Prepare for a Base jump

The mineral sands producer is being re-rated, as we flagged in August.

Summary: Ilmenite, rutile and zircon miner Base Resources is attracting strong buying support following the start of production at its Kwale project in Kenya. However, there are differing views on the outlook for the titanium minerals it is mining.
Key take-out: Base’s market capitalisation is currently $278 million, against a current net present value for Kwale of $440 million.
Key beneficiaries: General investors. Category: Shares.
Recommendation: Outperform (under review).

De-risking a mining project can do wonders for the share price of the owner. That is what is happening to the titanium minerals miner Base Resources (BSE) as its Kwale development in Kenya starts production, confirming an outperform rating given to the stock four months ago.

Back on August 7 Base was one of the stocks mentioned in my column (Minefield: Mining for price growth), with its outperform status based on the finalisation of construction of what is the East African country’s biggest mine of any sort.

Yesterday (December 10, 2013) saw what could be the start of a significant re-rating of Base as investors accelerated their buying of the stock, driving it up by an eye-catching 10% (4.5 cents) to 49.5c in an otherwise flat market. Some trades were booked at 50c, a 12-month share price high.

The rise of Base has not been in a straight line, thanks to uncertainty about the outlook for titanium minerals, concern associated with the company’s location in Africa, and the occasional talk by Kenyan government ministers about the need to increase “local ownership” of Kwale.

Political uncertainty and sovereign risk will remain an issue, as it is for all foreign companies operating in Africa. But there is with Base a demonstrable case of undervaluation, even at its current share price, which is 11c (28.5%) higher than when mentioned here in August.

Though it is not a widely researched stock, there are radically different views about where the share price is heading. Among other things, there are differing views on the outlook for the major products being mined at Kwale: rutile and ilmenite (titanium minerals used mainly in making pigment for paint) and zircon (used mainly in ceramic tiles and bathroom products).

One big investment bank, Credit Suisse, believes that Base is significantly undervalued, thanks to Kwale having started production a few weeks ago and with first shipment of rutile and ilmenite scheduled to sail from the port of Mombasa next month.

Credit Suisse has set a 12-month share price target for Base of 90c, 82% above yesterday’s near-record closing price.

Goldman Sachs does not agree. It has Base on a neutral recommendation and a 12-month price target of 38c, with its major concern being the oversupplied titanium minerals and zircon markets.

Both big banks cannot be right, but my view after a conversation with Base’s chief executive, Tim Carstens, on the sidelines of the Mines and Money conference in London last week is that Credit Suisse is more likely to emerge the winner. This is thanks to the high quality of the Kwale orebody and the structure of its mineral assemblage that is rich in premium value rutile and relatively low in zircon, which has suffered a sharp price fall over the past few weeks.

What caused Goldman Sachs to turn negative on Base, and most other stocks in the titanium minerals and zircon sector, is a gloomy view of the outlook for demand from the sector’s leading consultancy, TZMI Minerals.

At a conference for industry specialists held in Hong Kong last month, TZMI delivered a downbeat forecast of falling prices, with rutile tipped to average $US925 a tonne next year compared with $US1067/t this year, and ilmenite to drop to $US190/t from $US220/t.

It was those forecasts which caused Goldman Sachs to downgrade the Australian titanium minerals leader, Iluka, from neutral to sell.

Base, however, survived the cull, retaining a neutral rating that Goldman Sachs gave the stock in August when it was trading below 40c.

The recent heavy buying of Base shares, which saw large volumes pass through the market on most days last week, indicates that more investors subscribe to the Credit Suisse view of the stock than that of Goldman Sachs.

Carstens’ time at Mines and Money might have helped, and though he was not an official presenter he was busy chatting to London investment banks and mainstream investors as he explained the final steps in financing Kwale and the build-up of stocks trucked to the company’s export facility at Mombasa.

“Site work is largely complete and the processing plant has started without a hitch,” Carstens said.

“Normally when you start a project like this you expect to run it for an hour or so and then stop to check and see that everything is working as designed.

“At Kwale we turned it on and ran it for 26 hours straight, without a hitch, and only stopped to make sure everything was performing as designed.”

On the company’s schedule, mining and processing will now accelerate rapidly, hitting annual nameplate capacity of around 360,000 tonnes of ilmenite, 77,000 tonnes of rutile, and 25,000 tonnes of zircon by May next year.

On a product value basis, 48% of sales revenue will come from rutile, 28% from ilmenite and 24% from zircon.

Carstens said the current net present value of Kwale, even using the downbeat forecasts from TZMI, was $US400 million ($440 million), which is substantially below the $278 million market capitalisation of the stock at 49.5c.

More uplift can be expected from Base as the first ship is loaded, with the sailing date expected to be around January 25, and with a site visit for London investment bank analysts being scheduled to coincide with the shipment, or the Mining Indaba conference in Cape Town in early February.

The start of cash flow might also be a trigger for the two biggest shareholders in Base to start considering their long-term strategy. Pacific Road Capital (20.5%) and Taurus Funds Management (13%) are essentially specialist providers of private capital to early-stage mining projects. They are not long-term shareholders.
Graph for Prepare for a Base jump

At some stage in the next few months both Pacific Road and Taurus are likely to start looking for an exit, with major consumers of titanium minerals and zircon the logical long-term owners of Kwale.

Corporate activity on the Base share register could be another reason to expect the stock to become more exciting next year.