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Ferno Investment Group

2012-07-30

NORTHLAND RESOURCES SA

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The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


Ferno Investment Group

2012-07-30

additional iron ore deposits have been identified. Much of the economic rationale of today’s Kaunisvaara project is also based on the premise of economies of scale, as several future mines are envisioned to be able to utilize the same infrastructure that is currently in construction. Commonly touted by its proponents as one of the largest Swedish business projects in many years, Oslo (OSX: NAUR) and Toronto (TSX: NAU) listed Northland Resources is currently ramping up production at its Kaunisvaara iron ore project. The mine is seen as an important asset in the future development of northern Sweden, and its world renowed natural resources industry. However, following difficult financing conditions, the stock of Northland has hardly reflected any enthusiasm. With new projects in the pipeline, the question is if a ressurection is in the offing. Northland Resources is a late-stage development mining company with a soonproducing mine in with its Kaunisvaara project. Since acquiring its first option agreements in northern Sweden and adjacent Finland in 2004/05, the company – formerly named North American Gold – has not only expanded its portfolio, but worked diligently to convert resources into cash-flow generating mines. From previously having worked on the Barsele gold project, located in the heartland of northern Sweden and now divested to Orex Minerals (TSX: REX), Northland is now primarily focused on iron, as well as IOCGdeposits: a deposit type that is gaining increasing importance as it contains not only iron, but also significant amounts of copper and gold. Within Northland Resources’ current exploration licenses, which comprise approximately 16,000 km2, no less than 30

The iron ore & steel markets Although presented as a major project, in relation to the overall iron market, Northland Resources remains a very small player. According to statisitcs from UNCTAD, the global market for iron ore reached an all-time high production level of 1.827 billion million tonnes (billion mt). This market size would give the Kaunisvaara project and its forecasted 5 million tonnes per annum (mtpa) of iron ore a theoretical market share of 0.27 %. To put some more perspective on the scale of Northland, its production can be compared to those of world leaders Vale, Rio Tinto and BHP Billiton, with annual outputs of 309, 181, and 149 million mtpa, respectively. The three giants – which essentially control global trade in iron ore – have a combined market share of approximately 35 %. Since the financial crisis, demand – and thus prices – of iron ore has become increasingly dependent on Chinese economic growth, shifting away from the previously important US market. In the period 2000-2010, Chinese demand for iron ore grew by a compunded annual growth rate (CAGR) of no less than 17.5 %. Following the 2008 meltdown, China corresponded for the entire recovery in 2009. In 2010, China accounted for 59 % of world iron ore imports, and the trend is still increasing, albeit slowing economic growth. Toghether with Brazil, the nation also leads the way aseveloping countries gain increasing market share of world iron ore production. Clearly, the emergence of China has made a significant contribution to iron ore prices

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


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which, according to Swedish consulting firm Raw Materials Group, has reached extremely high (levels) in a historical perspective. This development is also reflected by data from the International Monetary Fund (IMF), which is illustrated in the chart below.

Iron Ore Price China import Iron Ore Fines 62% FE spot (CFR Tianjin port)

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characteristics that provides it with an edge in the more competitive market know developing. While pellet and sinter feed quality appears to be deteriorating on a global scale, Northland’s iron ore is of such good quality that it is estimated to command a fairly large premium – approximately $ 49 per tonne – over the 62 % iron ore benchmark. The premium is attributed to the following characteristics: 1.

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USD per tonne

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However, with approximately 600 million mt of ore production forecasted to have come on stream between 2011-2013, as well as a further addition of about 325 million mt in 2013-2015, several analysts estimate that the market is on track to attain balance. Headlines have gone from those in 2007 declaring that The race continues between supply and demand, to more recent ones in late 2011 that pose the question High prices and tight markets continue through 2013?. According to a market update from Business Monitor International, dated March 2012, prices have effectively topped out as Chinese demand begins to disappoint. From its (benchmark) peak at $192 per tonne in Q1 2011, iron ore prices are now expected to range between $115-170 per tonne over the next couple of years. Nonetheless, albeit its small size and dependence on macroeconomic effects on iron ore prices, with regards to Northland Resources it is important to emphasize that the company and its product has some unique

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69 % Fe content vs. 62 % benchmark: due to improved effieciency in steel production, each percentage point (%) above the benchmark rate typically commands a premium of $ 3-7/tonne. The most reliable premium is considered to be $ 3/tonne. Low impurity (SiO2/Al2O3): the company estimates that the low silica and aluminium dioxide contents of 1.1 % SiO2 and 0.18 % Al2O3, respectively, will command a premium. Producers using iron ore above 4 % SiO2 are punished by a per tonne fee of $3-4/%; the low Al2O3 – compared to a 2% reference – is estimated to command a further premium between $ 1.6-3.3/tonne. Low moisture: the low moisture content decreases the weight of the ore, and thus transport costs. Relative proximity to the shipping hub Amsterdam-RotterdamAntwerp – compared to Brazilian competitiors – is also believed to increase Northland’s sale price.

The premium calculation is provided by Northland itself, but as it has not been contested by any technical report, it should be treated as realistic. According to Raw Materials Group, the Northland product will be most competitive in (the) global market. The Kaunisvaara project Kaunisvaara is Northland Resources’ first project, comprising proven and probable reserves of 171.4 mt. In total, measured, indicated, and inferred resources amount to 348.74 mt. The project, located close to the town of Pajala, is constituted by the Sahavaara and Tapuli deposits. Tapuli will be the first to enter production; according to schedule in Q4 2012. The first loads of iron ore pellets are planned to be shipped in Q1 2013. The agenda below present some important production mile stones for Kaunisvaara:

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


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YEAR

2012-07-30

EVENT

2012

Production start Tapuli

2015

Ramp up to 4 million dmtpa @ Tapuli Sahavaara on stream

2016

Production start for the nearby Pellivuoma has not been determined as the company is awaiting the Definitive Feasability Study. The study is expected to be completed in H2 2012. No reserves have been established, but total resources, according to a 2010 report, amounts to 94.14 mt, with 38.54 in the measured category. Through 7-year off-take agreements, entered in 2010, Northland has secured 100 % of the forecasted production from Kaunisvaara. The parties of these contracts are Tata Steel, Stemcor UK, and Standard Bank: the two first with 20 %, and Standard Bank with 60 %. Standard Bank, by providing financing, has played a major role in advancing Kaunisvaara to production, and will continue to be important as it, together with Northland, will identify potential clients for the mined iron ore. At full production, scheduled to be attained at 4-4.4 mtpa in 2015-2017, Kaunisvaara will, with its approximately 300 employees in mining operations at full capacity, become the hub of Northland Resources’ future exploration and production operations. According to technical report estimates,

current reserves provide for a 19 year life-ofmine. However, these reserves naturally do not incorporate the Pellivuoma resources. The total after-tax NPV value of the Kaunisvaara project was, with an 8 % discount rate, put at $ 393 million. The Hannukainen project The Hannukainen project is located across the border, 30 kilometres from Kaunisvaara, in Finland. The deposit is of IOCG type – Iron Ore-Copper-Gold –, and has previously been mined by Finnish company Rautarukki. Rautarukki attained a total production of 4.5 mt., but decided to divest the property to Northland in 2005 due to unfavorable metals prices. As the IOCG chart below indicates, prices have risen significantly since then. Grades during production are reported to have been 34 % Fe, 0.88 % Cu, and about 1 g/t gold. Thus, iron ore grade could potentially be in the region of Sahavaara: significantly higher than Tapuli as well as the future Pellivuoma. When Hannukainen was incorporated for the first time in Northland Resources Annual Information Form (AIF) in 2008, the independent geological consulting firm Micon claimed the viability of the project to be much better than the average discovery. But not only is the geology favorable, but so is also availability of a suitable workforce, and access

IOCG Prices Base year: 1980 1800% 1600% 1400% 1200% 1000% 800% 600% 400% 200% 0%

Copper, grade A cathode, LME spot, $/t China import Iron Ore Fines 62% FE spot (CFR Tianjin port), $/t Gold, spot, $/oz 1 9 8 0

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The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


Ferno Investment Group

2012-07-30

to infrastructure. According to the Preliminary Economic Assesment of Hannukainen, the life-of-mine is estimated to 14 years. With more than 360 employees in direct mining operations, its scale would be slightly larger than Kaunisvaara, while after-tax NPV slightly lower at $ 280 million. However, more up to date information on Hannukainen will soon be available with the publication of a Definitive Feasability Study: this report which have been extended in order to investigate potential under ground operations. The study was expected to be published in early 2012, but was extended in late March 2012. It is now scheduled to be completed in the second half of 2012. Infrastructure & transportation According to a statement by Northland in one of its MD&As, (a) large part of the success of an iron ore company is access to and control over an efficient transportation system. Hence, one of the main assets of the Hannukainen mine is its existing infrastructure, and then in particular a rail line to the Baltic sea port of Kemi. Also, Finnish authorities have agreed to upgrade the line to be fully operational for mining operations. At Kaunisvaara, however, transportation has not been an easy issue: in fact, together with final project financing, the transportation solution remained one of the last risks to be mitigated. Initially, Northland envisioned that a pipeline to transport iron ore slurry to Kemi port along the Gulf of Botnia. However, this idea was never developed. Instead, the iron ore will be transported by 90 tonne trucks from Kaunisvaara to Pitkäjärvi; a distance of approximately 80 km. At Pitkäjärvi, the company is currently building the depot from which ore will be loaded on to trains, whose destination will be a port in the Norwegian town of Narvik. This port is also under construction, and will be operational in 2013.

At full production, 5 mt of ore will flow through the Pitkäjärvi depot, corresponding to four 500-metre long trains each day. The transportation is a major investment which was not included in the initial CAPEX budget. Merely the cost of the Pitkäjärvi site is estimated to $ 28.5 million at current SEKUSD exchange rate. The transportation solution has not only received heavy criticisim, but is also far from Northland’s preferred choice. Having 90 tonne trucks passing through small villages between Kaunisvaara and Pitkkäjärvi every 7 minutes will increase traffic dramatically, and is neither very practical, nor particularly efficient. Instead, a new rail line from the mine site would have been preferred, but although Northland have signed a co-financing agreement with the Swedish government, commentaries from officials make such a project appear implausible.

Future exploration potential As mentioned above, much of the rationale behind Northland Resources’ current projects is that they will provide the infrastructure for activities in the region far into the foreseeable future. Hence, although media focus is currently on development of producing mines, exploration is equally – if not more –

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


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important. Fortunately, there are some already existing exploration projects of potentially significant value, primarily in terms of iron ore and copper.Several of these areas of interest have already been examinied by various geological methods, and by various companies and organisations; Swedish as well as internationally recognized. Below is a mere selection of already identified targets: 

Marjarova/Käymäjärvi/Salmivaara: These projects are grouped together as they are presented as being part of Northlands 2011/12 exploration activities.The two first targets are located in proximity to Kaunisvaara, with Marjarova being a potential satellite to Pellivuoma. A smaller drilling campaign was conducted at Marjarova in 2012. Salmivaara is a skarn deposit located north of Gällivare: concentrations of interest have primarily been of copper and gold. Manakorki: Located 15 km from Hannukainen, this potential magnetite deposit has returned 25-35 % Fe over 3060 metres. This is a grade interval comparable to the company’s projects currently in development. Geophysical studies conducted in Q3 2011 pointed to a medium grade magnetite occurrence of several million tonnes.

Palotieva: Located close to Pellivuoma, Palotieva was identified by Anglo American in 2004: however, it was abandoned after only one diamond drill hole. The reason stated was very poor recovery. The Swedish Geological Survey has drilled a total of 26 holes to identify an historical resource at the site of 60.3 mt at 29.5 % Fe, including a 17 mt highgrade area at 39.7 % Fe. The target is defined as a potential IOCG deposit. In 2006, Northland announced that it had collected samples grading 11.8 % Cu and

2012-07-30

5.67 g/t Au. Although small samples, the findings are positive, especially as the global average grade for copper desposits, according to the European Union, is around 0.6 %. Certanly, this is not a complete survey of future production potential; nevertheless, it indicates that the value of Northland Resources lies in more than what is currently in the spotlight.

Valuation Given estimates obtained from the latest technical reports, the aggregated after-tax value of Northland’s Kaunisvaara and Hannukainen projects amounts to approximately $ 673 million, or $ 1.31 per share at current capital structure. At the USDCAD rate as of July 24, 2012, this corresponds to C$ 1.34 per share: a 167 % premium to current market price. Accounting only for the soon-proucing Kaunisvaara, the per share value falls to C$ 0.76. Hence, the company appears to currently be valued without any account of its growth opportunities. As late as Q1 2012, Northland’s stock traded around C$ 2.00 on the TSX, but a final project financing of Kaunisvaara that implied an almost 100 % dilution sent shares into a longterm plunge that is yet to end. Also compared to the overall market, here represented by the Global Industrial Metals index, Northland has underperformed significantly during 2012. And yet, albeit the pessimism, the company

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


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has cleared all obstacles to become a producing, cash flow generating mine.

Either expectations where too high initially – perhaps even unrealistic, given current market conditions of slowing Chinese growth, and a Europe in debt crisis – or the long slump is a classic example of blind over reaction. To investigate, Ferno Investment Group has conducted its own valuation of the emerging iron producer. The discounted cash flow analysis of the Kaunisvaara project, based on information from the June 2011Technical Review, results in a per share value of C$ 1.99. The WACC used to discount future cash-flows ranges from 12.80-13.03 %, depending on changing capital structure as the project proceeds. No further equity or debt financing is assumed. It should be noted that the Kaunisvaara report, as well as the Ferno valuation, do not encompass confirmed resources at the Pellivuoma deposit, but only includes the Sahavaara and Tapuli deposits. Putting a fair value on Northland Resources’ exploration targets is difficult – if not impossible. One way to get around the issue is to assume that the company, when established, will be able to continue operations at a steady level into the foreseeable future. With the assumption that Northland reaches a steady production level at approximately 5.5 mtpa of iron ore concentrate in 2020, the per share value – without consideration to possible future dilution – rises to C$ 5.52. The perpetual growth rate is set to 1 %.

2012-07-30

The C$ 5.52 valuation may appear high, but is in fact lower than some Swedish investment banks have previously – before the Kaunisvaara financing – put their price target at. Even if iron ore prices are assumed to fall by 10 % for each of the future four years (and consequently remain at $ 93.17/tonne, excluding premium), project value for Kaunisvaara holds up at C$ 0.62, while company equity value falls to C$ 2.48. This alternative valuation further assumes a 10 % lower peak production – in terms of ore mined – at Kaunisvaara than the initial valuation. The financing event has indeed become a major concern for many investors, but one has really to question its long-term importance. For instance, if Northland would have been able to finance Kaunisvaara entirely by debt, it would hardly have been in a situation to use as much debt in consequent projects. With a well balanced capital structure, and off-take agreements on 100 % of its forecasted production, the company has a good foundation to continue creating value, while limiting both financial, as well as operational risks. On many stock forums, the Northland management has been critizised for not being honest and fully transparent about the company’s activities. However, one must bear in mind that there are strict rules for a listed company, and going out every day to talk about hour-to-hour developments is simply not feasable. Although it may appear curious to see that insider ownership fell from around 11 % at the end of 2009 – when the stock had rallied to over C$ 3.00 – to a mere 0.7 % in Q4 2010 (thus timing the high), it is nevertheless difficult to question management and board expertise when it comes to mining. The fact

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


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2012-07-30

that management divested almost all of its shares at C$ 3.00 a couple of years also does not tell much about the future. Bottom line To conclude, Northland Resources is today an exciting new iron producer with potential expansions into both copper, as well as gold. Without much doubt, iron ore prices are very high today, but although the industry’s recent move away from its traditional long-term contracts – a move which is prone to make the market increasingly volatile – it is noted that a large part of the price development is structural, and that the trend will not go away in an instant. After a sharp plunge in its share price, Northland also does not only appear to be a decent company, but also has the prospects of becoming a profitable investment. Perhaps there are better choices in the world of mining, but what at least is for certain is that Northland Resources is very far from being the worst. Carl Pontus Ferno pontusferno@fernoinvestment.com

The content of this article does not constitute any form of professional advice and should not form the sole basis for any decision to buy, sell, or hold any asset or security. Always consult your personal investment advisor before making any investment decision. Ferno Investment Group (FIG) maintains a full disclosure policy. Neither FIG, nor the analyst of this report, has a position any of the assets or securities mentioned, but may initiate a position in the future.


Northland Resources SA: The Swedish Iron Man