Zenyatta’s Serious Potential
Thursday, October 24, 2013 in Blog
If you look down the page of our blog you can see/read the various posts we’ve published since April of 2012 on Zenyatta Ventures. Our email subscribers also witnessed our very aggressive stance to load up when the stock traded down to 15 cents in August 2012. Since that time, ZEN roared to a high of $5 per share in less than 12 months, creating significant wealth for investors who held on through the volatility. $10,000 invested in August 2012 under 20 cents was worth over $250,000. This is why we are all here and play this game. Now, we’ve witnessed ZEN retrace roughly 50% from its 52 week high of $5. There has been a short attack with a case built on lies, propaganda, and outright malice. In addition, like no other company I’ve ever seen in my 20 year investing career, Zenyatta has been attacked in the press by competitors in its sector. When everyone hates you due to your success….you’ve done something right. I’m happy Zenyatta is seen as a threat to many flake graphite companies…..because it is; and their attacks in and of themselves should tell you something about the validity of that threat.
We’ve also witnessed a mass staking rush around Zenyatta’s Albany graphite deposit in hopes that companies who have done so, would share in the markets enthusiasm for Zenyatta. They are also obviously hoping that they can replicate Zenyatta’s success and hit drilling pay dirt. I, however, doubt anyone will do so, even those next door. But, I do wish every/ all graphite companies success! What the critics don’t seem to quite get is that trying to shoot the All Star/King of the sector in the back, only damages the valuations of the space. I’d love to see the market bid most all graphite stocks to premiums because the best of the best will be rewarded the most, instead of having to buck the sector trend. So, I wish them all well and believe the global demand outlook for high quality graphite on a macro level is bright.
Before digging into Zen’s “serious potential” I’d like to address my personal vulnerability to being wrong. First off, with the stock still near $3, I would say that a 10 bagger in less than 18 months since we uncovered Zenyatta and recommended it as our top stock can be considered a huge success. So, the last thing I want to see is a situation where a huge winning pick gives up all/most of its gains, particularly when dozens of our favorite gold stocks are trading at multi decade low valuations. With our literal sector of focus being so cheap, I am hyper sensitive to the fact that people have short memories, and all that matters is the now and what happens next.
I wrote the following in the GIL July 29th Premium Issue right after ZEN hit its high of $5: “I sold 10% of my Zenyatta around $4 and put all of the proceeds into a handful of gold juniors I like best. If/when ZEN hits the $5-8 range, I’ll sell another chunk, this one closer to 20% of my position to do the same. What we need to examine is risk/reward and opportunity cost over time. Zenyatta is up 2500% in a year. To repeat this type of return from $5 the stock has to hit $125 per share. For 10X….$50 and for a double, $10. Now, for TLR to go up 10X it has to go to $2 and 25X….$5. It’s much easier for a stock to go from 20 cents to $1 or $2 than it is for a stock to go from $5 to $25 or $50 per share. I am still going to be holding most of my Zenyatta because I do think that we’ll see double digits, perhaps yet this year, and that the company will be acquired before going into production. But anytime a holding is up 25 fold in 12 months, it would be crazy not to sell some of it and mitigate at least principal risk.”
The point here is that if I’m wrong on Zenyatta going forward, it’s not because I’m blind. As much as I believe Zenyatta will be worth more in the future, when the stock was raging to new highs, I did express caution and the above was meant as a logical gut check. This is the old Warren Buffett adage that was ingrained in my mind as a young broker: “Be fearful when others are greedy; and greedy when others are fearful.” Right now, we’re coming off of a steep decline that created much fear and confusion. Now, we have a respite and another chance to buy-sell-hold prior to significant factual developments from Zenyatta in the forms of an initial 43-101 resource estimate in the next 30 days and a PEA (Preliminary Economic Assessment) in less than 6 months.
To put ZEN’s stock performance into perspective, let’s take a look at how it has done versus other main graphite players:
Extraordinary! Literally every other flake graphite stock out there has floundered while ZEN has flourished. Now, I want to unveil some data we put together and published in a special report on Zenyatta back in February of 2012. Then, we’ll look at what we can assess that they have now as the drilling since that time, and lab application testing, has provided further clarity and de-risked the project in the last 9 months. Whatever Zenyatta’s future holds, I am reminded of an old adage by Jesse Livermore who said “The big money is made in the sitting/waiting”. If any of you have not read it, I HIGHLY recommend this excellent book called The Big Score:
This book has helped me not sell myself short with Zenyatta. A massive and valuable discovery can make a stock go from pennies to hundreds of dollars per share so I am not interested in putting limits on ZEN necessarily just because it’s up so much relative to its sector but want to get down to value and be ahead of the curve going forward. All who are investors in resource stocks will love this book….very well written. In fact, when I first read an article on ZEN, I recall a reference to Voisey Bay and their intent to find base metals not Graphite! Diamond Fields stumbled into Voisey Bay by accident also but made Robert Friedlund (a down and out promoter after the Bre-X scandal) a Billionaire.
Does Albany have Voisey bay potential? Yes. I’m not going to get into comps but will lay out the possible value we can award Albany and look at the potential profitability once this is indeed a mine. This report is somewhat of a speculation of what the PEA (preliminary economic assessment) will end up confirming in Q1 2014. I am going to post what we wrote verbatim below but keep in mind….we now can feel quite confident that we can double or even triple these numbers:
The key to getting a Net Present Value (NPV) is obviously figuring out potential tonnage at Albany. Well, let’s use a metric of 200x200M, depth of 350 meters, and a 2.6 rock density (conservative) and you would have 36,400,000 tonnes of ore. Now, remember this number because we’re going to cut this down by 20% and actually use it as our high case scenario in terms of a valuation metric. However, I feel this is not only a realistic number in terms of tonnage, but it could prove to be conservative at the end of the day. Again, more drilling is necessary to prove up this resource but we have several key ingredients available to us at this point. We have consistent base percentage grades thus far, an idea of cost structure, and the lynchpin in terms of final product purity capabilities and pricing. The final product selling level is instrumental to our internal rate of return (IRR), as well as, the cost to produce the graphite and get it to a 99% plus high purity product.
The purity is a critical component and the cost in which to strip other elements down and the process to get to 99% plus purity levels is clearly vital. One thing we’ll show that makes Zenyatta’s story so unique is their potential IRR on this project. Some graphite companies who are recovering a natural flake graphite product from the dirt have to remove DOZENS of other elements before a final product with 90% purity is achieved, which increases costs to produce considerably (Mind you, selling that final product for $1,000-2,000 per tonne in many cases). In Zenyatta’s case, from what I understand, they had to strip only TWO basic elements before processing to a 99.96% synthetic graphite end product. Prior to the recent lab results from SGS lakefield, I was mega bullish on Zenyatta even if they had a $2-4,000 per tonne cost structure. Now, it looks very safe to assume their cost is going to be below $1,000 per tonne, selling a product into the highest end of the market. We’ll use $9,000 per tonne for our model, which is a 10% discount to the lower end of the market price and it certainly could be conceived that end users would pay higher than $10K per tonne for this pure of a product (The 99.96 to 99.999% purity market demand is smaller but pricier).
One of the first movers in the space (happy to provide these companies names but we don’t want to tick anyone off) has a 43-101 technical report that is public where we can look at the NAV/IRR compared to the space and then compared to Zenyatta, which is on another planet with their numbers. If taking their NAV at a 5% discount rate (we’ll use double for Zenyatta as a conservative metric), and using prices in the mid-range case, comes to about $150 Million. Currently, with their stock near $1, their market cap is $50MM, a 30% of NAV valuation. However, remember the IRR component and their IRR projections in this range case is barely 20%. In their most robust categories, it would bump to 22.4%, while at the lowest it goes to 13.7% and it’s also worth mentioning the grades they’ve reported are in the 1.5% arena, less than 1/3 of Zenyatta’s lowest case.
Another late stage Graphite exploration company also has a public 43-101 report in which you have a product that will cost them $5,000-6,000 a tonne to produce. Their IRR is better at just over 30% on a 20 year mine life and at a $70MM market cap and NAV of $255 Million, we’re also at about 30% of NAV in terms of a valuation (closer to 28%). Build out costs for their mine is quite close to Zenyatta’s at approximately $150 Million (I do not believe it will cost more than $200MM to build a mine at Albany). When looking at the NAV and a percentage of NAV we see what companies in the space are trading at as main valuation metrics but will also look at potential cash flow numbers for Zenyatta. Earnings metrics are a ways off but they will eventually determine the kind of value the market will put on the stock.
We have to take a step back and make sure that when we analyze a potentially fair and attractive valuation the street will put on ZEN as a % of NAV, it isn’t apples to oranges. Now, the examples above are in the same sector but they have DRASTICALLY different economic profiles. Let’s look at even a Potash company (Western Potash) with somewhat similar economics to the flake graphite companies. WP has a current public NAV of $550 Million, which is $2.76 per share and there actual share price (although very suppressed at the moment) is 20% of NAV. I have found several analysts that have much higher share price targets with justifications of an 80% of NAV valuation. WP has an IRR component of 22% in their data. These are just several public company analogies for resource businesses with fairly poor economics and “decent” internal rates of return, yet still command 20-30 plus % of NAV valuations. It should also be taken into account that 2 of 3 of these stocks are trading near historically low valuations, where once the first Graphite company mentioned above traded at 100% of NAV last April when the graphite stock market was on fire.
I’m running through these numbers because once we identify a realistic NAV that Zenyatta will show in about 12 months once their PFS is complete, at what % of Net Asset Value will investors value the company? I’ll spare the suspense, my internal rate of return numbers for ZEN are 1,000% higher than the blended average of the 3 examples above! Not to mention, the capital costs for Zenyatta are relatively modest to generate this substantial of an IRR. Now, let’s run a few exercises to see what we have here….let’s first use conservative metrics with an estimation that Zenyatta has 20 Million tonnes of ore at Albany (recall our basic example above showing the potential for 36 Million tonnes) then we’ll run a lower and higher case but this is our realistic/mid-range assumption that I feel quite comfortable with…..
5% Grade and 90% recovery rate equals a finished product of 900,000 tonnes
Selling price= $9,000 per tonne
Cost of Production= $1,000 per tonne
Life of mine- 15 years
Tonnes per year sold- 900,000 divided by 15 years= 60,000 tonnes per year (this is less than 5% of the synthetic/high purity graphite market)
Estimated profit per year- pre tax earnings $480,000,000/$345,000,000 after tax earnings
After tax NPV @ 10% discount rate- $2.6 Billion
NPV assuming a $150 Million Capex/mine startup cost= $2.45 Billion
NPV based on 57 Million shares outstanding= $43 per share
Internal Rate of Return= 230%
Clearly, these numbers are incredible! Now, if we simply used a 0% discount to NPV, which would be appropriate as the mine becomes closer to reality, the numbers essentially double to $86 per share NPV. But, let’s use the $43 above and put a 30% discount to NAV as a fair market value and we get…..$13 per share!
Now, once we get down the road and Zenyatta is a play on earnings, can you even comprehend what the market value will be on net income of over $300 Million dollars? 10X earnings is a $3 Billion dollar market cap. At $2 per share currently, using a fully diluted shares outstanding number of 57 million, the market capitalization is less than $120 Million! To get to $3 Billion we are talking about $50 per share. But, for the sake of our long term price target, we’re discounting that analysis by 80% and getting our $10 share price, which is also a 30% discount to NAV we feel will be revealed within 12 months via drilling into a Pre Feasibility Study. Our $5 price target brings us into a very reasonable $250-$300 Million market capitalization range and $7 is still under $500 Million.
Now let’s talk risk because any stock with this much potential still has risk to get there and many of these numbers are still assumptions. We’ll need more drilling to prove everything out, including and not exclusive to, tonnage. Not to mention, there is always market risk, which needs to be kept in mind as well and even if our price targets are ultimately hit, this will be a very volatile ride indeed! That said, I am very confident we’re in the ballpark with our numbers and when we see engineers/analysts plug in numbers from a Preliminary Economic Assessment, they will be similar, if not even more robust, due to the fairly conservative nature of how we plugged in our assumptions. I.E. we assume the $150MM mine build out eating the costs all at once versus over time, which is more realistic.
Let’s do 2 more exercises and look at the numbers with 10MM tonnes of ore and also 30 Million tonnes, these being our low and high cases of analysis. I honestly think our mid case scenario of 20 Million tonnes of ore is conservative but certainly 10 Million should be utilized as a real “downside” scenario. Clearly, with the depth and consistency of the pipe mentioned above that we are open at depth and can simply drill deeper to increase reserves, the upside on tonnage is realistically also open even above our high case of 30 MM tonnes. It doesn’t really matter for now because even if we use 10MM or 20MM the stock is going to trade much higher. Also, in our numbers above, we used after tax numbers but likely analysts will use pre-tax in some of their models, leaving upside. We are taking a 38% tax rate into consideration, which may vary in reality, but I think is reasonable to use.
** Eric Here: I am only publishing the 30MM tones analogy because, quite frankly, the 30MM tonne scenario is now the very LOW case. 10-20MM are obsolete and proved to be too conservative.
5% Grade and 90% recovery rate equals a finished product of 1,350,000 tonnes
Selling price= $9,000 per tonne
Cost of Production= $1,000 per tonne
Life of mine- 15 years
Tonnes per year sold- 1,350,000 divided by 15 years= 90,000 tonnes per year (this is less than 7% of the synthetic/high purity graphite market)
Estimated profit per year- pre-tax $720,000,000/$518,000,000 after tax
After tax NPV @ 10% discount rate- $3.9 Billion
NPV assuming a $150 Million Capex/mine startup cost= $3.75 Billion
NPV based on 57 Million shares outstanding= $65 per share
Internal Rate of Return= 345%
**Back to current comments:
There are several things that stand out to me that I think we can tweak in terms of PEA expectations. #1 the tonnage is much higher and I think we can use 50-60MM very safely. However, I think the engineers may take a more conservative tone on annual production. Let’s cut the production marks in half from these two scenarios and you have 30,000 and 45,000 tonnes annually. Keep in mind that this automatically doubles the mine life from 15 to 30 years and I’m speculating the minimum mine life we see will be 40 years, which is way more than enough.
The other tweak I would make is with recent confirmation of being able to sell into very high end markets we should see an average selling price between $10-$12,000 per tonne. So, use $11,000 average and double the cost structure to $2K per tonne (I still think it will be under $1k per tonne) and you’re looking at $9,000 per tonne in PROFIT. Even the lowest case is $270,000,000 pre tax annual income and just under $200MM net cash flow per year. The very realistic 45,000 tonnes per year is $405,000,000 pre tax profit and over one quarter of a Billion $$ in annual net cash flow!
There is no doubt in my mind that we will have between 1.5 and 2 million tonnes of finished product here as 50MM tonnes with a 90% recovery rate and 4% average grade is 1,800,000 tonnes. If you take that number and divide it by 45,000 tonnes of annual production, you have a 40 year mine life, which is incredible. If there’s ample demand in the marketplace and they can sell twice that amount annually, you’re still looking at a 20 year mine life and then if you want to take the cost down to $1k per tonne, you’re approaching $1 Billion per year in pre tax profits. Put a 10X PE on those numbers and your calculator might break!
This stuff is reality folks. It may not end up being exact (in fact I know it won’t) but that’s what the PEA will help assess, even though the first blush PEA will be conservative. My numbers are meant to mimic that conservative nature, not to be disappointed by the engineers. So, what happens next? Well, we’re now less than 30 days from a 43-101. The biggest problem we have with this stock is two things: Not enough institutional ownership (aka too much retail) and lack of credible analyst coverage from bigger firms. I truly believe the 43-101 could be a game changer for the first problem. There are many institutions who have been introduced to Zenyatta and like it. But, their internal mandates much of the time requires a 43-101 resource to buy these stocks.
So, with that in hand, I do believe we’ll see new fund buying into the end of the year. Frankly, that’s what’s needed to go to $10….retail won’t do it. The second piece we could do without and still succeed but if Zenyatta takes steps to take this mine into production themselves, a big juicy financing does await some firm(s). Along with that will be big boy coverage. We may see some new coverage by smaller firms after the 43-101…we shall see.
Frankly, I hope the second piece never becomes an issue. This is because I still believe Zenyatta will be bought out and probably sooner than people think. I think there is better than a 50/50 average that ZEN gets acquired before the PEA is released in Q1 2014. Many possible end users/buyers of the company are now testing the product for their uses. It would not surprise me in the least if one of the larger entities that see how good this graphite is make an offer for the company. How much can we get is the question. I’ve stated that I wouldn’t entertain anything below $500MM, which is ironically right under $10 per share (our ultimate price target). It’s going to depend on price action to a degree between now and Q1 if this scenario plays out and if we leap back into the spotlight with a strong stock, the premium could be huge.
The biggest reason is because the goods are there. If Albany produces the higher end of our ranges, this could be the most profitable mine in Canada for the next couple of decades! Short term when looking at the daily chart of the stock my biggest concern is the lower highs and lower lows. This trend will need to be decisively broken on the upside before I get too excited. However, look at this thing of beauty below….the weekly chart:
I’m extremely confident that hanger we see from last week when it flushed to nearly $2 was the low. I’m anticipating another move short term well into the $3’s but met with some resistance at the lower highs down trend line near $3.40-$3.50. However, after some successful backing and filling, I think we make another run into/after the 43-101 and I would not write off the possibility of brand new highs before year end. The stock today is marginally higher than when we wrote the special report in February 2012 but look at how much additional data and color on the project we now have. This is clearly substantially larger than when we ran our numbers early in the year and the profitability/IRR is insane. By the way, my numbers in February were only for the East pipe and the analogies above are for the east alone.
In summary, Zenyatta overpowered its opposition with ease but was knocked down in round 5 with a lucky jab. Zen has dusted itself off and is now playing a little rope a dope but all I care about is whether or not this horse finishes strong (http://en.wikipedia.org/wiki/Zenyatta). Zenyatta the thoroughbred racehorse only lost one out of 20 races. We just had our first loss this fall but now I think it’s time to head back to the winner’s circle. The potential is there for the numbers walked through here to be bested considerably. But, even if we bank on our mid- range examples this stock will be trading in the double digits at some point. I believe individual investors have a unique opportunity to have some much confirmation prior to an inevitable rush of institutional investor’s post 43-101.
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Disclaimer: I am long Zenyatta Ventures and wrote this article myself. I am offering ideas for your consideration and education. I am not offering financial advice. I am not a financial or investment advisor and am acting in the sole capacity of a newsletter writer. I am a fellow investor and trader sharing his thoughts for educational and informational purposes only. This publication is a 100% subscriber supported. No compensation is received by the author from any of the companies mentioned for the recommendation of a stock in this service (if this changes or there is exception-it will be clearly disclosed to our readers). *Medallion Resources is a sponsor of GIL. Opinions and analyses were based on data available to authors of respective essays at the time of writing. Although the information provided on the Website is based on careful research and sources that are believed to be accurate, Mr. Muschinski does not guarantee the accuracy or thoroughness of the data or information reported. The opinions published on the Website belong to Mr. Muschinski or respective associates and are neither an offer nor a recommendation to purchase or sell securities. Mr. Muschinski does not recommend services, products, business or investment in any company mentioned in any of his essays or reports. Materials published on the Website have been prepared for your private use and their sole purpose is to educate readers about various investments. By reading Mr. Muschinski’s essays or reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these essays or reports. Investing, trading and speculation in any financial markets may involve high risk of loss. We strongly advise that you consult a certified investment advisor and we encourage you to do your own research before making any investment decision. Mr. Muschinski, Gold Investment Letter’s employees and affiliates, as well as members of their families, may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.