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NEXT ARTICLE Unknown Aussie explorer riding on the African mining boom

Investors highy leveraged to the resources sector get worried every time there’s a blip in commodity prices, or when news from China is less promising than normal.

Recent economic data out of China was a good example of news causing a sell off in commodity prices. 

Beijing announced this month that China’s economy accelerated in the fourth quarter, with gross domestic product rising 9.8%, and inflation up 4.6% in December from a year earlier. It’s an ominous sign that the world’s second-largest economy may be overheating – and it’s feared that China’s surging growth rates could push Chinese officials to redouble its efforts to slow the country’s economy. Prices for oil, copper, grains and other commodities tumbled across the board.

Many investors are wondering if we have we seen the top in commodity prices for the time being, or if this is buying opportunity.

Share prices on commodity pure plays have enjoyed a tremendous run since September last year – as markets assumed that China economic growth would continue running at the same rapid pace as before the financial crisis hit.

With expectations that China growth could well meet the 8 percent mark, its appetite for raw materials and energy will most likely continue.

Bell Potter Securities senior client adviser Stuart Smith believes that commodity price falls on the back of China’s December GDP and inflation figures were overdone.  ‘The market has been quite aware that the growth was over 10 per cent.  All they’re (China) is trying to do is stifle speculation without denting the momentum that they’ve built up in the last 30 years.’

If you’re looking for take advantage of the recent price decline in commodities, Sundance Resources Limited (SDL) is an interesting pure play on iron.  SDL shares have increased more than 250 percent last year and are currently trading about 25 percent below the 52 week high it made earlier this month.

SDL is an interesting play for several reasons: firstly, it’s one of the few iron DSO pure-plays with a large scale, low cost project. Global diversified miners such as Xstrata, Rio Tinto, Vale and BHP Billiton have recently shown interest in West Africa for iron ore developments, and steel companies are seeking projects to secure long-term supply, thus reducing dependence on the iron ore majors mentioned previously (Vale, RIO & BHP).   

Sundance Resource’s market capitalization is $A 1.26 billion with 2,709,996,000 shares issued.

Company Description

Sundance Resources Limited is an international iron ore company, based in Perth, Australia.  SDL undertakes iron exploration in Central West Africa, where the company’s major asset is the Mbalam Iron Ore Project in the Republic of Cameroon. The permit is 100% owned by Cam Iron SA, in which SDL has 90% ownership, with the remaining 10% held by local Cameroon investors, with a portion held in trust for the Mbalam community.  SDL acquired the Mbalam permit in 2006.

Recent Events

Many important events occurred in 2010 for Sundance Resources. The most tragic included the death of its entire board in a plane crash in the Congo.

The other event was signing two key infrastructures MOU with two different Chinese groups.

The first MOU was with CRCC China Africa Construction Group for the study of the development of a railway for the Mbalam project. The second MOU was with China Harbour Engineering Co with similar studies for a bulk materials harbour port in Cameroon. The news of the MOUs was quickly followed by the announcement that that China’s largest investment bank, CITIC securities agreed to assist in securing debt and equity financing. The table seems set for a very big year for SDL.

2011 will another important year for Sundance Resources, starting with the expected results of a definitive feasibility study by the end of the first quarter. Upon completion of the DFS, assuming positive results, SDL will look to secure a strategic partner and financing. 

Sundance Chief Executive and managing director Guilio Casello recently told Resource Stocks that “2011 will be the year where we deliver a lot of the promises we have made over the past few years”.  He also said that 2011 “really is going to be the turning point” for SDL.  Construction of the rail is scheduled to start in December 2011, with mine and port construction starting in second and third quarters of 2012.  You can read more of Casello’s interview here.

Broker Reports

Analyst Fluer Grose of Southern Cross equities increased his price 12-month price target for SDL from $0.77 to $0.81 in his latest research report. Southern Cross’s Grose valued SDL at $1.10 using a Discounted Cash Flow model that assumes SDL has an 81% and 76.5% share of cash flows from CamIron and CongoIron respectively, and carries the government’s 10% share of capex. One of the most important variables for valuing mining projects like SDL is the assumption of future AUD iron ore prices.  Grose’s model used a price curve of future AUD iron ore prices with spot prices of $0.81 and rises to $3.35.

Any valuation model for SDL will have to factor in future dilution when Sundance will most likely have to sell a part of the project to further finance its activities.  Grose’s model discounts SDL’s valuation based on the assumption a portion of the project is sold to an offtake partner at a discount to his valuation, and that further dilution occurs due to an equity financing in 2011.  After taking some additional factors in consideration a 12-month price target of $0.81 seems reasonable. Grose’s report can be found on Sundance’s corporate website.

Southern Cross Equities report – Sundance Resources

You can also find broker reports by Bell Potter and Stonebridge Securities Analysts.  Stuart Howe of Bell Potter has a price target of $0.72 and Stonebridge Analyst Luke Smith target is $0.66. Bell Potter’s valuation of SDL is currently $0.72 based on DCF with the following assumptions: 10-year DSO project only and broker consensus iron ore and currency forecasts, and a 10.5% discount rate.

Bell Potter report – Sundance Resources

Stonebridge report – Sundance Resource

Mbarga and Nabeba Resources

SDL’s Mbarga and Nabeba resources were drilled following the analysis by BRGM in the 1980s. BRGM is le Bureau de Recherches Géologiques et Minières, a French public institution with responsibilities including geological surveying. The analysis concluded that high grade (DSO) hematite cap overlies a large itabirite resource. The geology of the Mbarga and Nabeba resources is such that a high grade direct shipping hematite cap (averaging 62% Fe) of up to around 140m depth overlies lower grade (38% Fe) itabirite mineralisation. This elevated nature of the resource, with minimal cover, should enable a relatively low strip ratio with low cost mining from the surface.

Project summary: Mbarga and Nabeba

SDL’s focus is the development of the Mbarga and Nabeba iron ore mines that is being broken up into two stages:

Stage 1:

Stage 1 key features are: Integrating two mines to deliver +35Mtpa iron DSO for at least 10 years ramping up from 2013.  Mbarga project forecasts 15-20Mtpa iron DSO and Nabeba ongo projects 15-20Mtpa iron DSO for crushing and blending with Mbarga ore. Stage 1 will also see the construction of a rail corridor approximately 480km in length, linking the Mbarga mine to port approximately 50km south of Kribi in Cameroon. Port infrastructure construction will occur simultaneously with the rail. The port is expected to be able to handle loading 300kt bulk (ChinaMax) vessels at a rate of 35

Estimated capital cost of Stage 1 to be around US$3.8b (including 20% contingency).  This will require an offtake partner.

Stage 2:

Assuming no other DSO exploration success, Stage 2 will follow the exhaustion of Stage 1 reserves (expected in around 2024). Stage 2 projects 35Mtpa and a 15 year DR pellet and blast furnace concentrates. If the exploration is success at targets close to Mbarga and Nabeba it is anticipated that it will extend the Stage 1 beyond the planned 10 year life. There is also potential for the project to be expanded beyond 35Mtpa through additional port infrastructure and train sets.

Stage 2 key features are: Investment in processing facilities to beneficiate the low grade (38% Fe) itabirite ore into high grade pellets for direct reduction (DR pellets) and high grade concentrates for blast furnace applications.

Risks

SDL is still in the development stage and still confirming reserves. The company expects operations to start producing revenues some time in 2012 and will not become profitable until approximately 2014. It currently has negative operating cash flow and negative free cash flow, which is not uncommon in a company that’s not producing yet. SDLs operations will be affected by continued price volatility in commodity prices. Commodity prices are driven mostly by Chinese demand which could be negatively affected if the Central Bank of China tightens monetary policy more than the market expects.

Summary

Sundance Resource is an interesting play given that it is one of the few large scale, low operating-cost iron ore projects.  With projects anticipated to collectively produce 35Mtpa at a cash cost of around US$20/t FOB for 10 years ramping up from 2014, SDL is an attractive strategic partner for any of the major diversified miners. With upside potential to improve the project’s current economics and extend the DSO mine life given the Itabirite resource beneath the current resource. This itabirite resource underpins the project’s long-term potential. 

With the Definitive Feasibility Study expected to be completed by the first quarter of 2011 and commencement of construction aimed for mid-2011, SDL future looks bright.