inc. with a SPECULATIVE BUY
recommendation and 12-month target price of C$2.60. Our target price is based on an
equal blend of: (1) NAVPS of C$2.35; and (2) a 6.0x multiple applied to our 2013
CFPS estimate of US 0.47.
Our NAV model for the Idaho Cobalt Project (ICP) is based on a Bankable Feasibility
Study completed in 2008, with FCO expected to produce 3.3 million pounds annually
(1,525 tons) of cobalt metal at an average life of mine (LOM) cash cost of
approximately US$6.00 per pound (including copper and gold credits) and using an
average cobalt price of US$21.95 per pound. We have also ascribed a nominal value
for the Saskatchewan uranium assets and the Mexican gold/silver assets.
Based on the annual cobalt production, prices and costs used above, coupled with
annual copper and gold production of approximately 3.8 million pounds and
approximately 3,900 ounces, respectively, our model indicates that Formation will
generate US$53 million in cash flow or US
.54 per fully diluted share.
Some of the major attributes of the project we believe to be key in making Formation a
quality investment include:
1) Sulphide Ore Containing Very Few Impurities: The ICP is a unique, primary cobalt
deposit containing few impurities and is capable of producing superalloy grade, highpurity
cobalt metal. This would therefore position Formation as both a producer of
premium-priced products, as well as products for less technically stringent applications,
thus ensuring Formation will always have an end market for its product.
2) Ownership of an Existing, Fully Permitted Hydrometallurgical Facility: Formation
purchased its Hydrometallurgical Facility out of receivership for US$1.2 million, by
paying a tax bill, and retrofitting is estimated to cost an additional US$2 million. A
new entrant would be faced with paying at least US$75 million for a comparable
facility (as well as substantial permitting hurdles), which would likely render a new
high-purity cobalt project economically unfeasible.
3) Location, Location, Location: The ICP will be the only cobalt producer in the
United States and one of only three high-purity producers within North America. The
United States accounts for approximately 60% of global high-purity cobalt
consumption. Furthermore, the ICP is situated in the heart of the U.S.
aerospace industry, which stands to be one of the fastest growing sectors in the coming
years.
4) Low Cost Producer: According to a Bankable Feasibility Study, Formation's ICP is
expected to produce high-purity cobalt for an average cash cost of US$7.73, and when
we include gold credits, our model yields an average cash cost of approximately
US$6.00 per pound. Gold was not included in the Bankable Feasibility Study because
there were insufficient quantities of ore at the time of the study. However, following
the Bankable Feasibility Study, Formation completed a multi-million dollar round of
pilot work, the results of which satisfied management that gold production estimates
will be realized.
ICP Has an Abundance of Exploration Upside We expect Formation's reserves to
increase following the release of the final assay results from FCO's 2010 mine plan
optimization drill program on the Ram deposit. The drilling confirmed economic ore
grade mineralization and an additional 390 feet along strike to the south and 200 feet
down dip, representing a 14% increase in the known strike extension of the Ram
deposit to 3,200 feet.
The Ram Deposit remains open along strike to the north and south and down dip, and
the ICP contains two additional known cobalt deposits.
ICP Provides U.S.-based Companies with a Secure, Dependable Supply of High-Purity
Cobalt
We contend that Formation's high-purity cobalt production will be a welcome
alternative in the U.S., relative to many existing cobalt supplies. For example, the
Democratic Republic of the Congo (DRC) produces 40% of global cobalt as a byproduct
from copper and artisanal mining, and is home to approximately one-half of the
world's known cobalt reserves. The country has recently undergone a civil war and its
political landscape remains unstable.
Moreover, China, who is the leading cobalt refiner in the world with approximately
39% of the market, imports approximately 90% of its cobalt ore, and approximately
85% is sourced from the DRC. Moreover, it is very difficult to produce high purity
cobalt from the Congo material.
Opportunity to Buy into the Product at a Discount
Cobalt prices (99.8% purity) have stabilized in the US$18.00 to US$19.50 per pound
range, after plummeting to US$12.25 per pound in December 2008, but still remain far
below the 2007 and 2008 averages of US$30.78 and US$39.04 per pound,
respectively. Based on what we believe to be favourable market fundamentals, we
expect prices to continue to recover to pre-economic crisis levels. High purity cobalt
typically trades at a premium to 98.8% grade cobalt.
Idaho Cobalt Project: Fully Permitted:
Due to a longer than originally expected permitting process, the project progressed at a
somewhat slow pace and did not gain meaningful momentum until recently. In 2007,
the project received a positive NI 43-101 Bankable Feasibility Study, and in June
2008, received a final Environmental Impact Statement. In early 2009, FCO received a
Record of Decision from the U.S. Department of Agriculture Salmon Challis National
Forest and a Record of Decision from the U.S. Environmental Protection Agency, as
well as a Section 401 Certification from the Idaho Department of Environmental
Quality.
In December 2009, the final approval allowing construction to commence was granted,
when FCO and the Forest Service signed the "Forest Service Evaluation".
The Company's mineral processing business consists of a hydrometallurgical facility in
Northern Idaho. This facility was originally purchased by the Company in order to
process the cobalt concentrate. It will have to be refurbished to process the cobalt
concentrate to meet the supply from the Idaho Cobalt Project when the mine is put into
production. The facility also contains a precious metals refinery, which the Company
has refurbished to process third party precious metals materials. Material is refined into
high purity silver and gold bullion.