SFX 2.65% 55.0¢ sheffield resources limited

Valuation & Price Target

  1. 2ic
    5,493 Posts.
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    To some extent there are so many moving variables it's almost a wasted effort diving down beyond a very high level NAV/share valuation. You can read a few of these older analysts efforts on the SFX website, then multiply their target prices by 1.5 (give or take to reflect ~50% improvement in TB's metrics) for rough guess what the new CFS is worth. eg Dr Chris Baker's last effort from Bridge St Capital in Dec 18, base case risked and diluted valuation of $1.64, multiply by 1.5 for a new CFS target of $2.46. That is close enough to my base case valuation, so for those without time you can move on. Otherwise, and you know this isn't going to be a short post, grab a cuppa and follow me down the rabbit hole.

    From what I've seen post-tax NPV8% to be the most appropriate figure to value a project on. This figure for the old BFS was $620M, and if we net the improved pricing against the capex increases could generously assume it remained the same today at long term TZMI pricing. The new CFS will have a post-tax NPV8% of ~$900M in imho, a 45% increase. Share price valuation is the tricky bit, determined critically upon dilution assumptions much more than any market or commodity price influence. To minimise dilution and maximise shareholder value SFX has obviously chosen to go down the partner JV funding route. So let's first look at what JV funding deal is required by SFX and how attractive that looks to a JV partner.

    In simple terms, SFX needs to sell down enough of the project to cover it's equity contribution requirement plus a bit more for cash/corp buffer. This logic shows tells us what SFX is pitching for as a minimum, there is no point going to the market for a CR top-up when the JV funding would be made at a much higher price. Table below shows how much a JV partner had to pay for various % of the TB project, at various discounts to the 2017 BFS $620M post-tax NPV8%. eg Buying 50% of JV a 0% discount costs half $620M, or $310M. Buying 50% of JV at 50% discount costs half again, or $155M etc.

    https://hotcopper.com.au/data/attachments/1639/1639234-0c34f007bc176d8ab19fd515f739c5d7.jpg

    The residual share of the critical 'equity gap funding' SFX needs to cover it's ownership of the JV obviously goes up with lower % of the JV sold down. On a 50:50 JV, SFX needs half the CR$237M equity funding gap to pay for their remaining half of the project. That is the green cell of $124M at a 60% discount to NPV. The red cell reflects extra funds required to replenish corporate coffers above of the funding equity gap. If 30% of the project was sold, SFX needs to stump up 70% of the $237M equity gap, or $$166m which is the green cell at only 10% discount to NPV. A 10% discount is simply too skinny to attract any JV partner IMO, as I will reinforce later based on annual EBITDA returns for the JV partner. For same reason I think selling 35% at 30% discount to NPV was also not realistic, selling 40% for around 40% discount was the best possible outcome for SFX, but only then if strategic value was recognised by the partner to justify very modest returns. It seems clear to me at least that returns after buy-in for potential partners was simply to be worth the risk, even at 60% disc for a 50% JV (highly desirable by big companies who don;t want to be distracted by small, minority positions). Thus back to the drawing board and Plan B.

    A JV partner has to look at their potential investment return based on an ' all-in " investment cost (ie purchase price plus share of JV equity funding gap). Then comparing such returns to their own internal return hurdles against other competing projects for that capital including internally owned projects that do not come with a 'buy-in' cost. The table below calculates returns based on this all-in investment cost against:
    1. the immediate investment return on a funded JV NAV metric ((ie (purchase price plus share of JV equity funding gap) / (NPV plus equity cont'n add-back, + explor'n value - corp costs)),
    2. Stage 1 annual EBITDA on total cost of investment
    3. Stage 1 NPAT on total cost of investment (incl interest
    https://hotcopper.com.au/data/attachments/1639/1639313-afaccbf06b8a147c922152efc24938b5.jpg

    Note the NPV return on investment is lower than the "discount" sold at because of the extra equity gap funding dilution effect. Although a 20% profit on investment at 35% discount may look attractive from an NPV point of view, the EBITDA and NPAT are not very attractive at 35% discount considering the high equity funding commitment. The NPAT sits roughly midway between a full debt interest figure and no interest figure, and is only included to show that EBITDA is a long way from the actual final net return JV partners can expect. Most corporates are chasing higher returns on their capital than the 2107 BFS presented and have better competing options. Reality is that even at 50% discount to NPV buy-in, JV partners are looking at modest annual returns. Stage 2 obviously gets better but not before more capital is sunk and years down the track.

    Now look at how the new CFS might look on a same-same comparison (CFS = $900M post-tax NPV8%).

    https://hotcopper.com.au/data/attachments/1639/1639330-f09764f570fd8155648a977bf2d4b734.jpg

    Straight-up with approx 45% increase in NPV and $100M knocked off the 'equity gap funding' requirement the JV sell-down required by SFX changes enormously. The 'break-even' sale required is now either a much lower JV %, and/or at much higher discounts to the NPV. The 'JV funding curve' (JFC, I just coined a new financial acronym haha) has shifted up and to the right making a JV deal much more likely and attractive to both parties. Selling 50% would now be at such cheap prices to be off the table, nobody will sell 50% of the great new TB CFS for a 85% discount to NPV, insane. Put another way, SFX would be selling $450M of discounted post-tax value for $68M... nah. Maybe SFX would sell 50% for $250M and make a capital return to shareholders of $145M surplus cash, or $0.50/share but at that point I think the partner would just make a TO instead. A 25% to 30% JV sale looks most likely as it funds SFX equity gap with enough left over to pay off debts and put extra cash in the kitty. How attractive is a 25-30% JV purchase around 40-50% discount to NPV for the JV partner though?

    https://hotcopper.com.au/data/attachments/1639/1639342-7ef0b4889aedd72ce5f1110e2a914df4.jpg

    Compared to the old 2017 BFS, clearly very attractive! At 40% discount to NPV the JV partner is getting an immediate 41% capital gain profit on total investment, but EBITDA and NPAT have also risen approx 50% into the sort of returns corporations are looking for. At 50% discount to NPV a JV partner would make an immediate 63% cap gain, then look forward to 26% EBITDA and 15% MPAT annual returns on Stage 1, now well above their weighed cost of capital and very competitive with competing internal projects. Returns selling at higher discounts to NPV get so ridiculous to be off the table now, and selling higher % of the JV simply isn't required. Add in strategic interest from corporate that wanted exposure to or hedging for world class Zr and TiO2 long life production and the investment decision looks a no brainer. Stage 2 numbers get better obviously, and the whole project without LTR processing simply looks far simpler and lower risk from an operational and sales point of view. Heck, SFX can give away 30% at 55% discount to NAV and be sitting very pretty indeed.

    How does this feed into a share price target today? Unsurprisingly I've a spreadsheet for that, but the simple answer is if you sell 30% into a JV for $135M, SFX after paying $94M equity into the JV, retiring debts ($15M) and with $25M cash left over is worth about $2.60 NAV/share for the 70% of TB it still owns. If instead, SFX were to raise the $135M 'equity gap' plus $40M extra cash on market while leave existing shareholders with a residual 70% share of TB, they would have to place $120M shares at $1.46. ie a placement leaves current SFX holders in essentially the same situation as selling 30% of TB into a JV for $135M. Clearly that's not going to happen given recent history and the need for CR placement holders to come out of the CR trading halt with a profit on market. The partner JV is clearly a preferred funding path.

    My logic is that fully funded, low-risk developing projects like TB's new CFS are discounted to about 50% of NAV two years out from mine operating at nameplate capacity. That discount covers build risk, ramp-up risk, mine/plant performance risk, time and market risk etc. Over two years that discount diminishes as milestones are met and the project becomes de-risked and starts washing it's own face. Shares will ultimately trade at say 10% discount to NAV and analyst price targets, all things being equal, with upside or downside for the commodity cycle etc. A 50% discount to $2.60 NAV/share is $1.30, which is the fundamental reason a CR will never get away at $1.46, there is no 'next-day' upside for placement holders and brokers will not be interested. Using this logic however, in the unlikely event no JV holder is found or TO eventuates, I can say that equity raised at $0.90 still shows broker placement holders with a 20% profit if shares list back at 50% of the NAV, and approx 135% profit 115% profit if they held 2 years for 90% of NAV/share.

    Sorry, more detail than you're interested in but I wanted to explain my point. The CFS is has increased valuation and reduced the equity gap requirement such that that a go-it-alone placement CR is now an option at prices much higher than on market today, while same logic on the 2017 BFS showed nothing over 30c CR price was realistic. The two feasibility studies look remarkably chalk and cheese considering they are both founded off the same project.

    Of course I don't think it will come to a market placement CR. The project is now so profitable, and the equity funding gap so reduced, such that the project shifts from a middle of the pack also ran, to one of the few truly rare and highly profitable commodity opportunities of scale up for grabs. Long life, Teir 1 jurisdiction, world scale production of both Zr and high quality chloride slag feed Ilm (after LTR), exploration upside, strategic value etc all add to the appeal of course. However, the fact is that a 30% investment for $135M shows a tremendous return of an immediate 100% capital gain on the purchase price, a 63% cap gain on the total investment including equity funding, Stage 1 26% annual EBITDA return, circa 15% after int and tax profit, lifting to 43% and 26% respectively for Stage 2. The CFS TB project simply doesn't need strategic or subjective valuation to justify an investment, the financial return alone demands it.

    2ic's call; either a 30% JV for $135m and shares come back on market at about $1.25 (50% the new ~$2.50 NAV) or we are taken out at $1.85/share. First the CFS release, then dog and pony show to potential partners, hope the markets don't crash of course, wait and see if we get a JV or TO. Like the industry super fund adverts say, it's not too late....

    Good luck


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