Kodal Minerals - Less than Impressive

http://www.kodalminerals.com/


Kodal Minerals (LSE:KOD) listed on AIM on the 30th December. Kodal is a small mining company operating in Norway, and its admission to trading has been highly successful with the shares are up almost 200% on their admission price. Immediately you probably think that the company's fundamentals are excellent. The reality is that they are not, and this is another company that I would class as being an overvalued AIM mining stock. The rise in Kodal's share price is little to do with the fundamentals of the company, and more down to trading momentum thus the valuation is ridiculous. For that reason I am immediately putting Kodal on a Sell tag. I'll outline the glaring reasons for that in this article. Kodal is currently trading at a share price of 2.04p having listed at just 0.7p which, with 670m shares in issue, means the junior miner is valued at £13.64m. As it stands, this valuation is difficult to justify despite the very bullish comments of broker SP Angel.


As per the chart above, Kodal clearly has momentum in its favour. Going against momentum is a risky tactic, so for that reason, the Sell tag is only for 50% of the standard £5,000 on the review results page. I will initiate the remaining 50% dependent on the market movement. Also, once again down to the momentum, this is a trade based upon a short-term correction materialising.

Looking back at the chart, the shares are trading upwards in a classic fashion, with steep rises and short, sharp pullbacks in between. The shares ultimately won't trade within this channel indefinitely, so will break out either horizontally or downwards. That would be a bearish signal, and could be fuelled by profit taking. So far there have been no real retracements that have signalled that it was a good time to take profits. The fact that volumes were very low on the first couple of days of trading indicates that the market was not overly impressed with the listing, as otherwise there would have been more initial interest. The shares look to have drifted up quite quickly going into the close on January 1st and that allowed momentum traders to mark it up on the morning of January 2nd and momentum has built from there onwards. The chart is not particularly bearish yet, but the fundamentals are weak enough to support a Sell tag at this price.

Just at this point, it's interesting that most of the shares which rise hundreds of percent, very quickly, have a low absolute share price. A few that spring to mind are REM, COMS and SAR. That's mainly down to these shares having a low market cap, but you do have to wonder whether it's also partly down to investor psychology and a low absolute share price being perceived as 'cheap' when the shares are in an uptrend.

As before, Kodal listed on December 30th at 0.7p, meaning the company was capitalised as £4.7m. As part of the admission, Kodal acquired a company known as Kodal Phosphate AS from Tetra Minerals, a Finnish private resource development company. From the admissions document, it appears Kodal Phosphate was out of cash and that was perhaps the reason for the acquisition, placing and admission. Kodal Phosphate has an exploration licence in Norway's Vestfeld County, located 85km North of Oslo where there is decent infrastructure and good transport connections. As an operating environment, Norway is a secure jurisdiction, and perhaps helped by the government's ambition to diversify away from their oil & gas industry.

The project spans 3 extraction licences with the permit expiry date in 2023. Exploration has already been undertaken, which has discovered a Titano-Magnetite (Iron) and phosphorus deposit. In the late 20th century, a company called Norsk Hydro investigated the project area and the surrounding area. Whilst they did not follow up the potential, they did say that the Kodal project area was the only area to have any economic potential. Through previous exploration, a JORC compliant total contained resource has been calculated at 2.34Mt P2O5 (Phosphorus in its in-situ form) and 10.51Mt Fe (Iron). This resource has been uncovered within two geological sections known as the Main Section, and the Transition Section.

To Kodal's credit, the one thing they do have is a very high grade phosphorus resource, which when turned into concentrate, has reached 41.8% P2O5 with a low minor element ratio meaning that the concentrate is of high quality. Broker SP Angel has said that the high grade means that it can either be used to increase the grade of lower grade phosphorus concentrates, or that it can be sold to the animal feed market. Further to this, they say that the project has a discounted cash flow valuation of $327m, and that once accounting for capex, this figure falls to $205m. They equate this to 31p per share, and then divide by 10 (supposedly to account for risk, but who knows) and reach a figure of 3.1p/share. This is their target price. The 12-month target price is higher at 4.5p with that seen as conservative in the longer run. Furthermore, on January 2nd they said that when Kodal listed at 0.7p, it was a 'bargain' and that the low valuation was due to the time of the listing.

Upon the IPO, Luke Bryan, Chief Executive Officer of Kodal Minerals commented:  "Following the fundraising and IPO we are looking forward to a busy year in 2014. The focus is now on completing the Environmental and Social Impact Assessment along with related preliminary engineering works. Once completed these studies will form the basis of permit applications leading towards an operating licence. The Company will also be undertaking marketing studies on its high grade phosphate concentrate (41.8% P2O5) and will be conducting some additional tests to try to improve on its 62% Fe concentrate."

This is where the criticism and negativity begins. I'll start with SP Angel's part in this whole IPO who are the financial adviser and broker to the company. However, the connections don't stop there.
- SP Angel directly hold 5.22% of the company's shares
- Partner of SP Angel, David Facey holds 3.21%
- Partner of SP Angel, Robert Wooldridge holds 7.47% and is a director of Kodal
- Partner of SP Angel, John Mackay holds 7.47%
- Consultant at SP Angel and Co-Founder of SP Angel, Emin Eyi holds 4.5% and is also a director of Kodal

For SP Angel to therefore be the broker giving price targets seems somewhat suspect. After all, you have to question how impartial their price targets and analysis is when they've got connections throughout the company (the total 'connected' holding exceeds 25% of Kodal Minerals) - Note that SP Angel also took a large amount of the IPO fees in shares. FTAlphaville also points out that Kodal's offices are within the same Mayfair address as SP Angel's. This all seems a bit too close. I wasn't at all impressed by SP Angel's comment that the low price was due to the time of year of the placing. They could have IPO'd at a different time of year or even have delayed it until the New Year if necessary. As a broker, they should know that ,and given that they hold a massive influence in the company, to say that is a pretty poor excuse.

There is more credibility if the broker is separate from the company - the two shouldn't be joined at the hip. A small consolation is that Allenby Capital is the nominated adviser.

Whilst this isn't exactly a huge issue, it does mean you have to start questioning the bullishness of the advice given by SP Angel. A 4.5p target price within 12 months implies almost 450% of upside on the placing price, which is absolutely ludicrous in my view, and the basis given for it seems quite woolly. The fact that the DCF retrieves a figure of 31p epitomises why I attribute very little value to these sorts of valuations when a company is nowhere near production (which Kodal have said could start in 2016). DCF valuations are only really useful for a company near production or in production. That is why junior explorers rarely reach anywhere near these DCF valuations. To base a price target off that is therefore unrealistic. Brokers can always change price targets, so I don't understand why they try to set a price target for 3 years down the line. You don't see that happening for large companies, who change their target prices all the time. You also get wildly optimistic price targets for some of the small cap market. You rarely get price targets in excess of 100% for any mid/large cap company, so caution should be advised. These price targets rarely get met.

Onto the underlying fundamentals. At the current share price, Kodal is valued at £13.64m. That is questionable for one simple reason. Kodal only recently bought the Norwegian permits, and they only paid around £1.84m for them. Cash on the balance sheet is only £708k after admission, so apparently we are meant to believe that an asset worth £1.84m a few weeks ago, is now worth £12.93m and is still cheap. I beg to differ. An asset is worth what someone is willing to pay. The fact that the acquisition was done predominantly in shares shows that it really isn't of that high a value. What bothers me even more is that the company did the admission and only managed to place shares at 0.7p. If there was so much demand and the investment proposition really was that convincing, they would have been able to get the admission away at a higher price. But they couldn't, and that underlines that the investment proposition isn't particularly good.

The acquisition did have a couple of other conditions:

- Tetra will receive a 1.5% royalty on any sales
- Options over 714,285,714 were given at 10p/share to Tetra that can be exercised if Kodal's indicated phosphate mineral resource reaches levels between 90Mt and 170Mt. 20% of the total options are unlocked with every 20Mt interval upwards from 90Mt

The latter condition is what is odd. The exercise price of the options is very high, and the total value of the options at that level is over £71m. The thresholds that need to be reached are also very high and the directors of Kodal believe the chance of them 'becoming exercisable in the near to medium term to be remote'. The condition seems completely disproportionate, but chances are that it won't get reached, even in the long-term so it's a useless condition in my opinion. The directors probably believe the same hence why they went ahead with the deal, but probably didn't want to write 'long-term' in the admissions document to prevent the tempering of optimism. In the minuscule chance that Kodal find a giant deposit, the exercise requirement is met, and the 10p level is breached, the options represent considerable dilution as they would more than double the current shares in issue.

The resource is a significant component of deriving a valuation though. Just before I get into that, you can't discount the weather risk in Norway. Snow is not uncommon due to their Northern position on the globe, and that can hamper operations, especially if they are open pit.

To check the phosphorus part of the valuation (I already know the iron component is not overly valuable), I did a quick comparison with TSX listed GB Minerals (who operate in Guinea-Bissau), as below:


This confirmed my initial thoughts, that the actual resource value whilst in the ground, is low, despite the phosphorus concentrate being very high grade (note that only in-situ grades are shown above). The concentrate grade of GB Minerals' resource is 33.1% so quite a bit lower than Kodal's, although the resource levels more than make up the difference. That said, you should attribute a higher £/t value than 0.31 to Kodal's resource due to the grade - even so, the valuation isn't large. Given that GB is only valued at £3.30m (£13.11m when adding back net debt), the current valuation of Kodal is far too high. GB has been listed for long enough so that the market can derive a fair valuation - Kodal has not. The CAPEX requirements are slightly different. Kodal has estimated £75m pre-production for a 1.6Mtpa operation, compared to GB who have estimated around £95m for a 1Mtpa operation, so Kodal wins in this respect. However, the £75m figure seems to be of low confidence, with only a plus/minus 40% accuracy rate due to the lack of data such as whether power is available through the Norwegian national grid.

The total Kodal resource can be further divided into that from the main zone, and that from the transition zone. The two zones are relatively evenly split in terms of total tonnage, but the transition zone is of much lower grade.
For just the indicated resource:
- MZ:  8.8Mt @ 7% P2O5, 31.2% Fe
- TZ:   5.8Mt @ 2.44% P2O5, 13.4% Fe
and for the inferred:
- MZ:  15.7Mt @ 7.26% P2O5, 30% Fe
- TZ:   18.6Mt @ 2.33% P2O5, 12.24% Fe

You do therefore have to start questioning the economic viability of the transition zone and what the implications of that are. The competent persons report (CPR) that was commissioned alongside the Admissions Document stated that there was a possible JORC exploration target of 40-60Mt at a grade range of 1-4% phosphorus and 10-30% iron, but that there has been insufficient exploration to closer define that resource upside. That's not particularly good upside in any case, especially at the lower end of the grade scales. Consequently, CSA (author of the CPR) suggest that the focus should be on upgrading the existing indicated and inferred resources to higher categories. To do this would require an infill drilling program along with core sample analysis, and further test work. A scoping study should follow. CSA touted that the infill drilling should be around 10,000m -> 20,000m as a ballpark estimate.

CSA also commented on the 2013 metallurgical testwork results that the 'economic recovery of ilmenite [weakly magnetic titanium-iron oxide] wouldn't be possible' due to the high titanium levels and the difficulty of subsequent separation. In addition, bulk sulphide flotation tests didn't produce a saleable product. However, they did state that across the entire project, economic recoveries of P2O5 and Fe are achievable if the test sample is representative of the wider deposit. Perhaps the most important part of the CSA report was the environmental impact analysis. CSA said that the project area is heavily wooded, and criss-crossed by walking and cycle trails with the area seemingly an 'outdoor wilderness recreation area'. They stated this had the ability to have a 'major impact on the ability to obtain permissions to mine'.  In such a scenario, the permit would be worthless to a phosphorus miner, and the risk of such a project stumbling on environmental grounds is very much real.

That is ironic because Kodal weren't too keen to unveil the company's past. Deep within the admissions document, it is revealed that previously the company was called Clearphos Limited and that the name change occurred in light of the acquisition of Kodal. Clearphos held a 74% stake in Clear Phosphate Minerals which was an exploration company in South Africa. To cut to the chase, the exploration licence in South Africa wasn't granted and the business was subsequently closed. That's not exactly what you would call a successful venture.

The price of phosphate rock has also been in decline with it having fallen significant from its heights of $200/tonne in 2011, to between $100-$115/tonne currently. That has been driven by increased production rates (capacity expansions) and the Indian government cutting fertiliser purchase subsidies (phosphorus is a major component of fertilisers). As a result, demand from India fell. There is a silver lining in this respect - the high grade of the resource means that it attracts a premium price. There is also a slight silver lining in terms of the shareholdings of the company. Tetra Minerals, the directors and SP Angel/Allenby have all entered Lock-In agreements meaning that they can't dispose of shares on the market for at least a year. The flip side is that you can argue it is in their incentive to see the share price as high as possible upon the first anniversary of the IPO.

Looking into Kodal's management, it's a bit of a mixed bag. Whilst there is plenty of experience among the board, it's not necessarily all the right experience. For example, the Chairman David Jones is a former CEO of FTSE 100 company, National Grid (LSE:NG.). CEO Luke Bryan, is the former COO/CEO of North River Resources (LSE:NRRP). However, during his period at the company, the share price declined from 6p to around 0.55p when he resigned from his post. This is a very crude way of measuring performance, but a share price chart can tell a lot about the key management of a company. It is worth bearing in mind the major mining market decline.  Emin Eyi is also Managing Director of Tri-Star Resources, another mining junior. Over his period there, the share price has declined from 0.8p to 0.27p currently. Then you have the issue of a large number of the SP Angel connections as mentioned earlier. It's difficult to argue that the management team inspires much in the way of confidence, based on their past performances.

One thing to look out for is if a company sneaks any options packages in with the IPO. Kodal has issued a combined total of 40,000,000 options at the price of 0.7p to both Luke Bryan and an external consultant. In cash value that comes to a cash value of £280,000. Apparently that's meant to incentivise management, which is yet another ridiculous statement. The options have an expiry term of 10 years as well. If the management really wanted to incentivise itself it would have set the exercise price as over 1p (at least) with an expiry term of 1 year. What they've effectively done is potentially give themselves free money in advance, depending upon whether or not the share price is over 0.7p upon the vest date.

On a brighter note, the company have stated that they have sufficient cash for at least 12 months of operation, but that they will require 'substantial additional capital' beyond this. £770k was raised during the admission, although this figure drops to £708k when factoring in the cash cost to Tetra minus the residual cash balance. Net payables on the balance sheet amount to £108k. I say that is a brighter note, but it's not really. The reason being that there isn't much money planned to be spent this year and that means upside catalysts are few and far between. The joke is that, this year, more money is set to be spent on working capital and overheads, than on the actual project itself. £385k has been sidelined for costs versus £300k for project expenditure. This £300k has been pencilled in to pay for environmental and social impact assessments, and engineering studies. Offtake agreements are a possibility. Those news announcements definitely don't have the speculative appeal that often drives the share prices of small cap mining stocks. Therefore I can't see this market cap being maintained. The hot money will probably soon flow away, taking liquidity and the share price with it.

Usually I don't attach a Sell tag to shares that I don't see as good investments. The only cases in which I do is where there is a very poor risk/reward scenario for investors. Kodal Minerals has an exceptionally poor risk/reward ratio at the current price. For the market cap to be in double figures is simply a joke, and it's disappointing because there are many more companies out there with good fundamentals that are valued at less than Kodal Minerals. There are a whole host of risks relating to the permits in Norway, and I don't believe the venture will be particularly rewarding for shareholders - certainly not at the current price. Kodal highlights why reading through the entire admissions document is a must for any investors looking at an IPO. There is often a lot that can be uncovered from the details within. At 2.04p, Kodal is a clear-cut Sell for the reasons stated above.

UPDATE (06/01/14) - KOD has opened up at around 2.30p and I have triggered the remaining 50% of the sell tag at this price, taking the site average up to 2.17p. Whilst the momentum remains, I can wait longer than Kodal can stay overvalued.

UPDATE (10/01/14) - KOD announced a heavily discounted placing this morning at 1.25p. That suggests the board knew the share price was overvalued and thus initiated the placing. The share price did not quite reach the 1.25p placing price, so I have moved Kodal from Sell to No Rating at 1.375p for a 36.6% profit in a very short space of time. I remain very negative on both the management and the broker SP Angel who have been unduly positive, selling the market a story about an asset that really is not very good. The market cap has also dropped down into single figures for now (although the placing will take it back up into double digits). The institutions who bought in on the placing are likely to stem any real rise, as they look to turn a quick profit.

8 comments:

  1. Very interesting! Assets seem to be bigged up

    CraigJ

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  2. Pathetic from SP Angel. How something can raise in value so quickly is crazy. Good job el1te
    Good job FTaphaville for finding that the offices are the same!

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  3. Lol. The folks on LSE ramping KOD up a gear after reading this article.

    Hilarious. Spot on elite. This company is a complete joke

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  4. Thanks. I'll be avoiding SP Angel from now on I think!

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  5. very interesting and a detailed analysis with reasons!

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  6. Just a suggestion - put a quick disclaimer towards the top of the article mentioning you've updated your views to reflect recent price movements and that they can be found at end of article... or something similar. Most people won't bother to read the whole thing (which is well written/ balanced, by the way) so it may come across as a bit biased and out of date.

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  7. SP Angel of course includes a number of personnel from Fairfax I.S. swanking it up large from offices in Berkeley Square....no wonder that outfit went to the wall. This is an utter disgrace and looks as if the share price will stay at this level or lower for a very long time. Was not Luke Bryan shown the door at North River Resources ?

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  8. This very thorough examination has shown the proof is in the pudding, reflected in the current
    share price.

    ReplyDelete