Description

Summary:

Conic is a simple story and a clearly orphaned security. Given the market cap of 21mm CAD and the low trading levels it is better suited for personal accounts but considering how compelling the valuation is I figured I would post it.

Conic metals owns a non-operating stake in a large and producing nickel-cobalt mine in Papua New Guinea. In roughly 12 month’s time, Conic will be entitled to start receiving part of this cash flow, which at current nickel prices works out to 8c per share. The stock is currently at 24.5c or 3x 2022 cashflow. Further, once project level debt on the mine is fully repaid, Conic’s share of the mine’s cash flow increases, jumping to 42c per share or a 168% FCF yield at current trading prices. On my numbers this isn’t forecast to happen until 2028 although there are ways to accelerate the timeline.

The company has no debt, and is sitting on 8mm in cash (12c per share). These numbers are all on strip Nickel pricing. Using a 12% DCF I get a present value of $0.90 or good for a 260% gain from current prices. If you’re a nickel bull like I am, the upside is even higher, with $10 nickel and a 12% discount rate getting us to $2.54 per share, good for a 900% gain.

Do I have your attention? Good, because this is a strange one and this write up isn’t going to be perfectly polished but the numbers speak for themselves.

(PS .  for the Nickel bulls Virtualodin did a decent write up on the bullish arguments for Nickel a couple of years ago, and after some fits and starts the thesis appears to be playing out. https://valueinvestorsclub.com/idea/Nickel_ETF/9272918473 )

Backstory:

Conic was spun out of a company called Cobalt 27 approximately 1 year ago. Cobalt 27 was set up as a directional bet on Cobalt. The company first stock piled large amounts of cobalt and then gradually sold some off to invest in cobalt and nickel streaming deals and non operated mine investments. The plan worked initially with the metal climbing from $10 to $50 before ultimately crashing. Last summer the largest investor, Pala, decided to take advantage of the low share price and made an offer to privatise the company. They would buy out everything except the assets that would become Conic, which was to be spun out to shareholders. Management of Cobalt would become the new management of Conic (CEO became new Chairman, COO became new CEO).

Conic spinco was pitched to be worth $1.92 per share based on a fairness opinion. The main asset was for the stake in the producing Nickel-Cobalt mine in PNG called Ramu. In fact, a large part of management’s change of control came in the form of stock of Conic using that $1.92 valuation. https://www.newswire.ca/news-releases/pala-investments-and-cobalt-27-announce-significant-improvements-to-arrangement-transaction-and-new-shareholders-meeting-date-of-october-11-2019-893086654.html

Conic started trading with very low liquidity at around 35c per share. Insiders where active buyers over the first few months until March when covid struck. The stock then plummeted with everything else to a low of 12c before climbing back over the summer as metals in general recovered.

What is Conic?:

The main asset of Conic is an 8.56% non-operating interest in the Nickel-Cobalt mine Ramu, based in PNG. The Ramu asset was discovered by an Australian company called Highlands in 1999 and developed over the 2000’s. The mine was commissioned in 2012 and after some fits and starts (as is typical for an HPAL nickel mine) the operation has been running smoothly since 2017 and in fact has produced over nameplate capacity in recent years. The mine life is currently slated to run to 2032, although there is strong reason to believe it will be extended until 2040 or beyond.

The mine is expected to produce between 32k and 30k of nickel over the next decade.

The main 85% owner and operator of the mine is a Chinese consortium led by China Metallurgical corp, or MCC. MCC is a large Chinese SEO and was merged into China Minmetals in 2015, one of the largest mining companies in China.

Cobalt became owner of this minority stake when they acquired Australian Company Highlands in May 2019. Using the price paid for Highlands we can build up Conic’s valuation as $1.10/shr + remainder of Conic + the value of having rolled forward one year in time and getting access to the cashflow. I don’t rely on this for my valuation but it is a nice sanity check.

Conic has 8.56% of the mine, and 6.4% is owned by the PNG government.

Conic also owns a portfolio of streaming rights to Nickel development projects all over the world, but none have shovels in the ground so let’s not waste time on those. Ill carry them at zero in my valuation.

Valuation:

For my valuation I kept things simple. I’m  not a mining guy and I don’t pretend to be one. I get the estimated production levels by year for the mine from the 43-101 the company is required to file on SEDAR in Canada.

https://www.sedar.com/DisplayCompanyDocuments.do?lang=EN&issuerNo=00048592

Using those numbers I make a few assumptions. I start with Nickel at $7.00 in 2021 and escalate it at 3% a year from there. I start with cash costs (net of cobalt credits) at $2.20 a pound and escalate them at 5% per year. As the mine ages the nickel concentration drops per the 43-101 report so it makes sense cash costs will rise. These cash costs are generally where the operation has been for the past year with cobalt at roughly $15 a pound, so we aren’t building in a high cobalt price, just what is effectively the forward strip.

I then assume an 18% reduction based on refining costs (per management) and use the maintenance capex numbers from the 43-101. This I how I get to my numbers for the next 12 years. In 2021 this leads to 272mm of project cash flow, 8.56% of which goes to Conic.

However, right now Conic gets nothing from this. When the mine was being built MCC basically put up all the cash for the partners. This is through loans to the subsidiaries and then project level debt. Conic gets nothing until the subsidiary loans are repaid. After that Conic gets 35% of their pro-rata cash flow, with the remaining 65% going to repay project level debt. When the project level debt is repaid Conic of course gets 100% of their cashflow. But it gets better. Based on the partnership agreement, when the project level debt is repaid Conic’s interest jumps from 8.56% to 11.3% on top of receiving 100% of their pro rata cash flow.

Conic should end 2020 owing about 23mm to MCC and should be able to pay that off in Q4 next year, setting up 2022 to be the first year that 35% of the cash flow can flow to Conic corp in Canada. This 35% cashflow will work out to 8.5mm in cash. Using 2.6mm for the corporate level cash burn, we get 5.1mm USD in real FCF to Conic shareholders, or roughly 8c a share Canadian.

Towards the out years after the project level debt is repaid and Conic’s stake increases, Conic would get as much as 42c per share in cash flow per year. All this vs a roughly 24.5c stock today. Lest you think I’m being aggressive or missing something these numbers also match up with management’s guidance of cash generation levels on slide 3 of the latest corporate presentation

https://www.conicmetals.com/_resources/presentations/corporate-presentation.pdf

Further Upside:

In my numbers I simply used the production data from the NI 43-101 report. But the resources used in that report only cover 15% of the mining license. Speaking with management it seems extremely likely that the mine life can be extended another 10 to 20 years. I won’t use that in my forecast but I think there is a decent chance the higher cash flow of the out years can be sustained for a decade, not the 3 years in my numbers.

There has also been talk from MCC two years ago of doubling the mine capacity. https://postcourier.com.pg/ramu-nico-announces-k4-8b-mine-expansion/

The capex would be roughly 1.5 billion. Based on the shareholder agreement between MCC and Conic, the expansion math works out quite favorably for Conic. Should Conic elect to not participate, they will be diluted according to the following formula.

Dilution = new capex/(new capex + capex for original construction + ongoing capex)

Roughly speaking Conic’s interest in the mine would be diluted by 33% yet they would experience a doubling of mine output. This also gives credence to the idea that the life of mine is much longer than 2032 mentioned above.

There is also the possibility of Conic repaying Conic’s share of the project level debt earlier than modeled for them to achieve the 11.3% interest in the mine. Conic is permitted to repay the loan using any cash they can raise. Should the stock price start moving to a level that makes more sense, Conic could in theory raise capital to accelerate the repayment.

Potential takeout?:

Given the last point, I think it would make sense for a larger entity with better access to funds to buy Conic. The most logical would be MCC to eliminate a small partner and retain more cash flow or have a large mining company that could repay the various levels of debt quickly, achieving the higher interest in the mine much quicker. When I asked management about this they responded it could happen but not for anywhere near current trading prices.

Management’s plan:

The numbers look great, but will anybody care about a tiny mining company in Canada? And what if management decided to empire build?

Good questions, which is why I asked the CEO his plans for the cashflow when it starts to come in in 2022. After all, he had worked at Sandstorm metals (a 2 billion marketcap streaming company) before joining Cobalt 27, so won’t he just use the cash to empire build and make more long dated streaming deals?

He told me at this current share price the effective cost of doing any deals would have to have an IRR of about 50% which is impossible. So his favorite use of cash would be buybacks if feasible, and a dividend. He pointed out buybacks wouldn’t be feasible given NCIB rules linking daily permitted buybacks to the average daily volume and thus dividends would be the most logical use. He then pointed out to setting up a Wheaton precious metals like policy of having dividends being fixed as a percentage of cashflow (for Wheaton it is 30%). I asked if they would consider something of 40-60% and he said yes, or maybe higher.

I think it would be reasonable for this company to start to pay out a 5c annualized dividend in 2022 and for this policy to be communicated to the market in Q4 2021 once the MCC loans are repaid.  This would be a 20% dividend yield at current prices and in my view would push the stock beyond 50c.

All this is depending on management being forthright and honest, a big leap of faith for a small mining company in Canada. I spoke to a sellside analyst who used to cover Cobalt and knows management. He said the general consensus is the Chairman is not loved by the street, but that the CEO of Conic is well regarded and was always an honest guy in their dealings. When the CEO and I spoke he at least said all the things I was hoping to hear. But of course this is always a risk that Conic fails to deliver on their dividend.

Combined the Chairman and CEO own 10% of shares on a diluted basis and 7.6% on a non diluted basis. Not massive, but they are also incentivised to get the stock moving higher.

Cash Burn/Balance Sheet:

The cash burn was trending at around 3mm per year at the corporate level and comprises mgmt. comp, auditors, public listing costs, an Australian office that deals with Ramu and travel. That has since been pared down to a 2.5mm number. The company was spun with 5mm on cash on the books but might have been at risk of needing a cash infusion before the Ramu repatriations kicked in. However, thanks to the Nickel mania that swept the market for a week after Elon Musk hyped the metal, Conic was able to sell some shares of an investment they held in Giga resources (GIGA). GIGA ran from 30c to $2.09 and is now back to 65c. Conic was able to sell their stake at $1.73 bringing in $6.9mm to the balance sheet. As of September 30^th, Conic is sitting on $8.2mm USD of cash. This should enable them to be at roughly 5mm of cash at the end of 2021 when the Ramu dividends begin.

Other risks:

Besides commodity risk on Nickel, there is country, partner and mine risk. I don’t see a giant Chinese SEO mining company with interests all over the world wanting to rock the boat with foreign partners. I also don’t think PNG would want to mess with the terms on the mine with a Chinese SEO. That risk reminded me of a meeting I once had with Robert Friedland of Ivanhoe and his new mine he was building in DRC. I told him the mine specs looked incredible, but how can I ever be comfortable with an investment in the DRC. He told me that’s why he partnered with Chinese SEOs. If the DRC tried to take the mine away from Ivanhoe, he couldn’t do anything. But if the DRC tried to take the mine away from China, they would put a bullet in the president’s head. (I wish I was exaggerating but he actually said this in a group lunch). I think a similar theme is at play here where it would not be in PNG’s national interest to interfere.

It is also worth noting there was a tailings spill last year, and the local governor is now suing the Ramu consortium for 5 billion. Management points out that this governor has a history of corruption, that the PNG national environmental regular CEPA has already cleared the company, and from the initial court hearings this is likely to be tossed out, but its worth including as a risk.

https://news.mongabay.com/2020/05/locals-stage-latest-fight-against-png-mine-dumping-waste-into-sea/

https://www.rnz.co.nz/international/pacific-news/411299/yama-granted-bail-after-being-charged-with-bribery

Conclusion:

Based on current strip pricing, Conic offers incredible upside. We have catalyst coming in the next 12 months with the initiation of a dividend policy, and if you are a nickel bull like I am the upside is even higher (see sensitivity table above).

While there are risks here the multi bagger potential makes Conic an attractive investment in a personal account with the stock set to double upon the initiation of the dividend and further upside beyond that.

Appendix:

Here are the rough numbers

Catalyst

Initiation of a dividend Policy

Nickel prices moving higher