After many years of consistent delivery, Western Areas ((WSA)) has downgraded guidance for the first time, as lower grades have affected production from Flying Fox and Spotted Quoll in the September quarter.
The former was affected by a seismic event that limited access to the ore and reduced grades, while for the latter grades were affected by a pegmatite intrusion. As Macquarie explains, around 40% of tonnage is mined at Spotted Quoll from development and intrusions can materially affect average grade when intersected.
The company expects the problems, particularly at Flying Fox, should ease in the second quarter and better production and grades should be encountered in the second half.
Western Areas has reduced guidance for nickel production by -10% while costs lift 8%. FY21 guidance is 17-19,000t of nickel in concentrate because an expected continuation of lower grades from Flying Fox in the December quarter. Cost estimates are increased to $3.50-4.00/lb.
Macquarie downgrades to Neutral, disappointed by the materially weaker result. It is evident to the broker that both mines are likely to produce slightly below reserve grade and this is now factored into the broker’s base case.
The outcome is a material reduction to the earnings outlook for the medium term and this opens up a potential funding gap by mid 2022, although Macquarie assumes any shortfall will be covered through debt agreements. A spot price scenario generates higher earnings over the next three years and this should remove the need for any additional funding, the broker adds.
Citi takes a more optimistic view, believing the sell-off in the stock is overdone and there is an opportunity now to buy a pure nickel stock, upgrading to Buy from Neutral. Price risks are to the upside in the broker’s view.
UBS reduces forecasts for production for FY21 to the lower end of the guidance range and lifts cost estimates to account for the more difficult mining conditions. Bell Potter agrees there is no avoiding reality as the two key production assets move into their sunset years.
This typically leads to lower grades, higher costs and less flexibility. The market needs to be aware of the higher risk this implies particularly, the broker points out, as Western Areas enters a capital-intensive period.
The future lies with Odysseus, UBS concludes, for which $335m over four years will provide a new 14,000tpa mine with a 15-year life. Yet, net cash has been reduced, and this will place pressure on the balance sheet to fund the $250m in expenditure required. Citi now models a modest drawing down on debt of $40m in 2022 to fund Odysseus.
Morgan Stanley expects there will be upside for the stock in the de-risking of Odysseus, which is progressing to plan. The company has also indicated it will investigate lifting mill capacity at the prjoect.
The broker, risking Odysseus at 90%, calculates de-bottlenecking and reaching capacity of 1mtpa with no extra capital could add around 9c a share and concludes the valuation is cheap.
Canaccord Genuity also risks Odysseus at 90% and expects Western Areas will fund a portion of its development via debt. The broker remodels the project with the recent inclusion of the AM6 reserve and extends the projected mine life until 2035.
During the September quarter a maiden reserve for AM6 of 2.1mt at 2.2% nickel was published. An integrated production schedule for the three ore bodies, which include Odysseus North, South and AM6, is expected mid 2021.
The main issue at Forrestania is how much of the downgrade to Flying Fox and Spotted Quoll is structural, Credit Suisse asserts, meaning whether nickel can be recovered in the future.
If structural, this would involve a reserve impairment and have implications for future production and costs. The company has indicated higher grade material has been deferred and that the downgrade is not an impairment.
Either way, the issues reflect increasing challenges, particularly as Flying Fox approaches the end of its life. Credit Suisse notes this mine has a history of seismic activity, although this has been inconsequential in the past as multiple mining zones have provided flexibility to access all from alternatives.
Flexibility is now reduced and therefore future production has a more heightened exposure to seismic or other incidents.
UBS agrees a consistent performance at the Forrestania mines is becoming more difficult as Flying Fox will end life in 2023 and Spotted Quoll in 2024. The broker considers the reserve downgrade at Flying Fox is still a risk and this may reduce the life of the mine further.
Canaccord Genuity asserts my life can be extended at Forrestania but this is likely to come from lower-margins sources. There is some potential from the New Morning and Diggers deposits and the broker models both, assessing New Morning is feasible at current prices. Diggers is lower grade and does not generate a positive valuation under current operating conditions.
Among the brokers not monitored daily on the FNArena database, Canaccord Genuity, has a Buy rating and $2.50 target and Bell Potter has a Hold rating and $2.10 target. The database has four Buy and two Hold ratings for Western Areas. The consensus target is $2.45, suggesting 27.1% upside to the last share price.