Sovereign Metals Limited (ASX: SVM) - Update

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1 Sovereign Metals Limited (ASX: SVM) - Update Ryan Armstrong Research Analyst ( ) rarmstrong@taylorcollison.com.au Security Details Ordinary Shares 217.3m Unlisted Performance Rights 1.4m Unlisted Options 15.2m Market Capitalisation (m, undil.) $23.9 Cash & equivalents (31/3) ~$2.8m Share Price (17/5/2017) $ week high/low $0.135/$0.061 Share Price Graph Investment Highlights 18 th May 2017 Speculative Buy Target Price 28c High-grade flake graphite has now been defined at the Malingunde Project (Malawi) over 3.4km strike length with cumulative across strike widths averaging about 140m. The primary focus is the saprolite-hosted graphite. Saprolite is a very soft, clay-rich oxide material that is formed from intense weathering of the original bedrock. The maiden JORC 2012 Malingunde saprolitehosted graphite resource: - Total: 7.1% TGC (4.0% TGC cut-off) - High-grade: 9.9% TGC (7.5% TGC cutoff) Free-dig mining and low strip ratios with mineralised material at or near surface will lead to low overall mining costs. Simple processing with no primary crushing and grinding will offer further capital and operating cost advantages. Directors Ian Middlemas Julian Stephens Mark Pearce Major Shareholders Chairman Managing Director Non-Executive Director Aterra Investments Ltd 4.46% Julian Stephens 4.45% Brown Bricks Pty Ltd 4.26% Pennee Osmond 3.45% Ian Middlemas 2.79% Malingunde ore test work has exhibited quality concentrates produced via a simple flowsheet, with metallurgical consistency and large flake size distribution. Results from the Malingunde Scoping Study are expected in Q Based on the low Capex/Opex aspects of the Malingunde Project, we view this as a positive step towards fast-tracking production. We continue coverage on Sovereign Metals Ltd and rate the company as a Speculative Buy with a 12 month price target of 28c/share (with upside based on the DCF valuation).

2 Malingunde Graphite Project NPV (TC Estimates) Graphite Price (US$/t) 1,200 Exchange Rate (AUD/USD) 0.75 Post-Tax NPV (AUD$m) - 10% DR ~135 Debt/Equity Split 50/50 NPV/share (fully diluted) Price Target (30% discount) 40c 28c FY17 FY18 FY19 FY20 Exploration (near-mine) (AUD$m) Feasibility Work (AUD$m) Capex (AUD$m) Working Capital (AUD$m) Total (AUD$m) Mining Ore (kt) Grade (% TGC) Production Details: Milled (kt) Recovery (%) Carbon Content (%) Graphite (in concentrate) (t) ,926 Cost Details: Mining (AUD$/t) Processing (AUD$/t) Transport (per tonne of concentrate) (AUD$/t) G&A (AUD$/t) Valuation: Revenue (AUD$m) Operating Costs (AUD$m) Royalty (AUD$m) All-In Cash Costs (AUD$m) EBITDA (AUD$m) Interest (AUD$m) (1.8) Depreciation/Amortisation (AUD$m) Finance Costs (AUD$m) Tax (AUD$m) Profit after income tax (AUD$m) Proceeds from Borrowings (AUD$m) Equity (AUD$m) Payments of Borrowings (AUD$m) Net Operating Cash Flow (AUD$m) P a g e

3 Executive Summary Sovereign Metals (ASX: SVM) is an ASX-listed graphite developer, progressing its 100%-owned Malingunde graphite deposit in Malawi. Prior to Malingunde, SVM was focused on the hard-rock Duwi deposit, 30km to the north-east, with a resource estimate having been defined along with the delivery of a Scoping Study. The Duwi Deposit was large and high-grade TGC) with a strong distribution of jumbo and coarse flakes, and was competitive on a cost basis next to its peers. Sovereign also looked at other opportunities within the Malawi Graphite Project and completed preliminary work on the saprolite targets. Based on this work, in 2016, a decision was made to shift the company s focus from the hard-rock Duwi deposit to the saprolite material due to the latter s superior economic profile. Malingunde is hosted within a soft clay known as saprolite. Sovereign has recently announced a saprolite-hosted mineral resource, which starts at surface and extends to vertical depths of ~30m. Typically this material produces the lowest-cost flake graphite due to ease of mining (with low strip ratios) and reduced blasting/crushing requirements. The deposit is close to quality infrastructure including a railway for direct access to deepwater ports such as Nacala in Mozambique. Water supply is also available in the area for operations and use of this will be investigated as part of the mining permit process. The metallurgical results presented by Sovereign so far have highlighted the simplicity and flexibility of the Malingunde process flow sheet. The test work has shown that increased grade of final concentrates can been achieved with minimal deterioration in flake size. Rather than a primary rod mill (used in hard rock operations), a scrubber is used to wash and disaggregate the material prior to the flotation phase, which will lead to reduced operating costs. Concentrate grades of up to 99.0% TGC across a number of different size fractions was produced through a simple, physical flotation process requiring no chemical or heat purification techniques. The high purity combined with outstanding flake distribution provides potential to attract a significant pricing premium in the traditional graphite markets; as well as the emerging Li-ion battery sector. Exploration/Resource Sovereign Metals reported a maiden JORC 2012 Mineral Resource Estimate from the Malingunde Project in April % of the total saprolite is in the Indicated Mineral Resource category and all the soft saprolite is within 30m of surface. Additional and substantial exploration potential exists within the a very large 3,788km 2 ground package, containing numerous other saprolite prospects discovered but not yet drilled. Beneficial features of the Malingunde deposit include: - A high-grade ~10% TGC which will provide the focus for the upcoming Scoping Study - Free-digging material for the life of mine and a very low strip ratio will equate to very low mining costs 3 P a g e

4 The total reported Mineral Resource is 7.1% TGC (saprolite, saprock & fresh rock; Indicated 80% + Inferred 20%). At an increased 7.5% TGC lower cut-off grade, the saprolite-only resource is 9.9% TGC (also Indicated 80% + Inferred 20%). Figure 1 Malingunde Mineral Resource Estimate at 7.5% TGC cut-off (source: SVM Announcement) Sovereign s intention is to focus the upcoming Scoping Study on the high-grade saprolite Mineral Resource. This 8.9Mt of high-grade material is expected to provide feed material for a significant mine life to be considered in the study. Figure 2 - Cross-section showing Resource blocks with TGC grade ranges (source: SVM Announcement) Infrastructure Malingunde is located approximately 20km south-west of Lilongwe, Malawi s capital, and boasts good access to services and infrastructure. The site will be serviced by an unsealed road, reconditioned and maintained by Sovereign, which will access the main Malawian M1 highway at Lilongwe. 4 P a g e

5 The proximity to Lilongwe gives the project a number of benefits: Access to a large workforce with daily (commuting) access for the Lilongwe-based personnel, removing the requirement for site accommodation and construction camps. Short 25km haul to under-utilised rail infrastructure at operational intermodal rail sidings at Kanengo and Balan gombe. Nacala deep water port in Mozambique undergoing major expansion (SVM investigating direct access via rail). Water is relatively plentiful in the immediate area and, subject to hydrogeological and hydrology investigation, the site is likely to be able to source sufficient water within the project. The access road will be upgraded for all-weather, heavy access suitable for heavy vehicle transit. Local and Lilongwe-based road use studies will be conducted as part of the project feasibility study evaluation before arriving at a final design. Initially the site will be powered by diesel generators and will remain the case for the purposes of any Feasibility Study. On a longer term basis, connection to the ESCOM HV power line could also be an option with further upgrades. Figure 3 - Infrastructure located near the Malingunde Project (source: SVM Presentation) 5 P a g e

6 Metallurgy Sovereign Metals continued with metallurgical test-work that focused on understanding variability and optimisation of the flotation process flow-sheet at Malingunde. A simple process flowsheet with no primary crush or grind was shown to produce both exceptional concentrate purity and outstanding flake distribution from the soft, saprolite-hosted graphite mineralisation. The results highlight the simplicity and flexibility of the Malingunde process flow sheet. Figure 4 Simplified Initial Malingunde Flowsheet (source: SVM Announcement) This work showed increased grades of final concentrates were achieved with minimal deterioration in flake size and achieved exceptional purity concentrates averaging 98.6% graphite, with 99.0% grade achieved across a number of size fractions. The metallurgical results also showed 71% of the final graphite concentrate exceeded 149µm in size, including 28% of +297µm jumbo flake and 9% of +500µm super jumbo flake. Figure 5 Flake Size Distribution at Malingunde after Flotation (source: SVM Announcement) Further to the initial metallurgical work, Sovereign has tested the graphite expansion ratios with positive results so far. Expansion ratios of 480 ml/g for +300μm jumbo flake and 450 ml/g for +500μm superjumbo flake were achieved, well exceeding those of typical Chinese concentrates. High expansion ratios are required for the production of high-value graphite products (outside of the lithium-ion battery sector). The concentrates were free of quartz grains and hence represent a good base material for the preparation of expandable graphite and production of graphite foils. Expandable graphite is used in 6 P a g e

7 various applications such as fuel cells, seals and gaskets, fire retardants and for thermal management in consumer electronics. Marketing Graphite is used in refractory applications, as a conductor of heat and electricity and in lubrication, and increasingly in advanced energy storage applications such as lithium ion batteries. The concern for the graphite market is primarily due to China s dominance on the supply side (80% of world production) and the reduction in high grade and/or large flake graphite production in the market. This is because oxide material at shallow depths is severely depleted in China (not the case at the Malingunde Project) and the increase in harder-to-process ore is leading to lower quality graphite concentrates being supplied to the market. This has forced market participants to secure additional sources of supply outside of China. Figure 6 - The Black Dragon Graphite Mine in China with depleted oxide material (source: Streetwise Reports) The new technology space (electronics, EV batteries, grid storage etc.) demands a high quality product and this is in short supply, with a number of Chinese mines closing down in recent years. The overall graphite market is expected to grow substantially over the next 5-10 years across the various industrial applications. The rapidly growing number of off-take agreements struck between Chinese graphite companies and foreign graphite developers highlights the point that market participants need to secure reliable graphite sources moving into an expected growth phase. Sovereign has indicated traditional markets will be the focus of their marketing due to the deficit of large flake supply. As at 2015, these markets accounted for over 80% of the total natural flake graphite market (see Figure 7). Notwithstanding, 7 P a g e

8 Sovereign will look to benefit from the EV battery space as growth continues in the sector, by providing a quality concentrate that suits multiple market end-users. Figure 7 - Natural graphite demand (2015) breakdown by end use Sovereign Metals Milestone Timeline Resource Scoping Study Downstream Test Work Further Metallurgy Feasibility Study Off-take Agreement/s Logistics Commentary Malingunde JORC 2012 Resource released. Further upside to be explored. Using the released JORC Resource, the economic parameters are currently being investigated for Malingunde. Further test work is being completed to test suitability of the graphite concentrate in a range of markets. This includes spherical and expandability analysis. Bulk test work in the process to confirm metallurgical flowsheet and confirm concentrate characteristics with potential off-take partners. To follow-on from results out of Scoping Study and optimise the mining operation. Discussions with potential off-take partners are advanced and marketing activities are ongoing with groups in China and Europe. Port and rail discussions are ongoing and will be covered within the permitting process over the coming 12 months. Status Completed Q Q Ongoing Ongoing Ongoing Commenced 8 P a g e

9 ASX Graphite Comparisons Figure 8 Comparison of Flake Distributions for ASX Listed Companies (source: ASX Announcements) Figure 9 Comparison of East African-Focussed ASX Graphite Companies (source: TC Estimates) 9 P a g e

10 Directors and Management IAN MIDDLEMAS B.Com, CA - CHAIRMAN Mr Middlemas is a Chartered Accountant, a member of the Financial Services Institute of Australasia and holds a Bachelor of Commerce degree. He worked for a large international Chartered Accounting firm before joining the Normandy Mining Group where he was a senior group executive for approximately 10 years. He has had extensive corporate and management experience, and is currently a director with a number of publicly listed companies in the resources sector. Mr Middlemas was appointed a Director of Sovereign Metals Limited on 20 July JULIAN STEPHENS B.Sc (Hons), PhD, MAIG - MANAGING DIRECTOR Dr Stephens is a Geologist with extensive experience in the resources sector having spent in excess of 20 years in board, executive management, senior operational and economic geology research roles for a number of companies. He has spent in 12 of those years working on African projects including 9 years on projects in Malawi. Dr Stephens holds a PhD from James Cook University, Queensland and is a member of the Australian Institute of Geoscientists. Dr Stephens led the team that discovered the Malawi Flake Graphite Projects. Dr Stephens was appointed a Director of Sovereign Metals Limited on 22 January 2016 and subsequently appointed Managing Director in June MARK PEARCE B.Bus, CA, FCIS, F Fin - NON-EXECTIVE DIRECTOR Mr Pearce is a Chartered Accountant and is currently a director of several listed companies that operate in the resources sector. He has had considerable experience in the formation and development of listed resource companies and has worked for several large international Chartered Accounting firms. Mr Pearce is also a Fellow of the Institute of Chartered Secretaries and the Financial Services Institute of Australasia. Mr Pearce was appointed a Director of Sovereign on 20 July DOMINIC ALLEN B.Com, B.Sc (Hons), CA - BUSINESS DEVELOPMENT MANAGER Mr Allen is a Chartered Accountant with over 10 years commercial experience, including senior roles with Rio Tinto Limited and Oyu Tolgoi LLC. Mr Allen previously worked for Ernst & Young Transaction Advisory Services, completing multiple resource and industrial transactions both in Australia and internationally. MATTHEW WHEELER B.Sc (Hons) MAIG - TECHNICAL MANAGER Mr Wheeler is a Geologist with over 20 years experience in mineral exploration. He has held various exploration and resource development roles on gold and uranium projects within Western Australia and the Philippines. Mr Wheeler was a co-discoverer of the Malawi Flake Graphite Projects. CLINT MCGHIE B.Com, CA, ACIS, F Fin - COMPANY SECRETARY Mr McGhie is a Chartered Accountant and Chartered Secretary. He commenced his career at a large international Chartered Accounting firm, before moving to commerce in the role of financial controller and company secretary. Mr McGhie now works in the corporate office of a number of public listed companies focussed on the resources sector. 10 P a g e

11 Disclaimer The following Warning, Disclaimer and Disclosure relate to all material presented in this document and should be read before making any investment decision. Warning (General Advice Only): Past performance is not a reliable indicator of future performance. This report is a private communication to clients and intending clients and is not intended for public circulation or publication or for the use of any third party, without the approval of ABN ("Taylor Collison"), an Australian Financial Services Licensee and Participant of the ASX Group. TC Corporate Pty Ltd ABN ( TC Corporate ) is a wholly owned subsidiary of. While the report is based on information from sources that Taylor Collison considers reliable, its accuracy and completeness cannot be guaranteed. This report does not take into account specific investment needs or other considerations, which may be pertinent to individual investors, and for this reason clients should contact Taylor Collison to discuss their individual needs before acting on this report. Those acting upon such information and recommendations without contacting one of our advisors do so entirely at their own risk. This report may contain forward-looking statements". The words "expect", "should", "could", "may", "predict", "plan" and other similar expressions are intended to identify forward-looking statements. Indications of and guidance on, future earnings and financial position and performance are also forward looking statements. Forward-looking statements, opinions and estimates provided in this report are based on assumptions and contingencies which are subject to change without notice, as are statements about market and industry trends, which are based on interpretations of current market conditions. Any opinions, conclusions, forecasts or recommendations are reasonably held at the time of compilation but are subject to change without notice and Taylor Collison assumes no obligation to update this document after it has been issued. Except for any liability which by law cannot be excluded, Taylor Collison, its directors, employees and agents disclaim all liability (whether in negligence or otherwise) for any error, inaccuracy in, or omission from the information contained in this document or any loss or damage suffered by the recipient or any other person directly or indirectly through relying upon the information. Disclosure: Analyst remuneration is not linked to the rating outcome. Taylor Collison may solicit business from any company mentioned in this report. For the securities discussed in this report, Taylor Collison may make a market and may sell or buy on a principal basis. Taylor Collison, or any individuals preparing this report, may at any time have a position in any securities or options of any of the issuers in this report and holdings may change during the life of this document. Analyst Interests: The Analyst(s) may hold the product(s) referred to in this document, but considers such holdings not to be sufficiently material to compromise the rating or advice. Analyst(s) holdings may change during the life of this document. Analyst Certification: The Analyst(s) certify that the views expressed in this document accurately reflect their personal, professional opinion about the financial product(s) to which this document refers. Date Prepared: May 2017 Analyst: Ryan Armstrong Release Authorised by: David Cutten 11 P a g e