March 26, 2018
Without the twitter and online-forum fan clubs that come with being a public lithium company these days, Sigma Lithium Resources has quietly been progressing a high-quality lithium project in Brazil. The project, which previously belonged to Australian Sons of Gwalia (prior owners of Greenbushes), has 9 historical lithium mines, and over 200 pegmatites in the company’s 4 properties. We recently learned of the company and project when we attended a roadshow presentation given by management in NYC. Given that the company is officially listing the stock on the TSX-V soon, we decided to give readers a deeper look into what we believe is a high-potential lithium project and company.
Located in the mining town of Aracuai, the project is split up into 4 properties, which the company plans to develop in stages. The initial drilling and development has focused on one major ore body, Xuxa, which was a historical lithium mine. The company defined a 13.5Mt resource at an average grade of 1.56% Li2O (~520kt LCE). While not massive, as the company continues to drill the other properties, they are expecting to expand the resource considerably to 61Mt, or ~2Mt LCE, by H2 2018. To help put that into perspective, compare that to the Mount Marion lithium project co-owned by Neometals, Mineral Resources, and Ganfeng Lithium. That project has defined a larger resource of ~78Mt, but at a lower grade of 1.37% (or roughly 2.5Mt LCE). So we can see that Sigma has the potential to be a significant scale project, placed on a lower size tier than the Kidman’s or Pilbara’s of the world, but above the Altura’s, and Critical Element’s type projects.
Currently, in the companies test work, they’ve been able to concentrate the spodumene to up to 7.2% in their Xuxa deposit. Furthermore, given the large crystals which are visible to the naked eye, the company is able to produce a concentrate that is more of a coarse product. While this is a factor many gloss over, we feel it is important to point out. Smaller grain sizes require a finer, dust-like mixture post crushing, which lead to lower end-stage recoveries given the higher rate of loss of lithium units. Consequently, if Sigma is consistently able to produce a product with larger particle sizes, they will be able to command a premium price in the open market, or achieve lower costs via higher recoveries when converting to carbonate/hydroxide in house.
In terms of project development, the company is currently working on expanding the resources of the other ore bodies, conducting the feasibility study, building a pilot plant, and working on permitting/environmental studies, all of which they believe will help drive a valuation re-rating in 2018. They expect to have completed the feasibility study for their main, Xuxa, deposit by the end of 2018, at which point they’ll move on to conduct studies for the other ore bodies. If all goes well, the company expects to begin production by late 2019, and reach commercial scale production of ~220ktpa of spodumene concentrate (~25-30kt LCE) by 2020.
In terms of operating costs, we will wait until the feasibility studies are completed to get official numbers, but currently, the company expects that they will be able to produce at $175/t of spodumene concentrate. As you can see from the below chart, Sigma is expecting to be among the lowest cost spodumene producers in the world.
Combine this with the fact that the company is expecting low project capital expenditures of only C$65m and you see why we were first attracted to this company. Given that the project is located in a mining town, and that it was previously home to lithium mines, much of the infrastructure needed to host the project is already built. It is well served by infrastructure, roads, a nearby hydro power dam, transmission lines, and water, all of which help keep capex low. Additionally, there is a regional airport in town, and an air hub about 300km away connected by a main road. And once they’ve produced lithium, there is a paved highway connecting the town to Port Vitoria which they can use to ship product.
This is the million-dollar question, and something we try to keep an eye on especially given the runaway nature of valuations in the lithium industry exhibited as recently as a few months ago. Without the feasibility study results, we have to rely on simple multiples like EV/Resource to get a rough idea of how this company fares on a valuation basis. Using such a multiple, at the C$2.50-C$3.00/share post-money valuation range of their recent private placement, the company would fall anywhere between $218 and $261/t LCE when using the 13.5Mt resource they have currently defined. Compare that to similar stage peers like Critical Elements, Frontier Lithium, or Nemaska who trade in the $200-$350/t LCE range. However, if the same analysis is done at the expanded 61Mt resource, the EV/Resource multiple drops way down to $62/t LCE.
While such an analysis is a good way to quickly gauge it’s standing among peers and determine that there is a case to be made that the company could be undervalued, we prefer not to solely rely on this metric. We’d prefer to see where the market settles at before comparing to public comps. But even then, we don’t like relying on comps-based valuations because we can come up with justifications for each company as to why they trade at a higher or lower multiple. As such, unfortunately, we believe it is too early for us to definitively pin an actionable valuation on this company. Rest assured though that once we get more data, we will be updating readers on how we feel about the valuation, much like we did for ALB, Altura Mining, and Lithium Americas.
Now does that mean we just wasted our time going through this whole analysis? Not at all. First, given the standing among peers, we can at least see that the valuation risk is more to the upside than the downside when considering the potential for resource expansion, and the fact that Sigma will not require as much capital to construct the project as the others will. These factors enable us as investors to feel comfortable starting a position while staying in tune with developments from the company, and adding at reasonable levels along the way.
Next, as value-oriented investors, above all else, we love finding good companies with solid management teams and high-quality projects operating in industries with favorable fundamentals. This company certainly fits that criteria in our book. However, the hardest part of being a value investor is the patience that comes with waiting to see how the market prices the company before acting further. If the stock takes off to beyond reasonable levels, we’ll keep it on our radar, and stay ready until we get an unexpected selloff like the one the lithium sector has seen to start 2018. At that point, we’ll quickly reassess to make sure the story hasn’t changed before adding to our position in a good company and a reasonable price.
On paper, Sigma has put together a great team, headlined by Calvyn Gardner, who possesses over 20 years of mining experience. Another interesting member of the team is Itamar Resende, who is the former CEO of AMG Brazil and UK, one of the major mining operators in Brazil who have been producing tantalite in the country for over 20 years. Of course, if you’ve been following us, you are aware that AMG is now focusing on developing their project to produce lithium. Finally, we’d like to note that the CFO, Thays Jorge, possesses experience as a finance executive with FMC, the agricultural giant who is currently spinning out their lithium business. Beyond these individuals, the team is rounded out by a good mix of mining and business experience.
On paper, and in our discussions, management is solid, very knowledgeable, and seems capable of bringing the project online and developing relationships with customers. However, given the stage of the company, it is too early to definitively grade management, so we will keep readers posted as the companies grows and evolves.
Lately all investors have been hearing about is the questionable long term outlook for lithium in terms of potential oversupply and lower lithium prices. Aside from this obvious risk, there are a others to pay attention to when evaluating Sigma. The company is still in an early stage and a couple of years from producing meaningful cash flows. As such, investing at this stage comes with a lot of executional risk. Furthermore, although it’s not as large of a requirement as their peers, the company still needs to raise capital for their project funding. There is no guarantee that they will be able to satisfactorily complete this endeavor. And even if they do, it may come with terms harmful to equity investors.
Long story short, we believe Sigma Lithium Resources is another undervalued lithium company that has been flying under the radar, something we expect to change now that they will officially list the stock. We will be keeping up with updates from the company as they progress the project along, and will be putting out updates along the way. Among other things, we believe it will be important to use the additional information to fine tune our thoughts on the valuation and reassess the size and scope of Sigma’s lithium operations. So make sure you are subscribed via email or Twitter to stay up to date on all developments as they hit the tape!
Disclaimer: We do not own shares of Sigma Lithium. This is not investment advice, and readers are encouraged to do their own research prior to making investment decisions.