JK comment
Thu Jul 7, 2016
SVH Tracker: Peregrine delivers positive PEA that justifies moving Chidliak to the PFS stage
Publisher: Kaiser Research Online
Author: Copyright 2016 John A. Kaiser
Peregrine Diamonds Ltd (PGD-T: $0.29)
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SVH Tracker - July 7, 2016: Peregrine delivers positive PEA that justifies moving Chidliak to the PFS stage
Peregrine Diamonds Ltd released a PEA on July 7, 2016 which indicates that the Chidliak diamond project has an after-tax NPV of CAD $471 million at 7.5% and an IRR of 38.1% for a 10 year 2,000 tpd open-pit mine that will recover 11.6 million carats. CapEx came in at CAD $434.9 million and OpEx at $94.40/tonne, which under the rule of thumb that CapEx should not be significantly higher than the NPV while IRR is above 15% signals that Chidliak should proceed to the prefeasibility stage. The fair speculative value range under my rational speculation model for a PFS stage project is 25%-50% of the ultimate value, or $118-$236 million. Based on 363 million shares fully diluted and a 100% interest that works out to a price target range of $0.33-$0.66 per share. The ultimate target price in the absence of any further dilution would be $1.30 per share. The stock traded as high as $0.315 before closing at $0.285 for a gain of $0.055. The next question is how Peregrine will fund the PFS stage and at what price. On the plus side the PEA only exploits part of the open-pittable resource and does not touch the underground potential. It also does not factor in the likelihood that other Chidliak pipes will eventually feed the mine. It is thus plausible that Peregrine can attract an institutional audience willing to fund the PFS in the $0.40-$0.60 range with an eye to a possible future buyout by Dominion Diamonds in the $0.60-$1.00 range. But for any additional serious price move we may have to wait until the technical report is filed, which Peregrine must do within 45 days. Although the press release includes irrelevant details about a tradeoff study for building an all-weather road or relying on a winter road, it is missing key information about the mining plan which allows one to model the PEA assumptions. This is quite inexplicable unless Peregrine plans to file the technical report sooner than later. Peregrine may clarify the missing information during its conference call on July 12. I believe there will be a much better market response once the institutional number-crunchers are satisfied.
The PEA differs from my May 20, 2016 Outcome Visualization (retired July 7, 2016) which assumed a 3,000 tpd operation that depleted the entire open-pittable resource of CH6 and CH7 over a 9 year mine life. The OV projected a CAD $700 million after-tax NPV at 9% and IRR of 49.1%, for which a $0.48-$0.96 price range would be fair speculative value at the PFS stage. My CapEx of CAD $400 million was a bit low but my LOM sustaining capital at $100 million was double the PEA's $48.7 million. My OpEx of CAD $93/t was almost dead on compared to $94.40 for the PEA. My recovery at 95% was lower than 98% but my "payable" of 99% was a bit more optimistic than the 96% implied by the 4% PEA selling cost, though both work out to 94% of head grade.
My biggest error was to assume the PEA would mine the entire inferred resource for CH6 and CH7 which totals 9,630,000 tonnes of 167 cpht containing 15,620,000 carats, and do so at 3,000 tpd. The press release does not reveal any ore schedule information, but it does indicate annual production will average 1.2 million carats, peaking at 1.8 million. That implies a slow production ramp-up or some very low production years, for the mine at 2,000 tpd operating 365 days per year for 10 full years will recover 11.6 million carats, which at a 98% recovery implies an in situ resource of 11.84 million carats. If we divide that by the 7,300,000 tonnes processed over 10 years with the mine operating all out, the average head grade would be 162 cpht. For some strange reason the press release declares it to be 167 cpht.
While it is understandable that Peregrine would not include the ore schedule in its press release, it is puzzling that Peregrine does not explicitly state how many tonnes of ore will be processed nor break down how much ore at what average grade comes from each of CH6 and CH7. Without this information it is impossible to construct a cash flow model for the PEA. How much of the inferred 4,464,000 tonnes of CH6 at 245 cpht containing 11,390,000 carats and how much of the 4,990,000 tonnes of CH7 at 85 cpht containing 4,230,000 carats gets mined? It would make sense to mine all of the CH6 resource, recovering 11,116,000 carats. That leaves 484,000 recoverable from CH7, or 494,000 in situ. Assuming the average 85 cpht grade that means only 581,000 tonnes would be mined from CH7. But the total 5,045,000 tonnes mined in this scenario is less than the 7,300,000 tonnes calculated for the 10 year mine life. Clearly only part of the CH6 ore is mined. Why do we have to wait until the technical report is filed within 45 days?
Peregrine also uses a 2.5% annual price inflator for the carat value which it justifies by pointing out that all the diamond companies do it based on their "analysis of long-term supply-demand balance in the diamond market": Dominion Diamonds with Sable, Mountain Province with Gahcho Kue and Stornoway with Renard. Doing so in the context of a global outlook of secular stagnation, the possible implosion of China, a consumer drift toward the consumption of experiences rather than things, and the rise of synthetic diamonds seems a bit of a stretch. But who am I to dissent when everybody is doing it? On the other hand, the USD $149 per carat base case price used for CH6 is lower than originally modeled by WWW, reflecting softer rough diamond prices during the past year. WWW had modeled a range for CH6 based on 1,013.5 ct parcel at $162-$236 with $188 the base case and measured $213/ct. I used USD $186 as a LOM average which was based on an optimistic $213 per carat for CH6 and $114 for CH7. The average LOM price used by the PEA is thus not that different from what I used. The difference between my OV's CAD $700 million NPV and the PEA $471 million NPV thus boils down to the lower throughput and decision not to mine all of the open pittable resources.
Net revenue after royalties (which presumably includes the 4% selling cost) is CAD $2,462,000,000 or $2,565,000,000 before deducting the selling cost (there are no royalties). That implies an average carat value of CAD $221 per carat, which compares to the LOM average of CAD $228 for CH6 and $196 for CH7. The latter may seem puzzling when you consider the CH6 value of USD $149 is 31% above the $114 per carat base case price for CH7. Clearly the CH7 ore is mined last and gets almost the same price relative to constant OpEx as did the CH6 ore. The diamond companies are getting away with boosting the profitability of their mines in a manner not done with other projects.
Peregrine has chosen a mining scale that allows room for future improvement. It has chosen an all-weather road to avoid expensive disruptions linked to global warming. The all-weather road also opens up this part of southern Baffin Island for the First Nations community at Iqaluit, a plus for securing a social license. Assuming the technical report clears up confusions created by the press release, I expect management to find a much more receptive audience for the Chidliak story going forward. With the caveat that I do not like output price side inflators, I am converting my Good Relative Spec Value Buy recommendation to a Good Absolute Spec Value Buy recommendation with a near term $0.40-$0.60 target.
*JK owns shares in Peregrine Diamonds Ltd
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