The target price was increased to $0.73/share and the BUY rating maintained.
Site visit confirms world class SOP project
We recently returned from Eritrea to visit DNK’s very large potash (SOP) project. We were very impressed with the country itself, and with the Colluli project.
Management has a very good relationship with the Government, and we were able to have meetings with several ministers. It is clear that the Colluli project is high on the Government’s development agenda.
We visited the Massawa port facilities (a container port where Nevsun is currently exporting copper and zinc concentrate). The port is a reasonable size and appears to be running efficiently, with a laydown area already allocated to DNK. Massawa itself is a mid-sized industrial and local tourist city and should have a good pool of skilled labour for the Colluli mine.
Access roads a potential for cost savings
The road from Massawa to Colluli is in poor condition, but the Government is planning to upgrade it, and we saw some evidence that works have begun. The recent DFS assumes a 24hour cycle time for trucks based on current road conditions. This appears conservative based on actual trip times (it took our party ~6hours in 4WD), but is a reasonable average assumption given there would be significant delays on the current roads.
The distance itself is only 180km, and is flat, sparsely populated and only travels through one modest township where speed could be limited. It would seem that relatively cheap upgrades could dramatically improve transport times.
The DFS assumes logistic costs of US$66/t ex shipping. If road conditions were eventually upgraded to allow Australian style road trains, we see potential for transport of ~US$20/t (we assume DFS costs in our valuation).
Site unpopulated (and very, very large!)
The Colluli deposit is very large. At night the Yara (Danakil) and ICL (Afar Dallol) camps are visible across the border into Ethiopia in the distance. There is a modest and unassuming army presence given the border location (note there is no history of conflict in the area), and we had no problems with access. The locals appear to be free to move, most likely even across the border. We visited local communities who were very supportive of the mine.
The region is arid with no formal agriculture. There is a government presence with schools and health clinics in most villages. We saw ruins of the railway operations from the original Italian potassium chloride (MOP) mine which was established in the region in the early 1900’s and an old sulphur processing plant.
Had the history of Eritrea and Italy/Europe been different, the Danakil region could already be industrialised. It is very well located to the coast, there is a good service corridor, there is potential for geothermal power, and there are several high quality minerals that could be economic once logistics are reduced (eg rock salt, gypsum).
Retain Speculative Buy with a price target of 73cps
Problems in the development of Yara and ICL (see link) projects regarding tax and government funded infrastructure and logistics, suggest that Colluli is the most likely to be developed project. The opening up of Eritrea to foreign investment gives someone the opportunity to develop a very large industrial salts/chemical business. We would not be surprised to see industry acquire the project given such potential. Otherwise, DNK may grow into a speciality minerals business (the closest ASX peer could be something like ILU.asx).
Danakali is developing its large potash project in Eritrea. The project will initially focus on the production of sulphate of potash (SOP). The reserve is very large (1.1Bt @10.76% K2O) with an expected mine life >200years, producing 425kt-850kt pa SOP at low cash costs (~US$290/t CIF). The project is unique in its scale, open-pit mining, favourable combination of potassium bearing salts suitable for production of SOP, SOP-M and MOP and ability for low cost expansions to lift production.
Digestible capital requirement for DNK
Phase 1 capex is estimated at US$298m. Mining is open pit mining using conventional truck and shovel and surface miners (no blasting required), with a low strip ratio (1.9x). The Company expects first production is possible in late CY18, but we are more conservative in our modelling. The Company expects the mining licence approvals before year end (CY16).
The project is via a 50/50 JV with the Eritrean Government (ENAMCO). The agreement states that DNK is responsible to fund 30% of the equity (implicitly this is a loan to the JV for the Governments share). The Company anticipates that the project can be funded with 70% debt, and hence DNK requires funds for the 30% equity (~US$90m based on DFS estimates).
Hartleys estimates Stage 1 EBITDA ~A$80m pa to DNK
We assume Stage 1 EBITDA of ~A$80m pa (DNK share), which should more than double after Stage 2 (year 5). Our pre-tax NPV12 for DNK is ~A$500m (project NPV roughly double). Consequently, despite the large capital requirement, the project is highly economic.
Our DNK base valuation is 91cps. Using spot prices (US$600/t), our pre-tax NPV12 for DNK is ~A$500m (project NPV roughly double), with Stage 1 EBITDA ~$75m pa ($150m pa to JV). Our spot price valuation is $0.86.