Mineral Asset Immunity

Considerable uncertainty has been injected into the energy mineral market by the emergence of a novel coronavirus first in China and then nearly every other country in the world.  China has extensive deposits of coal, which is a critical energy source at home.  The rest of the world is probably more interested in the materials China produces that are needed in sustainable devices and vehicles.  In 2018, China produced 8,000 metric tons of lithium needed for the lithium ion batteries that have become the ubiquitous component of sustainable devices.  This puts China at number three in the world for lithium production.   It is also a top producer of aluminum, magnesium, antimony, rare earths, and graphite. 

China’s influence in energy minerals does not end with mining.  The Red Dragon is also busy with graphite processing, another key material in lithium ion batteries.  In field work related to the coverage of Westwater Resources (WWR:  Nasdaq), an energy minerals developer in our coverage group,  the most recent developments in the graphite market were a central line of scrutiny.

Surprisingly, accordingly to Roskill, an industry research firm, graphite prices have remained stable.  Indeed, by the end of March 2020, medium and large size flake graphite prices were posting well above lows established near the end of 2017.  Likewise a recent report from FastMarkets pointed to a 3% increase in prices quoted in Europe for medium and large flake graphite during the first two months of 2020.  Particular attention is paid to medium and large flake graphite given the preference of lithium-ion battery manufacturers for these grades.

Firmness in pricing may be due in part to interruptions in supply stemming from government policies related to the coronovirus threat that has matched a slowing in orders.  We note that Syrah Resources, which began mining natural flake graphite in Mozambique in 2018, has suspended production at its Balama mine in compliance with government orders.  Graphite India also shut operations in the third week in March 2020, in response to local health policies.  At the same time, graphite buyers have also been shutdown along with all other non-essential businesses.   China graphite processing operations were shut down in February 2020 for an extended ‘New Year celebration.’  China processing operations are free to open again, but restart of business has been slow as some employees have chosen to remain in self-isolation.

Westwater Resources CSPG

In our view, pinpointing near-term prognosis for either graphite supply or demand remains more or less a fool’s occupation.  Investors might be able to sidestep this problem as regards Westwater and other energy minerals developers because it is the long-term dynamic that is more important for these companies.  It will be until well into 2021 when Westwater is expected to ship its first battery-grade graphite product to market.  Additionally, initial orders are likely to come from a customer that has already been in discussion for some time with Westwater management.  The pricing in those orders, if and when they are received by Westwater, are subject to negotiation and will likely be based on the pricing dynamic that is in place at the time. 

In early March 2020, equity values collapsed on worries over the impact of a coronavirus pandemic and inadequate government policies to deal with the threat.  According to Yardeni Research the price-earnings ratio of the S&P 600 Small-cap Index is 15.9 times. This compares to a price-earnings multiple of 18.5 times at the end of December 2019.  It is likely the reduction price/earnings multiple is due largely to a shift in sentiment that requires higher compensation for risk and uncertainty. 

The shift in risk sentiment is also evident in the mining and minerals sector.  Over the last two months it can be observed that valuation multiples have decline by approximately 15% for a group of energy materials developers and producers.

The health crisis is more akin to a natural disaster than an economic event or even to a business event, in that it is exogenous to the world economy and to company operations.  However, unlike in a natural disaster event, corporate assets remain intact and unchanged by a health threat.  Shutdown policies to combat and mitigate the health threat certainly impact near-term earnings of energy materials producers that must shut down operations. 

Yet for energy minerals developers like Westwater Resources in the long term such a health threat is not likely to impact asset value.  After all, minerals resident in large tracts of land are likely to remain unperturbed by a health disaster playing out across the world.  Those developers that can continue near-term development work, even if it is just at the kitchen table, it means value creation is still underway.  Indeed, shifts in the supply chain that may topple China's dominance could very easily be a plus for energy mineral developers in other regions.  Those companies could very well be immune to coronovirus and now very much undervalued.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.