Target Price: $2.00 ↓
Changes Today?
December 3, 2012
Great Western Minerals Group Ltd. (GWG – TSXV, $0.26)

The Less Common Approach

? Downstream to Profits: We recently visited Less Common Metals (LCM) and were pleased to see a fully functional Ulvac stripcast furnace, a brand new operations building and a very impressive team with extensive REE industry experience. While Steenkampskraal is integral to the Great Western Minerals Group Ltd. (GWG) business model, being its primary source of REOs, LCM is no less integral as the source of the bulk of GWG’s future profits. In spite of some likely bumps in the road, we retain our STRONG BUY rating, but we are lowering our target price to $2.00.

? Visiting Birkinhead: The new LCM building, outside Liverpool, is an impressive facility. With one working Ulvac 600 kg per pour furnace in action and a second that has just been commissioned in China and will be shipped to LCM shortly, the facility is beginning to take shape.
The first Ulvac furnace is now operational, and it is producing test batches for customers. Every magnet alloy customer has a preferred mix of trace elements in their alloys, in spite of the fact that, other than Dy concentration, almost nothing will alter magnet performance for the better (and Dy serves mainly to improve operating temperature range).

Exhibit 1 – 600 kg Ulvac Furnace and Stripcasting
Source: Less Common Metals
The Ulvac furnace is a stripcaster, which melts 600 kg of metals under vacuum, then pours the resulting alloy through a slot onto a rapidly spinning, water-cooled copper cylinder. The molten magnet alloy striking the copper cools quickly, allowing the alloy of iron, neodymium/praseodymium and boron to form a highly valuable crystal structure that is capable of the intense magnetic field strength that gives it value. Unlike magnet alloys made from samarium and cobalt, NdFeB alloy is non-eutectic, meaning all metals within the alloy do not melt simultaneously. If NdFeB is allowed to cool slowly, as could happen if is poured into so-called “book molds” to make thicker plates, then iron crystals begin to precipitate out of the alloy. This “free iron” in the remaining magnet alloy is capable of supporting, as would be expected, no more than the relatively low magnetic field strength of iron. NdFeB alloy containing free iron requires a great deal more processing time and energy to be applied by a magnet maker in order to have the alloy take up the free iron and fulfill even a reasonable fraction of its potential. Stripcasting is a way to ensure that free iron does not become an issue while manufacturing NdFeB magnet alloy.

At this point in time, Furnace #1 is paid for and installed at LCM. Furnace #2 is half paid for, and it will be delivered and installed prior to the end of 2012.

The staff at LCM is also beginning to study the use of electrolytic cells for the making of rare earth metals from oxides. Rare earth fluorides are heated in a graphite crucible insulated with ceramics. A metal electrode serves as the cathode, to eventually accept the pure rare earth metal. Neodymium or didymium oxide is poured into the fluoride flux, and a high current (4,000 A @ 12 VDC) is passed through the liquid, both keeping it molten as well as sending Nd or Nd/Pr metal to the cathode while oxygen is sent to the graphite anode. If this sounds something like the making of aluminum from alumina, it is exactly the standard Hall- He´roult process. The cell operates continuously for about three months until it is shut down for refurbishment. During this period, each pilot-scale cell produces 5 kg of Nd metal per hour; six such pilot cells can supply one 600 kg Ulvac stripcast furnace. Ultimately, larger cells will be required as the allocated area within LCM for metal making is not large enough to accommodate 30 cells and their individual power supplies. However, these pilot cells, built in China, will serve as the base from which LCM will develop a fully functional set of completely automated Hall-He´roult electrolytic cells, designed to operate without any attendants, 24 hours a day for three months. And in completing this development, LCM expects to be able to at least match or possibly undercut Chinese metal-making costs.

Exhibit 2 – Hall-He´roult Cell at LCM
Source: Less Common Metals
LCM plans to recruit its staff of metal makers from the decimated British aluminum industry. We believe there is the potential to not only develop techniques that are specific to LCM with this staff, but there are large numbers of techniques that can simply be appropriated from the aluminum industry and be re-deployed.

All told, LCM should work its way up to a total of five or six Ulvac furnaces over the next two to three years. There is also a need for a sufficient number of electrolytic cells to process the material from Steenkampskraal. LCM will retain its complement of older furnaces for both Sm and La alloys. In the end, the facility should have an annual output of approximately 3,000 tonnes of NdFeB alloy along with approximately 400 tonnes of other products. This will likely cost a total of less than $15 million, almost completely financed out of cash flows.

All in all, we conclude that LCM is progressing as it should, to support downstream revenue and margin generation from the 1,000+ tonnes of Nd2O3 and Pr2O3 made as part of the 5,000 tonnes of TREO to be produced annually from Steenkampskraal.

? Speaking of Steenkampskraal and PEAs: Visitors to Birkinhead were also told that mining operations at Steenkampskraal would commence no later than the end of 2013. One has to bear in mind that Steenkampskraal, even producing 5,000 tonnes per year of TREO, is a tiny mine. At nearly 19% average grade, and even if we assume a wildly pessimistic 80% TREO recovery rate, this is a 32,000 tpa mine. It is not outrageous to suggest that even a few analysts could successfully remove 32,000 tonnes of ore per year from Steenkampskraal.

Mining must commence at or before the end of 2013 to feed the completed hydrometallurgical and SX facilities, both of which should be in production by mid-2014. Thecompany remains committed to building a SX plant through a JV with Ganzhou Qiandong (GQD).
Our one and only concern with respect to Steenkmapskraal and GWG’s overall operations is that the PEA to be released imminently may contain a contingency requirement that will suggest GWG is in further need of capital. We can see methods by which GWG can reduce its immediate need for capital, thus rendering any need for a contingency moot, but we readily acknowledge that any shortfall on paper will be received negatively by the market.

? Speaking of GWG: Recently, the company re-stated Q2 financials, to better account for the effects of the most recent convertible offering. These results did not substantially alter the financial results, differing only in the evaluation of numbers of shares.

And as of November 29 the company released Q3 financial results. Revenues, driven by LCM, remained at roughly the level of 2011, which given the price deterioration in REOs since the beginning of H2/11 is extremely positive and supports our thesis that revenues from downstream, engineered products will always be less volatile than that derived solely from commodities. Admittedly, while this protects on the downside, it limits the upside, but we believe that REO prices will remain under pressure during 2013 as both Molycorp Inc. (MCP – NYSE, Molycorp) and Lynas Corporation (LYC-ASX, Lynas) crash into the market.
GWG’s cash balance remains robust at $54.6 million, but with hydrometallurgical and SX plants to build, this should be the case. Our analysis suggests that, should it be necessary, it may be to GWG’s benefit to initially toll process its REOs, especially for Nd and Pr content, either in China with GQD or elsewhere in the world, and defer the necessary $30 million expenditure on the JV-built SX plant in South Africa. The JV SX facility can be funded from future cash flows rather than from existing capital. Such action would likely only delay the JV SX plant for a year, and could well prove to be essential to bringing the entire mine-to- market model to production.

? Financial Modeling: We have refined our model for GWG yet again. This time, we assume mid-2014 production, but at a 5,000 tpa TREO rate. We assume our published REO price deck, and that alloy continues to sell for at least $60/kg (an effective $200/kg Nd/Pr metal price) in the future. We assume at least a 10-year mine life, which is supported by our visual inspection of the size of the monazite vein visible on surface at Steenkampskraal, and the assumption that the belowground extent of the deposit elsewhere along the vein is, on average, the same as at the existing mine. We also assume a gradual ramp of production within LCM, through the use of material from Steenkampskraal as well as elsewhere, to an eventual 10,000 tonnes per annum of magnet alloy. Our assumed total cash cost of alloy made using material sourced from Steenkampskraal is $18/kg. Our assumed cash cost of production for other REOs is $8/kg, but producing these TREOs is necessary given a desire to make the most important three TREOs, namely Nd, Pr and Dy.
By using an 11% discount rate, we calculate a NPV for the company of $2.50/sh. We will reduce our target price to $2.00, and acknowledge that the market has a dim view of rare earth companies and any financing risk at present. However, as one of the very few near- term producers of REOs outside China, and as a company with very significant downstream product intellectual property and experience, we feel GWG can rebound from any difficulties it encounters in the next 12 months.

? Conclusion: GWG remains our rare earth junior Top Pick. With production of engineered products outside of China, and with a near-term target for substantial output, GWG remains one of the industry’s strongest stories. As Molycorp and Lynas begin to demonstrate the value of REO production outside China, we feel GWG will be the most likely indirect beneficiary. We maintain our STRONG BUY rating, while establishing a reduced target price of $2.00.

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