Discovery Metals 14 Dec 11

Fat Prophets take profits

Discovery metals has provided at text book example of how to bring a deposit to production. The group has also been fortuitous in the copper price it hedged at in order to attract debt financing. However, with further discoveries pushing the shares higher and issues still possible we recommend members sell half.

In a world apparently filled with debt downgrades Moody’s recently upgraded the outlook on its A2 rating of Botswana’s sovereign debt. The agency said it was also expecting further improvements on the back of a revitalised diamond sector and a strong economic recovery.

This is as Botswana is expected to see a Government budget surplus in 2012/2013 after three years of deficits. The economic environment is therefore stable for resource groups focused on the country.

Discovery metals is one such company and is set to commission its Boseto copper mine in the first half of 2012 and should see first production in the same period. Since our last look at the group in September (21 September 11, FAT 291) the company has made good progress on exploration and development which has seen the shares perform well.

Structural resistance is located at $1.45 region, a breach of this level will likely result in a retest of the all time high of $1.52 in the near term. The bullish moving average cross in place is suggestive of momentum to favour the upside.

With reference to the weekly chart, the strong long term uptrend is bullish. A convincing break above the $1.52 resistance level on strong volume would signal the commencement of a new leg higher over the broader term.

Looking at exploration progress first of all and the company announced the discovery of a copper-silver deposit at its Mango prospect with a defined strike length over 36km. Mango is described as adding further “open cut and underground potential in the Boseto  vicinity” with its relative location in the below graphic:

At the Plutus cross section the group has also had positive copper-silver drilling results which support underground mining. The group also announced the discovery of a new zone of high grade copper and silver zone at Zeta North East - both Plutus and Zeta are cross sections of the Beseto deposit.

The Zeta underground definitive feasibility study is scheduled for completion this year with results announced in early 2012. Planning and construction for Zeta will start after that as the below timeline shows:

Turning to mine development and the quarterly activities report from the group (20th October 11) noted that the Boseto mine is now 75% complete. It is therefore on track for commissioning and production of copper/silver production in H1 2012.

Boseto construction remains on budget and as the bulk of it is finished the prospects for costs to run to plan looks good. However, issues are still possible with investors only needing to look to African Barrick in Tanzania to realize that things do not always go according to plan.

In current markets the uplift typically given to miners when they enter production may also fail to materialize. Recent examples of this include Archipelago Resources and London Mining which have not been re-rated on the start of production. Overall then now looks like an opportune time to take part profits in the stock.

Reviewing our initial recommendation of Discovery Metals in June 2008 and the stock has performed robustly against our entry price of 26p. The key was the Maun copper project (home of the Boseto mine) which covered seven prospecting licenses and an area of around 6,500 sq km in northwestern Botswana (in the Kalahari copper Belt).

The group was inexpensively valued relative to peers on the basis of copper resources and was targeting first production for late-2010 at a rate of 24,000 tonnes CU pa.

Clearly this objective has been pushed back with production due in the first half of 2012 but the resource potential remains and as we said at the time:

“We see a lot more resource upside at Maun, as the current resource base represents less than 5% of the potential 700km of strike length within the total tenement package. The project has the potential to be a company-maker for Discovery Metals....Discovery Metals combines an attractive portfolio of mineral assets in Africa that are at advanced stage of development. The company’s market value is modest, but the upside in our view is enormous, driven by its large ground position and the potential for more discoveries.”

The bankable feasibility study for the Beseto project was delayed after changes which saw capacity increased by 50% to 3Mtpa. Finally published in August 10 the BFS gave the below results:

It is interesting to compare the BFS assumed prices with where the hedges needed to attract debt financing were actually struck. Copper was hedged at US$4.01/lb and silver at US$36.07 which both compare favourably to the BFS assumed prices and secondly current market prices (copper trades around US$3.50/lb at present).

The hedges cover 40,000 tonnes of copper and 1.85m ounces of silver. This makes up around 40% and 65% of forecast production over the life of the loan although higher commodity prices could see the loan paid off ahead of plan.

The bankable feasibility study will see initial production at 34,400 tonnes Cu per annum with output lasting for five years. However, the development plan would extend the development to 15 years and the longer-term goal is for output of 50,000 Cu pa with a mine life of more than 25 years.

On a valuation basis Discovery Metals is attractive at around 6X earnings to the year end June 2013 (the first year with full production). Upside is provided by exploration within the significant Maun prospecting licenses. However, with the risk of delays on getting output started we believe now is a good time to take part profits.

Accordingly, we recommend members sell half of Discovery Metals.


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