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Zanaga is years from production and the shares are now overvalued

By Gary Newman | Sunday 19 November 2017

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

The typical life cycle of a small mining company from initial discovery of a resource through to eventual production tends to feature lots of peaks and troughs along the way as various stages are reached.

This tends to mean that after a piece of particularly positive news the share price often rockets, before subsequently dropping back when investors cash in and people lose interest awaiting the next piece of news, which in some cases can be quite a way off.

Iron ore miner Zanaga Iron Ore Company (ZIOC) had been trading steadily in the 4p to 7p range for around six months before news of the award of an environmental permit for its 50%  (less one share) owned Zanaga project in the Republic of Congo.

News of that award caused the shares to jump up to around 10p before pulling back slightly, which seemed reasonable given that it was another box ticked along the way to ultimately reaching production.

But then private investors jumped on the news and helped push the share price up to 25p before it dropped back to the current price of 17.75p and a market cap of nearly £49 million.

The news was of course positive, but at this stage I don’t view it as justifying a 200% rise in the share price, as any potential production is still a long way off, even if financing is secured, which could be a problem for a company of this size.

One thing that the project does have going for it is that the other half (plus one share) of it is owned by Glencore, which controls and manages the project, and that the mining permit is already in place. Plus recent higher iron ore prices help to demonstrate the economic viability of Zanaga.

Iron ore is currently trading at around $61.5/tonne, but that is for 62%Fe whilst Zanaga is expected to produce higher quality 66% ore pellet feed during the first stage of the development of the mine, so will attract a premium.

Initially any mine that is built will be targeting production of 12Mtpa, and over the 30 years of mine life, average operating cost per tonne would be around the $30 mark – reducing to $23.1/t when stage two is expected to be implemented in year nine, at which point an additional 18Mtpa is expected to be produced.

So the economics of the mine all look good once it reaches production, but the problem for a company the size of Zanaga will be funding its share of any mine development costs, which total $2.2 billion for stage one, meaning that the company will need to find $1.1 billion in finance, or farm-out/sell off part of its share of the project to get the money that it needs.

It is also reliant on Glencore to decide to go ahead with the project, and sometimes large outfits like that can keep these projects on ice for a number of years until such time as they need to replace existing production which is reaching the end of its life.

Currently reserves stand at nearly 2.1 billion tonnes of ore at 33.9% iron, and with further upside potential from the surrounding area, with the whole resource including nearly 7 billion tonnes of measured, indicated and inferred resources at 32%.

A fair bit of work has already been carried out, which included Glencore funding a minimum of $100 million for the feasibility study, in return for its controlling stake in the project.

But there is still a long way to go before the mine will produce anything, and the feasibility study showed that from a final investment decision being made, it would then take close to five years before the mine was in a position to begin production – 6 months for preparation for Front End Engineering; a further 12 months for FEED; and then three years for the actual construction phase.

For me that is much too far down the line to be taking a position in the company at this stage, especially with no indication from the company on how or when financing could be secured.

In terms of its finances, it had $4.2 million in the bank at the end of August and generally burns through around $100,000 per month when it isn’t spending money on any operational activities, so it has plenty of money to see it through on a day-to-day basis for the foreseeable future, so the risk of dilution for that side of things is minimal.

There are certainly things that I like about the company, and the fact that Glencore is its partner in the project is a positive, and should it ever reach production the profits generated from a Zanaga mine would be large.

I also like the fact that chairman Clifford Elphick has a lot of skin in the game himself via his beneficial interest in Guava Minerals, which holds nearly 32% of the shares in issue. Although the fairly limited number of shares in free float is potentially what has helped the share price to be pushed up as quickly and as high as it has been.

But at the moment it I hard to see how the company will get to a position where it is able to fund its share of mine development, so risk remains over the financing side, of things and just how much of its share it might have to give away to secure that.

There is also the problem that the Congo isn’t exactly one of the safest and more stable places in Africa in which to do business, and although some new mines are being built, there are plenty of resources there which look good on paper but are yet to be mined, even by the larger companies.

Overall this looks to have some potential if you are prepared to hold for a long time, but I certainly wouldn’t be tempted to buy at anywhere close to the current levels and would expect it to pull back significantly in the coming months barring any sudden unexpected news on financing – personally I think that will be a long way off. If you’ve been lucky enough to enjoy the huge rise, I’d be tempted to cash in and look to re-enter at a lower level.

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