Go Go Go - MGO - Marengo!

Equity Analyst: Peter Koay

Date: 16 March 2011

Target Price: ~A$1.00/share (18-24 months investment horizon)

MARENGO MINING LTD (MGO)
The next OZ Minerals in the making

PNG can be considered to be the upcoming rising star as a mining destination of the 21^st century. It is a resources rich nation, soon to be able to get into the ranks of Australia and Chile.

Now, how do we get exposure to this upcoming mining giant country? Sifting through a number of PNG mining companies that are listed on ASX over a weekend, a very interesting stock had been discovered to have the potential to become the next OZ Minerals, i.e. MARENGO MINING LIMITED. (By the way, OZ Minerals had recently been a darling stock in ASX as it’s generating a huge pile of cash from its Prominent Hill copper and gold mine.)

OZ Mineral’s Prominent Hill mine has a remaining 8 year mine-life from now, with latest reserves (as at Jun 2010) of 5.5 billion pounds of copper (1.135 billion pounds Measured, 2.43 billion pounds Indicated, 1.88 billion pounds Inferred) and 3.1 million ounces of gold (0.5Moz Measured, 1.4Moz Indicated, 1.2Moz inferred).  Refer to http://www.asx.com.au/asxpdf/20101109/pdf/31trr9pnqgpjlc.pdf .

Assuming copper price of US$4/lb and gold of US$1300/oz, that means OZ Minerals has $22B of copper and $4B of gold, a total of US$26B of resources (Measured+Indicated+Inferred).

Comparing MGO’s resources with OZL’s resources (refer to http://asx.com.au/asxpdf/20110228/pdf/41x36stqj3wspq.pdf) , MGO currently has 6.5 billion pounds of copper (1 billion pounds measured, 1.9 billion pounds indicated, 3.6 billion pounds Inferred). Assume same copper price of US$4/lb, it has a whopping US$26B worth of COPPER!!

In addition, MGO has a total of 204M pounds of Molydenum (45M pounds Measured, 68M pounds Indicated, 91M pounds Inferred). Molydenum is a material used to manufacture high corrosion-resistance stainless steel (e.g. super duplex steel). Assume price of Molydenum of US$20/lb, this means MGO has US$4B worth of Molydenum!!

This brings it to a total of US$30B worth of resource!!! MGO’s resource can be even bigger than OZL!! Doing a sensitivity analysis, you may say that that’s just a lot of inferred category stuff in MGO’s resource statement. If the inferred category is taken out and a comparison is made, OZL should have US$14.3B of copper and US$2.47B of gold, which brings to a total of $16.8B. MGO should have US$11.6B of copper and $2.26B of Molydenum, that brings it to US$13.8B. Basically, the message is, MGO would be in the comparable league of OZL category of companies!

Now, current market capital of OZL is A$4.81B with 3.24B shares issued. However, MGO’s current market capital is only A$273.36M. OZL’s mkt cap is now 17 times greater than MGO. However, both companies have almost the same amount of resources.

The following are a few reasons on why you may want to buy Marengo Mining Ltd at its current level (i.e. $0.27-$0.30/share):

Comparison Category	OZ Minerals (OZL)	Marengo Mining Ltd (MGO)
Resource (Measured+Indicated+Inferred)	US$30B	US$26B
Market Capital	A$4790M (at $1.48/share)	A$274M (at $0.275/share)
# of issued shares (M)	3240	994

Risk is proportionate to returns: the higher the risk, the bigger the returns. But the higher the risks, the bigger the discount to the share price too. If there’s a huge discount to the share price due to inherent risks of the share, then, we ought to ask: What are the risks that MGO have?

A few of MGO’s risks can be outlined and summarized as follows:

1. Management Risk: Low – Les Emery used to be the managing director for Lynas Corporation. Lynas is doing very well now, all thanks to Emery, who helped guided Lynas to get the lease for the mines that they now own. Do you think he has the capability to repeat a success story with MGO? Quite likely...

2. Capital Funding Risk:
1. Risk of getting the money to fund the capital cost to build the plant is low with China NonFerrous Metal Industry’s Foreign Engineering and Construction Co. Ltd (“NFC”) offering to provide at least 70% of the capital cost or help MGO connect with Chinese banks to lend their capital. If 70% of the funding is obtained via a Chinese bank debt, that means NFC has to fund it by equity issue of US$480M. With current share price, it needs to issue up to 1.8 billion shares – making it similar to OZL’s # of issued shares. But of course, the better option is to fund it all entirely with debt and pay it off. However, it is quite likely that NFC would try as much as possible to negotiate a higher % of equity stake in MGO.

3. Yandera Project Risks:
1. Risk of cost blow-out: Low, due to the arrangement of a lump sum EPC Project with NFC. In a lump-sum project environment, the real exposure is to claims lodged by the EPC Contractor against the company. However, with the partnering arrangement in place, this risk is minimized. The Chinese would not want to risk a backlash by Australian company when they are the ones needing the resource, and they wouldn't want to sink a company which they themselves have a huge stake in (when they participate in the equity offering and arrangement of bank debt). US$1.6B capital cost is needed to get the plant to 25M tonnes/year production.

2. Geological Risk: Low. PNG is a geologically active area (lots of earthquakes). However, this risk is low considering that there are so many major companies which are already investing into PNG on the same main island, e.g. ExxonMobil. If ExxonMobil (very conservative oil company) is comfortable with the risk, I think we should be quite comfortable with it too.

3. Environmental Risk: Medium. This is the only risk that could be a bigger challenge for the company. The possible ways for MGO to manage the mining tailings is to build a dam, use DSTP (Deep Sea Tailings Placement) similar to Ramu Cobalt-Nickel Mine and Lihir Projects, or to build a processing plant to treat the wastes. The PNG govt is quite likely not to have a huge appetite to build a dam to contain the mining waste as OK Tedi’s dam was damaged in an earthquake back in 1984, which was a factor contributing to OK Tedi dumping mining wastes straight into the river systems leading to a huge environmental disaster. Having a potential damage by earthquake of a dam, and end up releasing tonnes and tonnes of toxic wastes into the environment would be quite unacceptable. Possibly, the DSTP method may work for MGO.  

4. Product Sales Risk : Low. NFC has already offered to off-take a portion of the product from the Yandera project as part of the MOU signed with NFC. MGO has already secured a big customer!! And with the rising world demand for copper (China being a big driver of this demand), there shouldn't be any concerns on whether they could sell the product.

5. Political/Sovereign Risk: Low. MGO has very good political connections. It has the former PNG Mining Minister (Samuel Akoitai) and the former PNG PRIME MINISTER (Sir Rabbie Namaliu) within its board of directors!! These men would be able to help MGO in navigating to get the mining licenses/leases renewed and to assist in getting the environmental approvals required.

6. Construction Risk: Low. With NFC successfully constructing the nearby Ramu Cobalt-Nickel mine, NFC should have the capability to construct and deliver the project in PNG on time for a early 2014 start-up.

7. Resource Upgrade Likelihood: High. MGO still has $71M in cash as of 31 Dec 2010. This money is enough for it to continue its drilling program around the resource and prove more of the inferred resource into the indicated category. As drilling continues, the company shall keep on adding value to the company. When good news is released on any upgrade in the resource, this will drive the share price even higher.
8. Production Costs Risk: Low. See graph as per Note 2 below. The forecasted production cost is about $0.90/lb. This means that the copper price can drop even up to $2/lb (almost 50% drop from today's prices), and MGO can still keep the plant operating. The cost can be kept quite low due to lower wages of PNG nationals being hired. 

NPV Analysis:

A basic Yandera project NPV analysis based on available information shows us how much the share price should be. Based on a 10% discounting factor (i.e. 10% cost of capital), this will give it a current NPV of $2.67/share based on the following assumptions: 

1. 0.57% grade copper equivalent (including Mo)
2. Copper/Mo recovery factor: 0.8

3. 20 year mine life (with startup in 2014)

4. 25M tonnes of ore per year 

5. Net profit margin of 56% (as per OK Tedi most recent net profit margin)

6. 10% discounting factor

7. US$1.6B capital cost

8. AUD to US$ conversion ratio = 1:1  
9. Copper price: US$4.30/lb

Sensitivity analysis:

Even if the capital cost of that plant is US$2.5B (assuming another extra US$900M to deal with the mining tailings), the NPV for the project will lead us to $1.76/share. This is not taking into account that the company will find and prove more reserves with its continuous drilling program.


Even if copper price drops to US$2/lb (2008 GFC levels), the NPV for this project based on current resources level and 25MT/annum production is still $0.38/share (higher than current share price)!!

Share Price Risk Analysis:

§  MGO has recently issued 110M shares (fully subscribed) at a price of C$0.25/share (which is about A$0.255/share) to institutional investors. This helps set a floor price. Major institutional investors will generally not allow the share price to go below the price for which they’ve obtained the shares.

§  Share price has a huge potential to spike up as soon as Definitive Feasibility Study (DFS) is released (targeted for 1Q’11). It’s now getting to mid-March, so the DFS report is not far away (in the next 2 weeks). 

§  Strong institutional shareholders participating in recent offerings, implying low risk of share price falling any further than current levels:

Biggest shareholder: Sentient - 22.2%

Sentient has proven themselves to be very astute stock-picker of stocks that have potential to be a takeover target. MGO can be one soon! Refer to the following article on the track record of Sentient Equity fund: http://www.theglobeandmail.com/globe-investor/investment-ideas/private-equity-fund-shines-in-spotting-takeover-deals/article1918226/

2^nd biggest shareholder: Quantum Partners – 18.9%

Quantum Partners is a fund owned by George Soros. George Soros is a man who knows how to profit from financial crises. He still managed to earn $1.1 billion while the rest of the investment companies were reeling from the recent 2007/08 GFC. 

3^rd biggest shareholder: OMERS (Ontario Municipal Employees Retirement System) – 6.1%.

Supposedly, a retirement fund usually should be quite risk-averse. This gives us another comfort factor that the risk of investing in this company is low.

Conclusion:

From market capitalization comparison, MGO will soon become another OZL with market cap in the order of $3B. This would mean that MGO will have to be $3/share to be a $3B market cap company with current # of shares issued. Assuming that 3B shares have been issued then, it has to be at least $1/share for it to be a $3B Market Cap company. 

From DCF analysis, MGO will also be $1.76-$2.67/share provided that all risks mentioned above are managed properly.

From PE Ratio analysis, at 25M tonnes/year production, MGO will generate a net profit in the order of US$600M per year!  Assuming a 3 billion issued shares (similar to OZL now), and at the price of $2.00/share for MGO, the PE ratio will just be 10. When it ramps up to 50M tonnes/year production, the PE ratio will just be 5! 

Hence, MGO share price will be able to go up to at least to $1.00/share in 1.5-2 years time (very conservative estimate). This is not taking into account all the upsides that MGO has by its continuous drilling program in the 1900km2 tenement that it has in PNG. 

Do you want to be a part of the exciting story of Yandera Project in PNG? It's your choice...

Note: Marengo is Napolean’s favourite horse who had faithfully served him for 35 years. MGO is hoping to faithfully serve all who’re willing to buy a stake into it. 


Note 2: Additional Chart from http://www.asx.com.au/asxpdf/20100901/pdf/31s8g5wswdv31j.pdf 
Marengo is forecasted to be one of the lowest cost producers of copper (on a per lb basis), almost next to OZ Minerals. 

Disclosure: The analyst is a long-term shareholder of MGO. This share analysis does not represent an investment advisory service as no subscription or management fees are charged. The contents of the article are provided as general information only and should not be taken as investment advice or as a recommendation to buy or sell any security or financial instrument. Any investment decisions carried out based on information, analysis, or commentary provided here is solely your responsibility. You should consult your investment adviser before making any investment decisions.