Friday 2 August 2013

Tide expected to turn in Frontier Rare Earths’ favour, says CEO

While Frontier Rare Earths (TSE:FRO) is trading  below cash for reasons beyond its control, CEO James Kenny believes the company has one of the best chances of getting into production in the junior rare earth sector, with the boss expecting a “selective correction” in the industry later in the year to turn in its favour. 
Frontier, which lauds itself as being the only junior in the rare earth business to get a definitive agreement with strategic partner for an off-take deal, is developing its Zandkopsdrift rare earth project in South Africa, teaming up with Korea Resources Corp (Kores) - the South Korean state-owned mining and natural resource investor. A prefeasibility study for the Zandkopsdrift project is on track for completion in the third quarter. 
“We don’t need to be pioneers, as we are taking metallurgical processes that are already out there for the conventional host mineral monazite, and are essentially trying to optimize them to ultimately get the best outcome in terms of capital and operating costs,” says Kenny in an interview with Proactive Investors. “The flow sheet to crack monazite has been around for decades, and for this reason, we are very fortunate compared to the vast majority of other junior rare earth companies that do  have host minerals that have never been commercially exploited.”
Zandkopsdrift is considered one of the largest undeveloped rare earth deposits worldwide containing approximately 950,000 tonnes of total rare earth oxides (TREO). Kenny expects that the publication of the prefeasibility will confirm the upgrading of virtually the entire Zandkopsdrift resource into the proven and probable reserves categories.
Last December, Kores completed the acquisition of an initial 10 per cent stake in Frontier's Zandkopsdrift rare earth project, and has the option to increase its interest in the project to up to 50 per cent, becoming an equal partner with Frontier, on completion of the definitive feasibility study, and together with this, an off-take right and obligation for up to 50 per cent production from the Zandkopsdrift. Since the preliminary economic assessment report released last year and even since the last update in November 2012, the company has told investors that a number of improvements have been made to the flow sheet for the processing plant. It is planning to start rare earth production in 2016, with a total target capacity of 20,000 tonnes per year of separated rare earth oxides. 
However, the company, with a cash position of just over $40 million, is trading at around 40 cents, giving it a market cap of some $36 million. 
“Rare earths are difficult in terms of knowledge, as even a relatively sophisticated investor can have difficulty understanding the value proposition. It is more challenging than gold, copper or oil and many other commodities,” Kenny responded when asked why he believes Frontier is trading below cash.
“Rare earths don’t have that same familiarity and we have also suffered in tandem with the real massive rotation out of junior mining stocks and the significant pullback in rare earth prices. There isn’t a commodity that hasn’t seen a significant pullback in the past months.”
These forces – which include unfamiliarity with rare earths, weak commodity prices, and a general uncertainty in equity markets – have combined with the “possibly clouded investor perspective” on rare earth juniors that has occurred as a result of two bellwether stocks in the sector – Molycorp (NYSE:MCP) and Lynas (ASX:LYC) – both having suffered on account of a number of setbacks at their respective operations. 
Kenny poses the question: “In other words, investors are probably thinking why everyone else won’t have challenges if the two biggest and most advanced companies are?”
“But the demand for rare earth metals hasn’t gone anywhere and the business case is, in my opinion, fully intact. The rare earth opportunity will come back for investors and I predict there will be a selective correction for those that have the greatest chances of getting into production.
“We are very sure that we are one of those companies,” he adds. 
Indeed, reports out of China earlier this month say the price increase in rare earths as recently as early July relates to a government campaign to shut down unlicensed mines in China’s Ganzhou city. A spike in rare earth prices has happened before for reasons tied to supply concerns in China, the biggest producer of rare earth elements – in 2011, prices for neodymium, a rare earth metal used in the automotive industry, spiked to $500 a kilogram from just $15.00 a kilogram two years earlier as China cut back on exports of the metals.
As the name suggests, rare earth metals are indeed, rare, and as such are extremely vulnerable to supply and demand shocks. The elements are used for many different applications, but their ever-increasing demand is closely tied to high tech products like tablets and cell phones, and green technologies like hybrid automobiles.  
“We will see huge demand from large corporates 5, 10 and 15 years down the road from the automotive and electronic industries such as those in Korea, Japan, China and Germany, with that consumption largely having to be met with China-sourced production unless a number of western mines can get into production,” says Kenny.
“However, there is a very real expectation that the way demand is likely to develop, China will be unable to supply these critical rare earth oxides in the quantities forecast, and it will be incumbent on these big users to go out and find western REE sources. We fully expect Frontier to be one of these major sources.”
The chief executive is encouraged by the definitive strategic partnership agreement concluded with Kores, compared to various preliminary non-binding memoranda of understanding (MOU) deals inked by some of its peers with some fanfare, which Kenny says are “only just that”. “It is very encouraging for us, as we have a credible private party coming in through a straight cash deal, reflecting the significant value of Frontier. 
“It is hard to see how that is priced in to our stock at the moment,” concludes the chief, who adds Frontier’s value proposition can be defended under several different metrics, highlighted by the fact that Kores paid $23.8 million in cash for the initial stake in its South African subsidiary last September. 
A preliminary economic study on the Zandkopsdrift project, released last February, showed that the property is estimated to have a net present value of a whopping $3.65 billion, after tax and royalties, at an 11 per cent discount rate. Internal rate of return for the project was seen at 52.5 per cent, after tax and royalties, with a two year payback from start of production. 
After the prefeasibility study is released later this year, Kenny says the next step will be the definitive feasibility study, which he anticipates will take about 12 months from commencement, taking the company to the end of 2014. Assuming capital can be raised, the construction phase is pegged at approximately two years, with first production targeted on that basis for late 2016 or early 2017. 

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