Summary
- Allana's share price got hit by a declining potash price after Uralkali left the potash-cartel.
- As its deposit has unique characteristics, according to my calculations the project remains viable at the current ultra-low potash price.
- The partnership with ICL will prove to be extremely important, as ICL will offer technical expertise and financial backing.
- Debt financing is expected shortly, which will allow Allana to hit the ground running.
- My near-term target price is $0.52, increasing to $0.75 when funding for the project will have been secured. As such, Allana is a strong buy.
(Editor's Note: Investors should be mindful of the risks of transacting in securities with limited liquidity, such as ALLRF. Allana Potash's Canadian listing AAA.TO offers more liquidity.)
Introduction
In this article I'll have a closer look at Allana Potash (OTCPK:ALLRF) which aims to develop its Dhanakil potash project in Ethiopia, Africa. As the potash price plunged since Uralkali blew up the potash-cartel, Allana's share price went into a free fall, dropping to just $0.31 for a market capitalization of $110M at this moment. As I doubt the potash price will remain at the current level, I'll be looking to determine the fair value of Allana at a slightly higher potash price as a base case scenario, but lower than the MOP price of $430/t which was used in the feasibility study.
Source: company website
As trading on the US exchange in Allana Potash is quite limited, I'd strongly recommend to trade in Allana Potash through the facilities of the Toronto Stock Exchange where the company is listed on the main board. There's plenty of liquidity there, as approximately 400,000 shares change hands every day for a daily dollar volume of $140,000.
Where applicable I recalculated the amounts from Canadian Dollar to US Dollar using an exchange rate of 1.09. All images in this article were directly sourced from the company's website, corporate presentation and technical reports.
The Danakhil potash Project in Ethiopia: a unique project
The Danakhil project is located in Ethiopia approximately 60 miles from the Red Sea and has seen potash exploration since the 1900s, but this is the very first time a large firm has taken an attempt to prove up a reserve estimate and to compile a feasibility study to determine whether or not the Danakhil project would be economically viable as a large-scale project.
The team at Allana Potash did a great job to de-risk the project by completing a feasibility study in 2013 and signing an extremely important strategic deal with ICL earlier this year (see the next paragraph to read why this partnership is quite a big deal).
The Feasibility Study showed extremely attractive economics of the project, as the total cash cost FOB Djibouti would be just $125/t (sustaining capital expenditures included). This is very low so even after the recent crash in potash prices to $280/t, there will be a healthy operating margin. Most potash mines are extremely expensive to build (think about multi-billion dollar capex'es).
This isn't the case for Allana Potash, as the Danakhil project is amenable for solution mining which greatly reduces the capex and operating expenditures. Additionally, as the project is located in Ethiopia, Mother Nature is helping a hand as the evaporation rate is extremely high. That evaporation rate, in combination with plenty of water on the property has been very important to keep the capital expenditures relatively low at $642M. This $642M also includes a contingency fund to build a 75 mile haul road, even though the Ethiopian government has committed to take on the costs to extend the paved roads. So it's actually very likely we'll see the project come in at or under estimated capital expenditures instead of seeing a (OTCQB:HUGE) cost overrun like we saw at some Canadian projects.
Source: company presentation
So why is this project quite unique? You've got a government willing to take care of infrastructural needs, you've got an excellent evaporation rate which means you don't have to pre-heat the brine and thirdly contrary to what you might think about Ethiopia, Allana Potash has plenty of water available on the property. As the project is fully permitted, there's only one major risk left, and that's the financing risk. As Allana said it has received debt proposals covering 65% of the capital expenditures, I think a 65/35 debt/equity ratio is achievable. This would mean that Allana would need approximately $230M in equity, of which I expect $50M to be funded by the further ICL warrant exercise (see next paragraph), and another $50M by signing an additional offtake agreement for the remaining 20% of the production in the first five years. This means I'm expecting Allana Potash to raise $130-150M in equity, for an additional 450 million shares (assuming the company raises $150M at $0.33). This would bring the total share count to 775 million shares and I will keep this number in mind going forward.
Source: company presentation
Why the deal with Israel Chemicals is so important for Allana Potash
Earlier this year, Allana signed an agreement with Israel Chemicals ('ICL'), one of the largest producers (and more importantly: marketers) of potash. As this partnership agreement will be instrumental for Allana, one should not underestimate its importance.
First of all, as Israel Chemicals is a fertilizer producer (in fact, it's the sixth largest producer in the world, for a total market share of 6%), it can offer Allana Potash a lot of help on the technical side of things as ICL has a lot of know-how to tackle initial problems and help out with the teething problems every starting mine will experience. Additionally, ICL's assistance by offering its operational experience and expertise will remove the doubts about whether or not Allana Potash has the right people on the ground.
Secondly, ICL has taken a strategic position in Allana Potash by acquiring a 16.5% stake for $22.5M (or $0.43/share, a premium of 16% compared to the current share price). ICL can invest an additional $59M through the exercise of certain warrants at a strike price of $0.49 and $0.55 per share. Additionally, as ICL isn't only offering technical expertise but has also stepped into Allana's capital, prospective lenders will be assured by this move, as a reputable firm as ICL definitely won't have been impulsive about this investment.
Thirdly, and this might very well be the most important part of the agreement, is the take-or-pay offtake agreement for 80% of the production. This means that prospective lenders now have the certainty that Allana Potash effectively can generate revenues and that its end-product is saleable. As the sale of 80% of the production in the first five years of operation has been guaranteed, Allana should generate sufficient cash flow to service the debt. The mine plan calls for a production of 1 million tonnes of MOP per year, so 80% of the first five years results in an offtake agreement for 4 million tonnes MOP. At the current price of $280/t, $1.12B in revenues have thus been secured and should the potash price increase again to $350/t, this take-or-pay agreement will result in a guaranteed revenue of $1.4B. Why is this important? Now the lenders know that Allana Potash will be able to successfully sell the product, and as the all-in sustaining cost is just $125/t, at a potash price of $325/t, the first 4 million tonnes will generate at least $600M in free cash flow (after taking transportation and marketing costs into consideration), which could already be sufficient to repay all the debt it needs. So investors really shouldn't underestimate the real value of this take-or-pay offtake agreement.
The agreement with ICL has de-risked the project substantially and should convince investors and prospective lenders that Allana Potash is serious about doing business, and that all the pieces of the puzzle are falling into place.
The current potash price worries a lot of investors
In July of last year, the fertilizer world was shocked when Russian producer Uralkali announced it would leave the 'potash-cartel' and dump its entire production on the market. This has actually driven the potash prices down from close to $400/t in July last year to just $287/t right now (see chart). The fallout was (and still is) enormous, as at a potash price of less than $300/t most projects have been reduced to marginal producers, and none of the newly planned mines seems to be viable at this point.
Source: infomine.com
This means that most of the potash-juniors will die a slow and painful death if the situation doesn't improve over time. And I do think the situation will improve as soon as the market adjusts to the new situation. The demand for fertilizer is still growing, and I expect the potash price to edge up a bit from here (I doubt we'll see a sub-$275/t level for a longer period of time). This means that by the time Allana Potash should be up and running, I'm pretty sure the potash price will be higher again. I don't think we'll see the 'crazy hype' days with a potash price of $800/t back, but I strongly believe the MOP price will be at a higher level than today. Allana's feasibility study was based on a potash price of $430/t, but as I'll prove in the next paragraph, the project value will still be tremendous at $350/t and the net present value will be close to half a billion
So what's the value of Danakhil using a lower potash price?
The feasibility study was based on a MOP price of $430/t, and it's needless to say the situation has changed dramatically as the current potash price is just $280/t. So I'm wondering how the economics of the project are holding up when using a lower potash price. In the first calculation I will use the current potash price of $280/t, which is in fact my bear case scenario. The corporate tax rate in Ethiopia is 30%, and the discount rate I will use is 8%. This discount rate is relatively low for a project in Africa, but I'm basing my decision on a) the willingness of the Ethiopian government to assist Allana's development plans by providing additional infrastructure and having granted all permits, b) the fact a full bankable feasibility study has been completed and the fact lenders have already expressed interest in providing debt financing to bring Danakhil into production, and c) the partnership agreement with ICL which reduces the operational and technical risk and is a vote of confidence. The current planned mine life is 24 years to recover approximately 23 million tonnes of MOP. I will use a production of 300,000 tonnes in year 1, increasing to 750,000 tonnes in year 2, 900,000 tonnes in year 3 and 1M tonnes per year from year 4 on. The expected all-in sustaining cash cost (including shipping and marketing) is $150/t.
|
Cash Flow per year
|
Corporate tax rate (30%)
|
after tax
|
Discount rate (8% per annum)
|
NPV8%
|
|
-650,000,000
|
|
|
|
-650,000,000
|
|
39,000,000
|
0%
|
39,000,000.00
|
1.00
|
39,000,000
|
|
95,000,000
|
0%
|
95,000,000.00
|
1.08
|
87,962,963
|
|
115,000,000
|
0%
|
115,000,000.00
|
1.17
|
98,593,964
|
|
125,000,000
|
0%
|
125,000,000.00
|
1.26
|
99,229,030
|
|
130,000,000
|
0%
|
130,000,000.00
|
1.36
|
95,553,881
|
|
130,000,000
|
0%
|
130,000,000.00
|
1.47
|
88,475,816
|
|
130,000,000
|
0%
|
130,000,000.00
|
1.59
|
81,922,051
|
|
130,000,000
|
30%
|
91,000,000.00
|
1.71
|
53,097,626
|
|
130,000,000
|
30%
|
91,000,000.00
|
1.85
|
49,164,468
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.00
|
45,522,656
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.16
|
42,150,607
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.33
|
39,028,340
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.52
|
36,137,352
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.72
|
33,460,511
|
|
130,000,000
|
30%
|
91,000,000.00
|
2.94
|
30,981,955
|
|
130,000,000
|
30%
|
91,000,000.00
|
3.17
|
28,686,995
|
|
130,000,000
|
30%
|
91,000,000.00
|
3.43
|
26,562,033
|
|
130,000,000
|
30%
|
91,000,000.00
|
3.70
|
24,594,475
|
|
130,000,000
|
30%
|
91,000,000.00
|
4.00
|
22,772,662
|
|
130,000,000
|
30%
|
91,000,000.00
|
4.32
|
21,085,798
|
|
130,000,000
|
30%
|
91,000,000.00
|
4.66
|
19,523,887
|
|
130,000,000
|
30%
|
91,000,000.00
|
5.03
|
18,077,673
|
|
130,000,000
|
30%
|
91,000,000.00
|
5.44
|
16,738,586
|
|
130,000,000
|
30%
|
91,000,000.00
|
5.87
|
15,498,691
|
|
|
|
|
463,822,020
|
Even at the current low potash price the project would definitely be viable and have an after-tax NPV8% of $464M. This shows how strong the Danakhil project is, as it would still make sense to build the project. The payback period would be roughly six years which is mainly caused by the lower production in the first few years due to the ramp-up.
Let it be clear the $280/t scenario is my conservative scenario as I don't believe the potash prices will fall much further. Let's now see what the economics would look like using a potash price of $350/t.
|
Cash Flow per year
|
Corporate tax rate (30%)
|
after tax
|
Discount rate (8% per annum)
|
NPV8%
|
|
-650,000,000
|
|
|
|
-650,000,000
|
|
60,000,000
|
0%
|
60,000,000.00
|
1.00
|
60,000,000
|
|
142,000,000
|
0%
|
142,000,000.00
|
1.08
|
131,481,481
|
|
170,000,000
|
0%
|
170,000,000.00
|
1.17
|
145,747,599
|
|
200,000,000
|
0%
|
200,000,000.00
|
1.26
|
158,766,448
|
|
200,000,000
|
0%
|
200,000,000.00
|
1.36
|
147,005,971
|
|
200,000,000
|
30%
|
140,000,000.00
|
1.47
|
95,281,648
|
|
200,000,000
|
30%
|
140,000,000.00
|
1.59
|
88,223,748
|
|
200,000,000
|
30%
|
140,000,000.00
|
1.71
|
81,688,655
|
|
200,000,000
|
30%
|
140,000,000.00
|
1.85
|
75,637,644
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.00
|
70,034,855
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.16
|
64,847,088
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.33
|
60,043,600
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.52
|
55,595,926
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.72
|
51,477,709
|
|
200,000,000
|
30%
|
140,000,000.00
|
2.94
|
47,664,546
|
|
200,000,000
|
30%
|
140,000,000.00
|
3.17
|
44,133,839
|
|
200,000,000
|
30%
|
140,000,000.00
|
3.43
|
40,864,665
|
|
200,000,000
|
30%
|
140,000,000.00
|
3.70
|
37,837,653
|
|
200,000,000
|
30%
|
140,000,000.00
|
4.00
|
35,034,864
|
|
200,000,000
|
30%
|
140,000,000.00
|
4.32
|
32,439,689
|
|
200,000,000
|
30%
|
140,000,000.00
|
4.66
|
30,036,749
|
|
200,000,000
|
30%
|
140,000,000.00
|
5.03
|
27,811,805
|
|
200,000,000
|
30%
|
140,000,000.00
|
5.44
|
25,751,671
|
|
200,000,000
|
30%
|
140,000,000.00
|
5.87
|
23,844,140
|
|
|
|
|
981,251,995
|
At a potash price of $350/t (which is quite likely, given the fact the longer term potash price outlook is around $400/t), the project has a value of $981M. If I'd use a 1/3-2/3 weighing for both scenario's, I end up with a fair value of $808M for the Danakhil project in Ethiopia.
Investment Thesis
You need to buy when blood is running in the streets, and in Allana's case it's flowing in the streets, mainly because investors see the potash price decline and are abandoning the Allana-ship. And guess what, they are wrong. As I have proven in this article, even at the current potash price the project remains viable and $280/t and there's tremendous upside should the potash price recover to $350/t.
As Allana Potash is aiming to raise 65% of the capex in debt, the equity dilution will remain limited and I'm aiming for a total share count of 775 million shares after all necessary dilution. This results in an after-tax NPV8%/share of $1.04. At this stage (fully permitted and a completed feasibility study and having an important partnership with ICL), I'd use a ratio of 0.5 x NPV, which would result in a price target of $0.52 (for a 68% premium compared to the current share price). The moment the financing for the project has been secured, the ratio could increase to 0.75 times the NPV.
I believe in a structurally higher potash price a bit further down the road, and after making my calculations I will very likely increase my position in Allana Potash by purchasing more shares on the open market.
Editor's Note: This article covers a stock trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.
Additional disclosure: I have a long position in Allana and will add to my position shortly.