Let your winners run, even the speculative ones – Kidman Resources update

Chief Investment Officer and founder of Aitken Investment Management
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In resources, it’s all about the “resource”. The quality and duration of your resource all but decides the profitability of your project. The good news for ASX-listed Kidman Resources (KDR) is that both the quality and duration (mine life) of their Earl Grey deposit continues to improve.

Kidman Resources (KDR) remains my no.1 lithium exposure globally. Kidman Resources shares are up four times since we bought them for the AIM Global High Conviction Fund and recommended them in the Switzer Report as a “speculative buy” and I believe further capital gains are ahead for Kidman Resources as it transforms from speculative explorer to large-scale producer. AIM is Kidman Resources’ largest institutional shareholder right now, and its performance has contributed to our strong returns.

Earlier this week, Kidman Resources announced a 54% increase in the combined Mineral Resource Estimate (MRE) for the Earl Grey Lithium Deposit (Earl Grey). Following a comprehensive 12-month Resource Definition and Exploration drill program, Earl Grey is now estimated to contain 189 million tonnes of 1.50% Li2O, or 7.03 million tonnes of Lithium Carbonate Equivalent (LCE). This is a high confidence estimate with 91% of the estimate classified as Measured and Indicated. Below we have pulled the key information out of the company announcement.

Substantial Increase in Earl Grey Lithium Mineral Resource Estimate

  • 54% increase in Earl Grey combined Mineral Resource Estimate
  • Estimated to contain 189 million tonnes of 1.50% Li2O or 7.03 million tonnes of Lithium Carbonate Equivalent; 91% of Resource classified as Measured or Indicated
  • Confirms Earl Grey as one of the world’s most significant hard rock lithium deposits
  • Expected to be at the low end of the global hard rock cost curve
  • JV activity progressing rapidly; proposed refinery site to be announced in next quarter
  • High level of interest from various parties seeking lithium hydroxide off-take

This major resource upgrade to Earl Grey makes Earl Grey a truly world class hard rock lithium deposit. It justifies the confidence that Brazil’s SQM had in the project and will now more than likely create tension between end users of lithium for an offtake agreement (think car manufacturers).

Part of the institutionalisation of a stock is that major investment banks start research coverage on the given stock. This has started to occur for KDR with JP Morgan now covering the stock. Below I quote directly from JP Morgan’s KDR research post the resource upgrade.

JP Morgan view on Kidman Resources (KDR)

KDR has announced a 54% increase in the mineral resource estimate at its Earl Grey lithium deposit in Western Australia. The Earl Grey resource now sits at 189Mt at 1.50% Li2O, a globally significant deposit. Importantly, 91% of the resource sits in the Measured & Indicated categories. KDR and its JV partner SQM continue to work towards advancing development of the Mt. Holland project; the next steps are identification of a preferred site for the refinery (likely within 2-3 months) and completion of the Mine Feasibility Study, which is due mid 2018. We have increased our mine life assumption to 30 years (which consumes only a third of the resource). This has lifted our NPV by 12% to A$2.80/sh. We retain our Overweight recommendation.

  • Earl Grey evolving into a quality asset: This update significantly increases the geological confidence in the Earl Grey deposit, increasing total tonnage by 48%, but also improving grade by 4%. Given the very clear contact between pegmatite ore and host rock, the additional tonnes are genuine discovery within the resource shell, not a smearing effect related to modelling. Secondly, tighter drill spacing (50m x 50m infill) has improved confidence in grade continuity, delivering the higher overall grade. Average iron content of 1.13% Fe is elevated vs. other southern pegmatites but lower than the Pilbara ore bodies. KDR notes this estimate is ‘uncut’, and may be affected by iron contamination from wear on drill bits and iron-rich host rocks. Given the fact Earl Grey concentrate will be going to a purpose-built refinery, we don’t expect iron content to be a significant issue.
  • Next steps are refinery location and feasibility studies: KDR expects to identify a preferred location for its refinery within 2-3 months (options include Kwinana, Bunbury and Kalgoorlie) and then completion of the Mine Feasibility Study by mid-year. The Refinery Feasibility Study is due in the second half and we expect will lead to a final investment decision on the integrated project. Our base case is KDR funds its share via a A$250 million debt facility and A$200 million equity, however we recognise that recent corporate transactions (ORE and TTC, PLS and POSCO) highlight that downstream customers are willing to pay a premium for offtake of ex-China supply.

That final line from JP Morgan Research is interesting. Downstream lithium customers are willing to pay a premium for offtake ex-China supply. I absolutely wouldn’t be surprised to see a major global car company buy a stake in KDR (at a premium) to fund KDR’s part of the refinery. I’d be very surprised if KDR shareholders were tapped to fund the refinery. This again means that if you want to own KDR you need to buy it on market before it becomes further institutionalised and corporatized.

JP Morgan’s NPV of $2.80 is arguably conservative and we feel a higher share price than that will evolve over the years ahead as the pathway to cashflow and profits becomes clearer.

At AIM we feel there’s a pathway for KDR to be a $4.00 to $5.00 stock in the years ahead. We are structurally bullish on lithium and feel KDR is doing smart deals to maximise the profit share from Earl Grey without either putting its hand in shareholders pockets or giving away too much of the upside.

However, I must stress again to you that KDR is a speculative and volatile stock, which is becoming less speculative and less volatile, but that still means it needs to be appropriately sized in portfolios.

In our view, this is a classic example of “let your winners run”. KDR is a winner, the investment case is getting stronger, the likelihood of profits and dividends is getting stronger, and the strategic value of the company is increasing. That is a good combination in a stock that is only just now being institutionally “discovered”.

I’ll keep it short today, I just wanted to update you on the meaningful news from KDR this week and reaffirm my high conviction that KDR will continue to prove a good place to invest in the global lithium space.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.

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