Whereas most of the graphite companies listed on the TSX Venture Exchange aren’t producing graphite yet, Elcora Resources (ERA.V) actually is already producing from its 40% owned Sakura graphite mine in Sri Lanka. In this report we will investigate the profitability of this operation, Elcora’s future plans and discuss the geopolitical risks of doing business in Sri Lanka.
We also had a discussion with Dr. Ian Flint, Elcora’s Vice-President of Processing and Refining.
The Acquisition of a 40% stake in the Sakura mine in Sri Lanka
Unlike most other listed graphite companies which are still in the development stages, Elcora Resources was able to negotiate a deal with a local Sri Lankan partner whereby Elcora acquired a 40% stake in the Sakura mine. As per the mining laws in Sri Lanka, a 40% stake is the maximal allowed stake held by a foreign entity. On top of the direct 40% equity stake in the subsidiary which owns the project and all necessary licenses, Elcora is also entitled to a 20% stake in the net mining profit and an additional 30% of the processing profit (whereby the graphite will be upgraded from a head grade of 94%C to 99.9% C) will flow directly into Elcora’s treasury.
As said before, the Sakura mine was already in production at the time of the purchase albeit at a very low rate of just 20 tonnes per day. This was caused by some operational bottlenecks caused by the use of explosives in the underground mine which resulted in a one shift per day operation as the mine needed to be ventilated before the miners go back in. With the arrival of Elcora on the Sakura-scene, the efficiency and productivity has been increased really fast and the company should be at an annual production rate of 1000 tonnes per year now. This should increase to 2,500 tonnes per year in the first half of next year.
The graphite in the Sakura mine has a very high grade as it averages a purity of approximately 94% which would receive a price on the market of roughly $1,500 per tonne. However, Elcora Mining is currently constructing a processing plant which should increase the grade of the end-product from 94% C to 99.9% C. This might sound like a small difference but it will allow Elcora to double its price for the graphite.
About the upgrade works and the financial situation
The construction of this processing plant is still on schedule and should cost less than $750,000. As you can see, the Sakura mine doesn’t demand large up-front capex and the money Elcora is putting in should dramatically improve the economics of the project. The processing cost per tonne will be roughly around $200, but this will allow the company to fetch a price which will be $1,500 per tonne higher than the current product.
Elcora Resources has raised cash earlier this year and should have sufficient cash resources to finish the processing plant. Unless there’s a possibility to opportunistically raise cash, we don’t expect Elcora to tap the equity markets again, unless the company wants to have a larger financial buffer. On top of its cash position, Elcora also owns 443,136 shares of the Global Resources Investment Trust which is listed in London. The market value of this investment is – at the current share price and GBP/CAD exchange rate – approximately C$240,000, but the NAV of the underlying assets is roughly half a million, so there’s no rush to sell this position.
Additionally, the Sakura mine has roughly 500 tonnes of Direct Shipping Graphite on its premises, and this could be sold immediately to generate additional cash flow. At this point in time we’d estimate the fair value of this stockpile to be $0.5-0.75M. There is however no urgent need to cash in on this stockpile, and after talking to CEO Troy Grant we have the impression Elcora would like to ‘leverage’ this stockpile to kick discussions with potential offtake partners in a higher gear.
What are the next steps?
Elcora won’t stay at a production rate of 2,500 tonnes per year for long, as the company is planning to rapidly expand this to 5,000 tonnes and 10,000 tonnes per year within the next 18 months. The capital expenditures for the expansion plans should be covered by the cash flow generated under the 2,500 tpa scenario. We expect the further expansion to quadruple the initially planned output to be cheap as the current set up of the processing plant will allow Elcora to quickly add parallel circuits. The total price tag from 2,500 tpa to 10,000 tpa will be probably be less than $5M and this includes developing additional adits to known vein structures. As you can imagine, the low capital requirements and high operating margins will result in sky-high internal rate of returns.
In a longer term plan, Elcora plans to increase its production rate even further to 20,000-30,000 tonnes per year and this could easily be achievable given the fact there are numerous mine openings on surface which could easily be rehabilitated.
What’s the value of this project to Elcora Resources? A calculation of the Net Present Value
As there is no official NI43-101 compliant resource estimate or PEA on the Sakura mine, investors have been left a bit in the dark as the company isn’t allowed to publish non-compliant numbers. We have made some calculations based on a 40% stake in the mine, a 99.9% graphite price of $2,500/t (which is conservative as the company is aiming to receive $3,000/t) and an all-in sustaining production cost of $700/t (this includes mining, processing, additional exploration and sustaining capex). The corporate tax rate is 28% in Sri Lanka and there’s a 5% royalty payable to the government, as well as an export tax of $10/t.
Again, these NPV estimates are our own and not an official company guidance. These numbers (which we think are quite conservative) are only meant to give you an idea what the effective value of the project is if the aforementioned assumptions come to fruition. The calculation is also assuming a phased production increase from 2,500 tpa in year 1 to 10,000 tpa in year 3 and 25,000 tpa from year 5 on. The capex for these expansions will be budgeted at respectively $5M and $15M, which is also on the very conservative side. Even though the historical resource estimate estimates a mine life of in excess of 100 years at a production rate of 25,000 tpa, we will limit our mine life to 20 years, for simplicity’s sake.
We have been quite conservative with our input numbers and even under the most conservative scenario with a discount rate of 15% being applied, the fair value of the 40% stake in the Sakura graphite mine (even ignoring the 20% on mining profits and 30% on processing profits) is much higher than the current share price of C$0.19. We usually get nervous when we see price targets at a multiple of a share price, but if Elcora’s plan effectively works out, then its investors will be in for a fun ride.
About Sri Lanka
Most investors aren’t familiar with Sri Lanka, so we’d like to clarify the situation a bit here.
Sri Lanka and Graphite have always been connected with each other as graphite was already discovered on the island in 1675. The peak of the historical production occurred in the first 15 years of the 20th century and right before the Great War, this tiny island was supplying half of the world’s graphite. So it’s needless to say that Sri Lanka is definitely familiar with graphite mining. However the sector went downhill fast and whereas roughly 2,500 graphite projects were producing by the time the Second World War started, there currently are only three producing underground graphite mines left (of which Sakura is one).
The country’s mining code is very straightforward, and Sakura will have to pay a 5% royalty to the government on top of a 28% corporate tax rate. An additional export tax of $10/t will be due when the graphite will leave the port of Colombo. Infrastructure around the project is pretty decent and the government will construct a highway just two kilometers from the Sakura mine gate. This will significantly reduce the time needed to truck the end-product to the port of Colombo.
There is an exploitation license in place and there’s no maximum tonnage limit for the mining activities, so theoretically Elcora Resources can increase its production rate whenever it wants. The exploitation license and environmental license will be renewable every year, but as the property remains in good standing this shouldn’t be any issue at all.
Conclusion
Whereas most graphite companies are still in the planning stage, Elcora Resources now owns 40% of an already producing graphite mine. Once the additional measures to increase the efficiency will have been implemented, the production rate should tenfold to 2,500 tonnes per year producing an end-product with a purity of 99.9%. As the cost of labor in Sri Lanka is very low, the basic cash cost of Elcora’s graphite should be just $400 per tonne (excluding additional exploration and sustaining capex) which would result in an industry-leading operating margin of 84% based on a product price of $2,500/t.
Elcora is prepared for the worst and theoretically the company doesn’t have to get back to the equity markets anymore as once it reaches the 2,500 tpa output rate, the company will be self-funding and will be able to finance the further expansion plans out of internally generated cash flow. Our NPV models show that the fair value of the Sakura mine could be somewhere in between $137M and $199M (assuming a successful expansion of the operation), and Elcora’s stake in the project results in a fair value per share of roughly C$1. The main catalyst in the near future will be additional news on the company’s attempt to produce graphene. We are also expecting Letter of Intents with potential offtake partners and of course reaching the production rate of 2,500 tpa will be extremely important as well.
Q&A with Dr. Ian Flint
SGS is currently conducting rests to reduce the size of the graphite particles. Why is this an important step for Elcora?
Sri Lankan graphite comes in large agglomerations of graphite crystals that can be 94% pure from the mine. However, this is not a usable form for most users. They require a specific size distribution of particle sizes. While the maximum size is usually not specified it is typically about double the size of their largest stated size class. Thus, the Sri Lankan graphite has to be reduced in size. This is a unique challenge with Sri Lankan graphite as the graphite is being liberated from other graphite particles resulting in potential bending of the flakes. While this is not critical for most applications, it is for the high value applications that call for expanding the graphite and for the creation of graphene. Techniques to solve this problem with the Sri Lankan graphite had already been developed by Elcora prior to engaging in Sri Lanka and this test work is confirmation that these techniques work.
Sri Lankan graphite is essentially free of the graphite host rock liberation problems that most graphite mines have, meaning that the host rock is not bound with the graphite or wrapped in it during processing. This allows Sri Lankan graphite to be processed by physical means to far higher grades than most other types of graphite deposit.
The mill will allow the company to produce 2,500 tonnes of 99.9% graphite per year. How does the upgrade from the Run Of Mine grade of 94% exactly work?
The contaminates in the Sri Lankan graphite are silica and metal sulphides (iron and copper). Most of these occur as dice or larger sized chunks that can be removed by simple screening during the size reduction process. The rest is removed by a flotation step immediately after size reduction. The first flotation test has been performed by SGS; however, this test was not to improve grades but to see at what size the graphite could be floated. The results indicated that sizes well beyond a millimeter could be separated. This size will be considerably lowered in actual processing so we now know that flotation can be performed at any reasonable size of graphite particle.
Can you elaborate on how the water jet blasting works in an underground graphite mine?
Water blasting is simply a high pressure water stream. These devices are commonly used commercially and at the household level; power washers. This method can and is used in mines where there is a significant difference between the hardness of the valuable material (in our case the graphite) and the host rock. The mine is simply designed with a drainage system and sump pumps remove the water and suspended graphite. This removes the need for production blasting (but that is still required for development work through the host rock) and removal of the graphite using carts and or hoists as it is now pumped as a slurry from the mine. The water is separated from the graphite on the surface and returned for reuse making it a closed system.
Disclosure: We were engaged by a third party to commission this report. The author holds a long position. Please see our disclaimer for current positions.
