Heron Resources 16 Sep 09

Good financial position

The last time we reviewed Heron was in FAT-MIN-167 when we considered the company’s unique position with a significant interest in a potential world-class lateritic nickel project known as KNP. Heron still believes in KNP and is working on obtaining a better estimate of the reserve base, and is looking at pit optimisation and mine scheduling. However, for over a year the company has been seeking to buy a project with a relatively near term cash flow. After looking at 50 opportunities around the world the company has decided to buy an option to purchase the A1 Gold Mine in Victoria.

Let’s recap some of the history from which we can compare Heron’s strategy to become a Victorian gold producer. The company was built by Ian Buchhorn who stepped down from being MD, taking up the role of Executive Director of Strategy towards the end of January 2007. Mathew Longworth who previously filled the role of CFO became the new MD.

KNP is made up of many deposits with total resources of over 900M tonnes grading 0.74% Ni and 0.05% Co. Not only is KNP the world’s largest undeveloped Ni resource but two of the largest miners in the world are major shareholders. BHP had 14.75 and CVRD-Inco (Vale) owned 13.9% of Heron. Vale was earning the right to a 60% interest in KNP and in February ’09 delivered a positive pre-feasibility study. This study was based on 36,00tpa Ni production at a cash cost of US$4.42/lb after a credit for cobalt production. The capital expenditure for the program was estimated at US$1.5bn. What with the global financial crises and the problems that BHP Billiton had at its Ravensthorpe Nickel Project, leading to it closure, Vale pulled out KNP. This action left Heron with 100% of the project and all the technical data that cost Vale $34.5M.

Heron still believes in KNP and is working on obtaining a better estimate of the reserve base, and is looking at pit optimisation and mine scheduling. The pre-feasibility study considered 4 of the14 deposits making up KNP. A review of mining is aimed at optimising production rates and capital utilisation. Unfortunately the large lateritic nickel projects have been plagued with problems with operating costs generally exceeding expectations. These were going to be the new low cost nickel mines but in the end have mostly failed to deliver against sulphide deposits. In part this is due to the very high initial capital costs and high ongoing maintenance capital charges.

During May ’09 Heron announced that it had completed a binding framework agreement with Ningbo Shanshan Co. Ltd. With respect to its second nickel project Yerilla. The idea is that Yerilla would produce a Ni-Co concentrate that would be treated in China. The Chinese can earn 70% of the project by sole funding construction and commissioning of the project to an agreed capacity. As part of the transaction Heron will place 12M shares with Shanshan, plus 4.8M options exercisable at $0.30. There is also a provision for Shanshan to subscribe for another two 5% stakes in Heron.

Looking at Herons share price it does not look as though any of the nickel announcements have had a significant impact. This is most easily explained on the assumption that investors never really thought that KNP would get off the ground and are likewise sceptical about the outlook for Yerilla. The other problems that Heron faces are the big blocks of shares that BHP and Vale own. Perhaps the solution is for Ningbo Shanshan Co. Ltd. to acquire all the outstanding shares in Heron. Non-nickel assets could be put into a new float.

Fat Prophets initially recommended buying Heron Resources at 71 cents in November 2006 (Fat Mining 48). Our last review of this stock was in March (Fat Mining 167).

From a charting perspective, the performance of Heron Resources has been particularly disappointing over the past 18 months. Following a sharp decline during 2008, prices have since tracked sideways at the lows, confined to a range between resistance at $0.26 and support at $0.12.

In the absence of renewed buying support, further consolidation is still likely. Furthermore, given the significant amount of chart resistance above current levels, we believe rally attempts are likely to remain short lived at this stage.

For over a year Heron has been seeking to buy a project with a relatively near term cash flow that could be financed from existing cash reserves that stood at $29.6M at the end of June. After looking at 50 opportunities around the world the company has decided to buy an option to purchase the A1 Gold Mine which is located in Victoria, 120km north-east of Melbourne. The A1 mine satisfied all of Heron’s criteria. It can fund the purchase from existing cash reserves. Being in Victoria there is very low sovereign risk and there is a transparent approval process. The surrounding region is well supported with good infrastructure. Moreover, Board members have had experience operating gold mines.

The A1 was worked from 1861 to 1992. The average grade of ore mined was believed to have been around 22g/t gold. Unlike the gold bearing saddle reefs at Ballarat and Bendigo, the gold occurs in fractures within a dolerite dyke. The project is on a granted mining lease. Heron will explore for stockwork mineralisation amenable to a combination of small scale mechanised mining to hand held mining methods. In the past, stockwork mineralisation could not be profitably mined using hand held methods.

So what will this new opportunity cost shareholders? The term of the option period is two years at an upfront cost of $0.76M. The exercise price is $0.24M plus 20M fully paid ordinary shares in Heron. Then there is the cost of the evaluation program to be carried out during the option period of $18M. The total cost to Heron shareholders will be around $24M of which $19M will be paid in cash.

The concept is to start by recovering remnant reefs. A new decline will be constructed to allow rubber tyred haul vehicles that can move larger tonnages more efficiently at lower cost than the existing rail haulage. The idea is to lower mining costs to make sure that remnant reefs can be mined economically. Remaining stockwork mineralisation left behind grades 7-15g/t gold, and are good targets for mechanised mining. Heron will seek annual production of 25-30,000oz. Trial bulk mining will be required to estimate grade that can be very challenging for this type of deposit. However, Heron is confident of obtaining a JORC compliant resource. The A1 will not be a low cost mine. The mining cost could be anywhere between $300 and $500 per tonne. The A1 is not a company making asset and we are somewhat surprised that this was the best project that the company could find. Some equity investments would carry lower risk than investing in a high-grade underground Victorian gold mine. Another concern is that the company has reported that the best case scenario for the first gold pour is February 2012. If either of the nickel projects were ever going to get into production they would be even further down the track.

In summary, in the medium term Heron is shifting emphasis from two challenging lateritic nickel projects that have the potential to develop into world class projects into a high risk small scale underground gold mine. The two mineral assets have no commonality. Heron’s current market capitalisation is about $50.6M which means investors are valuing the assets at $21M. The valuation of the company is not excessive. We believe that the market is not attributing any value to the A1 option, and that the valuation represents a small option premium for the nickel assets.

However, in the short- to medium-term we do not see any catalysts that will see Heron outperforming the Metals and Mining Index other than a takeover of the company.

The outlook for Heron has become increasingly uncertain. We will continue to closely monitor the company’s announcements for catalysts that will add to shareholder value.

In the meantime, we are removing Heron from the Fat Prophets Australian Mining Portfolio and recommend the company as a Sell around $0.20.


DISCLAIMER Fat Prophets has made every effort to ensure the reliability of the views and recommendations expressed in the reports published on its websites. Fat Prophets research is based upon information known to us or which was obtained from sources which we believed to be reliable and accurate at time of publication. However, like the markets, we are not perfect. This report is prepared for general information only, and as such, the specific needs, investment objectives or financial situation of any particular user have not been taken into consideration. Individuals should therefore discuss, with their financial planner or advisor, the merits of each recommendation for their own specific circumstances and realise that not all investments will be appropriate for all subscribers. To the extent permitted by law, Fat Prophets and its employees, agents and authorised representatives exclude all liability for any loss or damage (including indirect, special or consequential loss or damage) arising from the use of, or reliance on, any information within the report whether or not caused by any negligent act or omission. If the law prohibits the exclusion of such liability, Fat Prophets hereby limits its liability, to the extent permitted by law, to the resupply of the said information or the cost of the said resupply. As at the date at the top of this page, Directors and/or associates of the Fat Prophets Group of Companies currently hold positions in: ASX-listed Australian stocks: ASX-listed Australian stocks: AAC, AAD, AGO, AJA, AMP, ANZ, APA, APG, AVG, BCI, BHP, BKN, BOQ, BRL, BRU, BTR, BWP, CBA, CCL, CDD, CFE, CGL, CKF, CNQ, CVO, CWN, DLS, DNX, DUE, ELD, ENV, EVN, FID, FMG, FXJ, GJT, GMG, GNS, GOR, GPT, GXL, HUB, IAU, IFL, ILU, IMF, JHX, MFG, MGR, MML, MMS, MND, MNF, MPL, MTR, MTU, NAB, NCM, NMG, NUF, OBS, ORE, OSH, OVH, POS, PPS, PRG, PRT, PXG, QAN,QBE, RIO, RXL, RRS, S32,SDG, SFR, SGP, SIV, SLR, SPK, STO, SUN, SYD, TAM, TEN, TLS, TME, TTN, WBC, WFD, WES, WHC, WOW, WPL, WSA. International stocks 3i Group, Acacia Mining, Amec Foster Wheeler, Anglo American, Archipelago Resources, Arian Silver Corp, Aviva, Avocet Mining, Bank of China, Barratt Developments, BMW, Berkeley Energy, BG Group, BOLSAS Y MERCADOS ESPANOLES,SOCIEDAD, Bovis Homes, BP, Braemar Shipping Group, British American Tobacco, BT Group, Cairn Energy, Centamin Egypt, China Life Insurance, China Mobile, China Overseas, China Taiping, China Vanke, Country Garden, Daejan Holdings, Development Securities, Dragon, Enquest, Esure, Euronext, FedEx, Fresnillo, Ibiden, Infosys, Glaxosmithkline, Glencore International, Goldbridges Global Resources, Google (Alphabet), Grainger, Gulf Keystone Petroleum, Highland Gold Mining, HSBC,ICICI Bank, Ironveld, iShares Physical Metals, J Sainsbury, JKX Oil & Gas, John Wood Group, Kazakhmys, Legal & General, Lloyds, Low and Bonar, Market Vectors Junior Gold Miners, Market Vectors Oil Services, Market Vectors Vietnam, Marstons, Medusa Mining, Mitchells & Butlers, Mitsubishi Tokyo Financial, Mitsubishi UFJ, National Grid, Nippon Telegraph and Telephone, Panasonic, Paragon Group of Companies, Petra Diamonds, Petrofac, Petropavlovsk, PICC Property & Casualty, PPHE Hotel Group, Randgold Resources, Rank Group, Reckitt Benckiser, Royal Dutch Shell, Solgold, Sony Corporation, Standard Chartered, STV Group, Sylvania Platinum, Tata Motors, Tencent, Tertiary Minerals, Teva Pharamaceutical, Toyota Motor, Tullow Oil, Unilever, Vedanta Resources, Vodafone, Walt Disney, Zillow.