African Minerals

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African Minerals’ development of its flagship Tonkolili iron ore project continues to progress and impress even as its production forecasts get scrutinised.

African Minerals (AML) received a large seal of approval in March this year after the closing of a $1.5 billion deal with Shandong Iron & Steel Group (SISG), virtually ensuring that phase II expansion plans for its greenfield iron ore project in Sierra Leone will progress on target.

But leading up to the handshake, the company had a bumpy ride near the end of 2011 when an issue with a port stacker meant that ships could only be loaded directly from trains without a stockpile. Shipped tonnage in the fourth quarter plunged to 0.2Mt compared to an expected 1.2Mt. In the first quarter this year, however, the company is back on track having produced 1.2Mt and shipped 1.1Mt. 

At the same time, AML has revised its 2012 production guidance downwards – from 15Mt/y to 10Mt/y – even while expressing confidence in meeting a ramp up run-rate of 20Mt/y by end of 2012.

Mike Jones, head of corporate development and investor relations, admits that there are still some moving parts in the forecast.

“We know what we are doing in terms of current production capacity, and we know where we are going to get to, but the interaction between the two is a little uncertain during this current ramp-up phase. Having said that, though, we are still very confident of exiting the year with a 20Mt/y production capacity,” Jones says.

Until it closed, the investment deal with SISG was first and foremost in investors’ minds. Jones describes the investment, which had been 20 months in the making, as being similar to a long courtship where the partners get to know each other well before the wedding, compared to a more European style of mergers and acquisitions (M&A), which are more like an arranged marriage after which you have to learn to live together.  The deal will see the Chinese company get a 25 per cent stake in the mine and associated infrastructure.

The investment also meant that AML could retire a $418 million dollar facility from Standard Bank, one of the leading resource banks in the West African region. AML is now in a very strong cash position with low gearing, and on the liability side has a $350 million convertible bond and $100 million stand-by facility at the corporate level, as well as $93 million of vendor financing at the project level.

Post-SISG, however, the focus will be all about controlling costs while hitting production targets. Currently the mine is operating at a run-rate of 8Mt/y and an infrastructure run-rate of between 6 and 8Mt/y.

Ramp up

First production began in late 2010 and first shipments were heading out in November 2011 from Tonkolili, while rail and port infrastructure are both relatively well developed.

In the second quarter this year, AML plans to commission a wet plant at the mine end and a second stockyard at the port end, as well as to near completion of railway upgrades to allow for increased speeds and axle loads.

One of the key benefits is the project’s location. Sierra Leone is well-placed to deliver to its target market China, although Jones notes that Europe would also be a commercially attractive market.

“The bulk of our product is going to China but with Europe we would be able to ship potentially smaller vessels, thus removing the need for trans-shipping, which would allow us to look at expanded margins, but our base case is certainly Asia,” he notes.

Off-take agreements with SISG have been in place since June 2010, which allows for a discount of up to 15 per cent on 2Mt in phase I, increasing to a total of 10Mt once phase II is complete and beyond, he adds. On 20Mt that would work out to a one per cent discount on the full production quantity.

Broker’s view

If there was a surprise in the preliminary 2011 earnings release, it was the company’s accounting decision to capitalise its revenue and costs over the period, which led its headline numbers to not line up closely with consensus estimates. Figures were also affected by a number of one-offs, including tax credit treatments and fair value reductions of listed entities, explains Seth Rosenfeld, equity analyst at Jefferies.

At the same time, this treatment is not unique to AML and the focus, from an investment standpoint, is the production outlook, he adds. 

“The most important thing is whether [AML] will be able to assuredly reach that 20Mt run rate in the next 12 months. There is some flexibility in the near term but we want to see that its medium term execution is solid. What is notable from its release yesterday was that it cut its production guidance for 2012, initially forecasting 15Mt of production, now it’s at 10Mt,” Rosenfeld says.

The market responded positively to the release with the stock outperforming immediately after.

“It is now a realistic piece of guidance that investors believe the company can meet if not potentially exceed, and [the guidance] seemed to more accurately reflect the speed of ramp up on the ground, which many people understood might face some headwinds along the way,” he says.

In addition, investor confidence was boosted by the SISG deal, which significantly de-risked the outlook for Tonkolili, confirming a strong end-market for iron ore sales; China making up some 60 per cent of the market for all seaborne ore and also providing easy access to capital for later-stage production expansions – phase II is expected to increase production to 50Mt/y.

AML has also managed to take the sting out of the low grade of its ore resource – at only 58 per cent iron content with impurities. Tonkolili currently has a JORC-compliant ore resource of 12.8Bt that extends over a combined strike length of 30km and includes a substantial Direct Shipping Ore (DSO) and Saprolite mineral resource overlying a very large magnetite ore body.

Rosenfeld points out that exploitation of the DSO resource is a prudent move.

“[AML’s] first six years of operations requires very limited processing capacity and therefore it lowered the CAPEX for that, as well as that of phase I production.

That six years of 20Mt/y means it is a relatively low-grade product; it has some impurities, it is still at a discount, but requires very little processing capacity and so reduces costs to build the mine,” he says.

Greenfield projects in West Africa face significant hurdles: a lack of access to rail and port infrastructure; the expense of processing resources, in which magnetite ore tends to be dominant; unstable relationships with the government or unstable tax regimes; and the financing realities facing what are often small and mid-cap companies.

So why is AML succeeding when so many other greenfield iron ore projects in West Africa are destined for failure?

“[AML] broke the mould because it took over partly pre-existing rail and port infrastructure. We estimate that this cut CAPEX by close to $1 billion. Very early on, it had the support of outside development partners such as CRM [China Railway Materials] and now SISG as well, so AML was able to lock in a mining license and tax plan with the Sierra Leonean government that has an accelerated depreciation schedule but is not, in our opinion, a sweetheart deal and will therefore be sustainable,” Rosenfeld says.

Sustainable outreach

In terms of corporate social responsibility, AML’s operations in the region have significant additional benefits.

“It is amazing what an increased level of activity does for a country. With any major project like ours you see impacts on civil services – such as ports and clearing, revenue and customs – hospitality services for hotels, restaurants, transport; this is true for any company. For us specifically, we have at last count more than 9,700 people working for us, 82 per cent of which are Sierra Leoneans and that multiplier effect of direct employment is tenfold into how communities are supported,” says Mike Jones of AML.

As in many frontier jurisdictions, the company faces challenges in engaging the local community, and specifically managing expectations in a country with such a high level of unemployment. While AML’s policy is to use as much local labour content as is practicable, an important area of investment for the company is in “business incubators”. For those that can’t be employed by the project directly, the company supports enterprises in sectors such agriculture, tailoring, brick-making and carpentry. After helping these local enterprises get set-up, AML also becomes the first customer.

Next steps?

With phase I executing well, the next logical question becomes what else the company can continue to do at the Tonkolili project. Does it want to ramp up to a blue-sky figure of 70 million tonnes at the one asset or does it want to look elsewhere?

Jones is tight-lipped about any specific plans, but does state that “the ability to identify resources, attract the right level of finance and fast-track a project quicker and more efficiently than our competitors is a major advantage and we hope to replicate what we have achieved at Tonkolili elsewhere, either in Sierra Leone or another country”. 

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