VonReich, read Luisa Moreno's reportVonReich, didn't you read Luisa Moreno's analyst update note for JacobSecurities on ORT and the non-issue that Hykawy of Byron Cap has raised (to protect Byron's interests in REE companies obviously now threatened by ORT's tech)??????
Here it is..... and you're getting really close to being put on IGNORE. Sorry to say.
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[Analyst report from Luisa Moreno-- some boldfacing added for emphasis]
Bear-s no Weight!
Recommendation: We maintain our Speculative Buy recommendation and target price of $11.20
Orbite Aluminae Inc. (TSX:ORT)
Stock Rating: Speculative Buy
1-Year Target Price $11.20
1-Year ROR 463% [from current price on 4/24/12 of $1.99 CAN]
Prior: Unchanged
Risk Rating: High
April 24, 2012
Jacob Securities Inc., 199 Bay Street, Suite 2901, Toronto, ON M5L 1G1 +1-416-866-8300 www.jacobsecurities.com
EQUITY RESEARCH
Luisa Moreno, Ph.D, Analyst lmoreno@jacobsecurities.com +1 (416)866-8380
We were recently asked to participate in BNN’s Bear/Bull debate show [with basher analyst Jon Hykawy of Byron Capital] to offer our Bull view on Orbite Aluminae. Unfortunately, due to technical difficulties with the audio and resulting delays, several of our key positions could not be properly conveyed during the telecast. Therefore, we take this opportunity to clearly and more thoroughly present our bull arguments in the contexts of the topics raised during the show and to demonstrate why we believe the opposing Bear view is not backed by sound due diligence.
Key Bull Points
Near Term Revenue Orbite is set to become the world’s lowest cost producer of high purity alumina (HPA). Production is expected to start by 4Q12/1Q13 and cash from the HPA sales could partially fund the smelter alumina grade plant (SGA).
Low Cost Producer of Alumina The SGA plant is also expected to become one of the lowest-cost alumina refineries in the world. The by-products will certainly make the refinery even more competitive.
Rusal UC Partnership Rusal - the world’s largest producer of aluminum and a major alumina producer - spent several months performing due diligence and decided to enter in an agreement with Orbite. That is a strong validation of the Orbite technology and business model. We anticipate that once other industry partners are identified, Orbite will sign the definitive agreement with Rusal.
Renowned Technical Team Orbite has built an international team of renowned chemical process engineers that are confident that they will be able to build the most economic red-mud-free alumina refinery in the world.
As part of our due diligence, we visited Orbite facilities multiple times and we have spent countless hours talking to Orbite’s technical team, independent engineering contractors, chemical processing engineers and alumina refinery experts in various countries (e.g. Jamaica and Australia).Additional comments in the next page.
One of the Bear points raised in the debate was that the Hydrothermal Acid Regeneration Process (H-ARP), one of the technologies being considered by Orbite to regenerate a fraction of the waste acid, may not be viable and the one at the ThyssenKrupp Steel (TKS) plant in the U.S. may be replaced.SMS Siemag (Siemag) built the H-ARP for TKS and may use it to test Orbite’s spent acid ahead of the SGA plant construction. We have contacted Siemag directly for an update and Siemag made it absolutely clear that there are no plans to decommission or replace the HARP. Additionally, we have found no supporting documents that indicate that there are currently any environmental or emission issues with the H-ARP at TKS plant [as charged by basher analyst Jon Hykawy of Byron Capital].
Paper Trail Sequence
According to documents submitted to the Alabama Department of Environmental Management (ADEM) on May 23rd and 24th of 2011, TKS conducted “an initial performance test” on the Hydrothermal HCl Acid Regeneration Scrubber (code S10) to demonstrate compliance with the emission regulations. Particle matter and Cl2 emissions were found to be normal but HCl emissions were higher than permitted (>12 parts per million by volume [ppmv]).
It should be noted that these kinds of systems are not exactly “plug and go”. It seems that the first emission tests for the H-ARP occurred in May 2011, during which, “mechanical issues” were identified. As per regulatory documents a corrective plan was promptly implemented. Setbacks are not unusual even in the commissioning of well-established technologies. In this case it seems the air-scrubber (Exhibit 1), a commoditized item, that is not built by Siemag but by a third party and is not part of H-ARP, had to be optimized.
One document submitted by TKS and dated June 24, 2011, mentions that there is “limited information” about H-ARP and the system had limited “operating hours”. The hydrothermal acid regeneration system at the TKS plant is first of its kind at a commercial scale, and it was purposely adapted and designed for TKS, thus the limited information. Our understanding is that tests on H-ARP didn’t start until spring of 2011 due to limited availability of spent acid, possibly because the TKS plant was not operating at full capacity. From May 2011 onwards as the hydrothermal process was being optimized, the excess acid that was not being processed by HARP may have been outsourced to a third party acid regeneration firm, a common practice in the steel industry.
The exact sequence of events for the rest of the year 2011 is best captured in a document dated January 10th, 2012 that TKS submitted to ADEM: “On July 26, 2011 TKS submitted an air permit modification application to permit certain physical modifications to the Acid Regeneration Plant” “On July 29, 2011 ADEM issued a modified air permit that allowed TKS to make certain enhancements to the emissions control systems installed on the ARP which helped ensure future compliance with the HCl emission limit of 12 ppmv during ARP operation. TKS determined that augmentation of the control systems installed on the ARP beyond the modifications approved in the July 29, 2011 modified air permit were necessary to assure that HCL emissions meet the requirements.” As such, TKS proposed to reduce the HCl content of the stream before entering the scrubber via modifications to the venting system to the scrubber in the modified air permit application submitted to ADEM on November 15, 2011. Based on a review of the potential emissions from the addition of a condenser to the emission control system associated with the APR, it was determined that no state or federal emission standards were expected to be exceeded. Therefore, on November 21, 2011 ADEM issued a “no permit determination” letter to TKS.” This suggests that there was no need to issue a new permit, actually a positive point instead of negative, as suggested somewhere else [i.e., by Jon Hykawy].
It seems that during the optimization process that started in May 2011, the system may have been stopped two times to allow for improvements (requests were received July 26th and November 15th). On March 9, 2012, the TKS received an extension permit to operate the hydrothermal acid regeneration plant until September 6, 2012. This extended period of operation “is to allow for emission testing, plant adjustments and for an inspector from the Air Division to inspect the unit while in operation”.
Thus, it seems that the hydrothermal process is not being replaced but instead it continues to be optimized to offer higher efficiency. As per the regulations, TKS will continue to request temporary authorization to operate (TAO) every 6 months, until TKS (and Siemag) decide that no additional modifications related to the H-ARP are required or desired. TAO requests during plant commissioning or optimization are also a common practice in Canada.
What does it all mean?
Not much actually!What we described above is a standard bureaucratic communication between a steel company and a regulative body during commissioning of an industrial facility with a potential environmental impact; specifically, the documents show the steps that TKS went through to ensure that all changes/improvements associated with the H-ARP were disclosed. Not all the changes had an impact on emissions but it seems that they still had to be reported and assessed by the ADEM given the type of system.
There are hundreds of documents in the ADEM data base associated with TKS plant commissioning, some are related to the hydrothermal acid regeneration plant but as far as we could tell none indicated that the H-ARP is not environmentally friendly or that it is in noncompliance with any permit.
Furthermore, none of the documents indicate whether the H-ARP plant has indeed "very low atmosphere emissions" or not; they deal with substantially different matters related to the assumed effects of mechanical modifications on exhaust gas quality (in terms of pollutant concentrations per unit of volume), which is mostly a bureaucratic regulatory measure.
Misinterpretation!
As we pointed out earlier, it is common for large complex industrial plants such as that of TKS, to undergo optimization and fine-tuning during commissioning. Any system change that may affect emissions always requires regulatory checks/reviews followed by temporary permitting.
In our opinion, none of the documents that we consulted indicate that TKS is in violation of emission regulations or that the H-ARP is not working or will be replaced. Suggesting otherwise [as Hykawy does] is poorly interpreted or simply inaccurate. This sequence of events seems to suggest that TKS and Siemag continue to be committed to the development of H-ARP.
Heads up!
We anticipate that there will likely be more requests by TKS to the ADEM for corrections, adjustments or improvements to the H-ARP plant; it is after all the first of its kind. Furthermore, it is important to note that, if Siemag decides to test Orbite spent acid at the TKS plant, the system may be subjected to changes and therefore TKS would have to submit in writing all the planned alterations. The ADEM in turn will review them in their own time and respond accordingly. We anticipate more correspondences between TKS and ADEM in the future but that is just the norm.
Role of the Additional Acid Regeneration System at TKS Plant
We are not sure about the role of the additional acid regeneration system that may be built by International Steel Services (ISSI) at the TKS plant. As we have suggested before, it’s possible that ISSI’s acid regeneration services may have been used by TKS during H-ARP optimization work. We believe that an additional acid regeneration system will open the opportunity for Siemag to test Orbite’s and other non-ferrous industries spent acid using the hydrothermal process. If that is the case we see it as a positive development for Orbite and other non-ferrous industries.
H-ARP Design: Orbite vs TKS
The hydrothermal acid regeneration process is an evolutionary version of the PORI process developed in the early 70’s when the lack of advanced materials limited its viability. Currently there are numerous research and development groups at universities and industries focusing on the development of the hydrothermal process. We have learned that Orbite actually identified the H-ARP technology early in the design of SGA. As they were designing it they realized that Siemag had built a full-scale plant and then decided instead to mandate Siemag to build a simpler version, based on their specifications.The Orbite team actually believes that the H-ARP does not present a major technical challenge for their project.
The hydrothermal acid regenerating system that is being designed for Orbite is not identical to that of TKS. First, Orbite’s waste acid feed reaching the hydrothermal acid regeneration plant is expected to be much cleaner than that of a steel mill pickling operation.Orbite’s waste acid feed to the H-ARP is expected to contain mainly water (H2O), hydrochloric acid (HCl), iron chloride (FeCl3) and rare earth elements. Everything else would be diverted (e.g. aluminum chloride is calcined and the magnesium oxide is spray roasted). The point here is that a cleaner spent acid means less process risk.
Also, according to Siemag, the design of Orbite’s H-ARP is expected to be simpler than that of TKS’s. The spent pickle liquor from the steel industry usually contains mixed irons and it requires autoclave oxidation before hydrolysis; however, Orbite can skip this technically complex step as its feed contains only trivalent iron that is directly hydrolysable. As no high pressure autoclaves are necessary there is less operational risk for Orbite’s future H-ARP.
Orbite’s tests have been performed by Siemag at their pilot plants in Europe over the last 7 months. The plants implement the whole process: crystallization of aluminum chloride preconcentrator, hydrolyser, filtration, heat recuperation and exhaust gas treatment.We have learned that according to reports from Siemag to Orbite, so far the chemistry, the utility and energy consumptions, product qualities and acid recoveries have been proven.
Technology Risk
There is always a number of technology risks associated with companies developing new technologies. It is not our intention to suggest that Orbite Aluminae has no technology risks, that would be naive and incorrect, to say the least. In fact, in our initiation report we pointed out some of the same issues raised in the Bear/Bull debate.
As with all technologies there is always a chance of failure; however, Orbite aluminae and their international team of experienced experts are confident, based on the results so far, that they will be able to deliver the first economic Orbite process refinery for the production of red-mud free alumina.
As far as the TKS’s hydrothermal acid regeneration system is concerned, the industrial large scale implementation has neither been proven successful nor been proven a failure as the plant is still undergoing completion of commissioning. However, Orbite engineers who had access to process data during their due diligence at TKS’s H-ARP were satisfied with the overall process operation given that the energy requirements and product quality have been met.
It should be noted that even the 50 years old pyro-hydrolysis based acid regeneration system, has its own challenges. For instance, as publicly available information in the U.S. courts attest, ISSI's plants have repeatedly triggered action by regulatory bodies in the U.S., which in no way indicates that ISSI (and its subsidiary AMROX) is incapable or that their pyro-hydrolysis plants does not work. It simply shows that even a well-established technology can at certain points in time be out of compliance with applicable permits. Spray roaster systems, although more established, are not perfect or immune to technical misfortunes and some have even failed.
We do not expect TKS’s H-ARP system to be decommissioned; however the H-RPA technology is not immune to fatal unforeseen future difficulties or accidents either. So, when will we know for sure if the hydrothermal acid regeneration system is a viable technology? As per any newly introduced technology, the viability and feasibility of the H-ARP will only be established after a few years of operation, when enough records on operation and maintenance cost are available.
There are a number of other risks associated with Orbite Aluminae and are listed below.
Price Assumptions
Orbite preliminary economic assessment (PEA) included sensitivity analysis with different price scenarios with and without by-products which show that the SGA plant could be economic without the sale of by-products. We have performed a detailed estimate of the costs of the smelter grade alumina as part of our due diligence. From our analysis and assuming our cost assumptions are correct, it seems that Orbite does not need by-product (e.g. rare earths) revenue to be competitive or economic.
Energy
We still believe that the best option for Orbite to have access to clean fossil fuel is to have the plant built near existing natural gas or equivalent fossil fuel infrastructure. In fact, Orbite just announced the acquisition of new claims that cover a substantial portion of the aluminous shalebearing Orignal Formation in Quebec and includes the area of Saint-Apolinaire, West of Quebec city where natural gas is readily available. Orbite will initiate an exploration program this summer.
Justification of Target Price
We use the enterprise value DCF approach, which is an adequate valuation methodology for industrial companies with cash flow potential in the near term. The weighted average cost of capital of 12.5% was determined assuming a risk free rate for Canada of 3%, a beta of 1.92 and a market premium of 5%. We estimate that in the long term the company capital structure will comprise of very low levels of debt.
Key Risks to Target Price
It should be noted that a definitive feasibility study for the Orbite process has not yet been completed and there are various risks associated with Orbite Aluminae, including: Technology Risk; Cost Risk; Patent Protection Risk; Financing Risk; Geopolitical Risk Price Risk; Currency Risk; Takeover Risk; Management Risk.
A detailed description of these risks can be found in our initiation report published in November, 2011.
Investment Summary
Our Bull points for Orbite include the potential (i) for near term revenue, (ii) to become a low-cost producer of high purity and smelter alumina, (iii) partnership with the world’s largest producers of alumina, and (iv) an international team of renowned and experienced chemical process engineers who have built, commissioned and optimized large scale plants.
In our opinion it seems unusual to conclude that the TKS’s hydrothermal acid regeneration plant will be replaced, just because – as per ADEM documents - an auxiliary system (scrubber) of well proven nature is still undergoing optimization, and then associate that with the certainty of Orbite’s preliminary economic assessment (PEA). With the risk of stating the obvious, it must be noted that a PEA is not the same as a definitive feasibility study.
It is important to note as well that the H-ARP for the Orbite process is expected to be simpler than the one at the TKS plant, and although Siemag has been contracted to design Orbite’s H-ARP, the engineering principles are well known and according to Orbite engineers is not actually that complex (for Orbite’s specific application). We anticipate that Orbite will offer more specific details about the SGA plant design and the viability of the auxiliary technologies as it completes its definitive feasibility study and it receives more specific details from its contractors.
This exhausting exercise of paper trailing for problems with Orbite’s related technology was yet another opportunity to better understand the different parts of the Orbite process and the associated risks. There have been unprecedented attacks and so far unfounded attempts to discredit Orbite’s project.
We will continue to monitor the sentiment towards the stock. For now we maintain our Speculative Buy recommendation and target price of $11.20