npv$937m vs mkt cap $2m, page-21

How Does Top Resource Fund Manager Brian Ostroff Invest in Domestic Peace of Mind? Two Words: Gold and Phosphate

The Gold Report, The Gold Report October 02, 2013 4:17 PM

TGR: Windermere is known for focusing on less-covered sectors. With the growing global middle class, is agriculture a good investment? What's the best way to enter that space?

BO: Windermere has done quite well by focusing on lesser-appreciated commodities. Currently, our largest holdings are in phosphate. I think that the fertilizer space, in general, is interesting. Ultimately, population continues to grow and people's diets continue to get better. There is going to be a continued demand for the grains and farmers need fertilizer to grow those grains. That said, I don't think that there is a wide spread depth of knowledge in the fertilizer space among investors.

"It is important is to understand the different commodities, the supply-demand dynamics for each and realize that when you're talking about commodities, you're not talking about a basket that will all go in the same direction. They each have their own uses. They have their own market dynamics."

Fertilizer is made up of three components: potash, nitrogen and phosphate. A lot of investors don't understand how different those three components are and that they each have unique supply and demand mechanics. A good example was in late July, when Uralkali (URKA:LSE), which was in a potash cartel with Belarus, decided that rather than maintaining price, it was going to focus on volume. That threatened potash prices across the board and the potash stocks all experienced a considerable drop. The problem is that all of the fertilizer stocks fell; phosphate and nitrogen included. To me, that shows investors view the fertilizer sector as one without understanding that the components all have separate markets.

Windermere's interest right now is very much focused on phosphate. Phosphate is the one component of fertilizer where North America is not self-sufficient. Recently, that deficit has grown even larger because Agrium Inc. (AGU:NYSE) closed one of its mines in Ontario due to depletion. This lack of domestic supply is exacerbated because of the source of the imported supply. Most people go to bed at night worried about Saudi Arabia and what could happen to oil prices. But most people don't realize they should be worried about Morocco. Morocco is four times bigger in phosphate than Saudi Arabia is in oil. Other big players in phosphate are Tunisia, Egypt, Syria, Jordan and Israel. These are not places large integrated fertilizer companies want to rely on for feedstock. Security of supply is a big issue and we think it needs to be addressed.

The term phosphate is used generically. People use it to refer to phosphate rock, phosphoric acid or finished phosphate fertilizer products. Typically, when most people or the media talk about phosphate, they talk about finished phosphate products like monoammonium phosphate (MAP) and diammonium phosphate (DAP). Our interest is in the phosphate rock market, which is the feedstock to make MAP and DAP. That is where there is a shortage of secure supply and thus the opportunity.

Large fertilizer companies want to be vertically integrated. They want their own rock going to their own phosphoric acid plants, mixing their own ammonia to produce and sell their own MAP and DAP. They are going to continue to try and source their own rock supplies rather than depend on third-party suppliers to ensure supply. Aside from the practical reasons for securing their own supply, there are large economic incentives to doing so, namely in the way of increased margins. Agrium recently experienced a sharp miss in earnings. That was the result of compressed margins exasperated by its need to source some third-party rock from Morocco in order to compensate for the mine closure in Ontario. The situation is going to get worse as Agrium, The Mosaic Co. (MOS:NYSE) and Israel Chemicals Ltd. (ICL:TASE) all face further mine closures over the coming years. This does not even address the current list of countries and companies that do not have enough of their own rock. Companies that own their own rock supply can save as much as $100/ton and that can make a big difference to the bottom line when you are talking about millions of tons.

TGR: Right now, the phosphate rock price is at $145/ton. It's been as high as $420/ton in 2008. What numbers do you use looking forward?

BO: Phosphate is not like gold. Gold that is produced in Argentina or Russia or Canada is all the same?and trades for the same price. Each phosphate deposit has its own unique geology, and results in a different quality of phosphate. The numbers you are quoting are Moroccan FOB. Because they are so large, that is the benchmark. But it is a fairly low-grade concentrate, about 30%. Higher grade concentrates can command higher prices. But even the Moroccan prices will probably increase because of increasing demand. And if there is conflict in North Africa, anything could happen to the price because supplies could be cut off. Ultimately, I don't believe that the large fertilizer companies want to rely on North Africa for rock supply if there is an alternative.

TGR: What North American companies could help fill this need?

BO: The largest holding in our fund is Arianne Phosphate Inc. (DAN:TSX.V; DRRSF:OTCBB; JE9N:FSE). Since we last talked, the company has been very busy. Additional drilling has tripled the resource in just its Lac à Paul pit. It now has 750 million tons (750 Mt) phosphate rock grading a little over 7%. That makes it the biggest undeveloped phosphate asset in the world. It is a unique deposit. Ninety percent of the world's phosphate deposits are sedimentary, which often has a higher in situ grade, but cannot be turned into as high of concentrate grade. Sedimentary deposits, such as those in Morocco or in Florida where Mosaic has most of its production, also tend to include contaminants like uranium, thorium and cadmium, which pose environmental issues.

Arianne has an igneous deposit, similar to several Russian deposits. Although a lower grade in situ, it can make a very pure concentrate. Arianne's metallurgical tests show it produces a 39% concentrate. That gives it roughly 30% more phosphate content than a typical Moroccan style 30% concentrate. The beauty of igneous deposits is they don't have any of these deleterious materials in them; they don't have uranium, thorium or cadmium. It also means they can command a premium price. PhosAgro, a Russian producer of 39% concentrate from an igneous deposit, is selling rock in the neighborhood of $230?240/ton. That is the type of pricing Arianne should be able to get.

In addition to tripling its resource and confirming its metallurgy, Arianne has made some additions to its board and management; these are some pretty serious guys. Steven Pinney was former head of fertilizers at Cargill and then senior vice president of phosphates at The Mosaic Co. He joined the board along with Dominique Bouchard who was the president of Rio Tinto Iron Ore and Titanium. Dominique has a great understanding of bulk commodities and how to transport them. He also lives in the region so he enjoys a strong relationship with the community, the First Nations, the port and rail authorities. Brian Kenny, a seasoned mine builder, joined as CEO. He built Falconbridge Ltd.'s New Caledonia mine and spent the last few years in the Middle East with Dubai Aluminium Co. Ltd. He was also president of Bechtel Canada, where he oversaw the design and construction of several projects. The most recent addition to the company's board was Pierre Fitzgibbon, who has held very senior positions with National Bank and sat on the board of the Caisse de Depot et Placement du Quebec. I think that as the project moves into either a development phase or a merger and acquisition phase, he will be a big help.

TGR: Dundee Capital initiated coverage on Arianne in March with a target price of $1.90/share and several other brokers cover the company as well. The stock is currently at $1.24. What could move the price 50% higher?

BO: There are a number of pending catalysts. First, despite the progress made in the last few months, the market cap remains around $100M, which is only 10% off its billion-dollar net present value. Going forward, the company will put out its bankable feasibility study (BFS) sometime around mid- to late October. That will tell a lot. A prefeasibility study released a year-and-a-half ago estimated a capital expense (capex) of about $800M to build a mine. In my experience, it is not uncommon for a BFS to see a 50% increase. My head is at a capex of $1.2?1.3 billion.

TGR: That's a big number.

BO: Yes, it is, but I think that has to be put in perspective. If it were gold or copper, that would be a hard number to swallow, especially in today's world. But, the reality is we are talking about a phosphate mine and there are not a lot of these things all queued up and ready to be built. Further, it's in a jurisdiction where it's sorely needed. Lastly, the companies that would have an interest in the project all have market caps in the billions of dollars so, rightly or wrongly, I just don't see that capex as a major impediment. It's funny, people look at the capex but don't give much thought to the other side of the equation, namely, a project that will do roughly $700M in revenue and have gross margins of over $300M a year.

What I do believe is important is the operating expense (opex) and not just how much it costs at the mine. How much does this cost to put onto a ship? Because the infrastructure already exists in Quebec, it should be reasonable. Roads are in place. Power is in place. There is the deep-sea port. Once you start a mine, the capex money has been spent, and while you do depreciate it off your balance sheet, that money is gone. Opex is about what the mine will cost to run for the next 40, 50, 60 years, the life of this mine. That is where the focus will be for the majors considering an acquisition of the company. If the all-in cost to produce the phosphate and put it on a ship ends up being somewhere around $120/ton, that could appeal to a lot of suitors. Remember it?s a 39% concentrate so, $120 and ready to go wherever it's needed is very attractive.

TGR: So you agree with Dundee's target price of $1.90?

BO: I actually foresee a higher price because I ultimately see no other logical conclusion to this story than an acquisition. Large, integrated fertilizer companies want to own all the phosphate rock they require. Their missing link is phosphate rock. There are enough large players out there that are short of phosphate rock and not comfortable relying on North Africa and the Middle East for their supply and this, to me, makes an acquisition inevitable.

If these companies see a viable opportunity to go back to being fully vertically integrated and owning their own rock supply, this will be very attractive. If they can save $80?100/ton by owning a mine rather than buying the raw commodity from a third party, at 3 Mt/year (Arianne's planned production rate), you're talking about a savings of $300M each year. Within three or four years, the acquirer has made back the cost of building the mine. And for the next 40 years, it will reap the savings while escaping the international supply risk.

TGR: Any other companies in North America that could help fill that need for domestic supplies?

BO: The other project that has moved along is Paris Hills in Idaho, which is owned by Stonegate Agricom Ltd. (ST:TSX, SNRCF:OTCPK). It's a very different type of situation. The deposit is smaller and the annual production is lower, but it comes with a much lower capex.

TGR: Stonegate is in the permitting phase. Are there any catalysts coming up we should be watching?

BO: It has moved along on its permitting and is hoping to receive the last of its necessary permits by the end of 2014. That is the final catalyst. There are some concerns around permitting process, but this is a resource that North America needs, and I think that it will be successful.

TGR: When could it have a mine?

BO: If everything goes according to plan, it could be in production in 2016.

Between Arianne at 3 Mt and Stonegate at 1 Mt, we could be a long way toward closing the North American deficit. I think there is a strong opportunity for both of these assets to come into production.

TGR: Any final advice for investors looking to protect or even grow their wealth going into 2014?

BO: It is important is to understand the different commodities, the supply-demand dynamics for each and realize that when you're talking about commodities, you're not talking about a basket that will all go in the same direction. They each have their own uses. They have their own market dynamics. You have to understand the underlying commodity before you start making choices about specific companies.

TGR: Thank you so much for taking the time to talk to us.

BO: Thank you.

Brian Ostroff is a managing director at Windermere Capital, where he focuses on the junior and mid-tier mining sectors. He brings over 25 years of small-cap mining expertise to the table, having served at RBC Dominion Securities and as a managing partner at Goodrich Capital, an M&A advisory firm. Prior to joining Windermere Capital in 2009, Ostroff spent four years as an independent proprietary trader.


Read more: http://www.benzinga.com/markets/commodities/13/10/3962045/how-does-top-resource-fund-manager-brian-ostroff-invest-in-domesti#ixzz2hG6kGujj

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"There are a number of pending catalysts. First, despite the progress made in the last few months, the market cap remains around $100M, which is only 10% off its billion-dollar net present value"

whats our NPV vs mkt cap ?