LARGO RESOURCES
SPECULATIVE BUY
(LGO - TSXV C$0.58)
12-mo. Target Price: C$1.75
Market Capitalization (Basic): C$66.8 Million
Risk Profile: SPECULATIVE
Potential ROR: 202%
Largo Resources Secures Off-Take Agreement
Event
Largo Resources and Glencore International have inked an off-take agreement for the Maracas vanadium project in Brazil. Glencore is one of the world's largest suppliers of a wide range of commodities and raw materials to industrial consumers including aluminium, zinc, copper, lead, ferroalloys, nickel, coal, oil and agricultural products.
Noble alloys, such as vanadium pentoxide and ferrovanadium, are used as hardening elements in the production of carbon and special steels. Glencore or its subsidiaries supply major steel mills in Europe, Asia and the United States.
The off-take agreement between Largo and Glencore covers all vanadium produced at Maracas for the first six years of commercial production with a renewable option for a further six years.
Details of the specific pricing agreement are confidential and have not been released. What we can say is that the deal is based on a discount to the spot ferrovanadium price. We have produced two tables to show how Largo’s NAVPS changes for different ferrovanadium prices. The current spot price is $US 62/kg.
Analysis
This announcement is an important milestone. Largo has secured a market for at least six years of its vanadium production and can move forward with development of the Maracas deposit. Largo anticipates the production of 5,000 tonnes of ferrovanadium per year starting in 2010. Start-up capital costs are estimated at US$126 million.
Long-term average price expectations for ferrovanadium are $23/kg through 2017. The current price for ferrovanadium is $62/kg. It is important to note that Largo's expected costs are anticipated to be less than $10/kg for ferrovanadium. At current ferrovanadium prices, discounting taxes and CAPEX costs and additional revenue from iron pellets, Largo would net $52/kg of ferrovanadium produced.
The following sensitivity tables outline the variation in our NAVPS7% for the Maracas project in terms of a selection of ferrovanadium prices:
Exhibit 1 - Maracas NAVPS Sensitivity to Ferrovanadium Price at Current Levels
Price
NAVPS
Spot Price
$60.00
$8.60
5% discount to spot
$57.00
$8.03
7% discount to spot
$55.80
$7.80
10% discount to spot
$54.00
$7.46
12% discount to spot
$52.80
$7.23
15% discount to spot
$51.00
$6.89
* NAVPS calculated as per initiating report using 7% discount rate
Source: Fraser Mackenzie estimates
Exhibit 2 - Maracas NAVPS Sensitivity to Ferrovanadium Price at Long-Term Levels
Price
NAVPS
Spot Price
$23.00
$1.59
5% discount to spot
$21.85
$1.38
7% discount to spot
$21.40
$1.29
10% discount to spot
$20.70
$1.16
12% discount to spot
$20.20
$1.07
15% discount to spot
$19.50
$0.94
* NAVPS calculated as per initiating report using 7% discount rate
Source: Fraser Mackenzie estimates
Our NAVPS is based on a 7% discount rate, assuming a fully financed and fully diluted share structure for the Maracas project alone and does not include Largo’s Northern Dancer project. We have assumed Largo will finance Maracas on a 75:25 Debt to Equity basis at an average share price of $1.00.
Our base case model on Maracas is predicated on a conservative long-term price forecast of $23/kg of ferrovanadium. As illustrated in Table 2, a ± 10% change in ferrovanadium price would result in a ± $0.44 change in the NAVPS7%.
If we assume Largo and Glencore have arranged a 10% discount on the spot price of ferrovanadium as an off-take agreement, by applying a spot price of $23/kg of ferrovanadium the chart indicates that Largo’s NAVPS7% for the Maracas project works out to $1.16.
If we assume a higher spot price of $60/kg, closer to the current spot price of ferrovanadium, and a 10% discount our analysis shown in Table 1 suggests the NAVPS7% for the Maracas would be $7.46.
Since Vanadium is a key additive in hardening steel, the driving factor behind vanadium prices will be a strong steel market. If the growth rate and demand profile for high strength steel remains robust, and supply remains tight, as experts predict, continued strong ferrovanadium prices will increase the value of Largo’s Maracas project.
Conclusions
The stock is currently trading around $0.60 which is a significant discount to our stand alone NAVPS7% of $1.59. The Off-take agreement cements Maracas’ position in the ferrovanadium market and reduces the level of investor risk and ultimately supports our investment thesis.
When the NAVPS7% of the Northern Dancer project and the risk-adjusted upside exploration potential are added to the equation on a fully diluted fully financed basis we reach our current target price of $1.75. We reiterate our SPECULATIVE BUY rating and our $1.75 target price.
Thomas Schuster – 604-609-6166 - tschuster@frasermackenzie.com
Andrew Edelberg – 416-995-4777 x239 - aedelberg@frasermackenzie.com
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