ISSUE 05 12th January, 2011

Transcription

1 ISSUE 05 12th January, 2011 In this week s report we re further diversifying our portfolio by looking at three companies that offer exposure to three commodities until now not covered in our portfolio: oil, uranium and iron ore. Oil was the surprise packet in commodity terms during the second half of 2010, quietly pushing higher in terms of price past the US$90/barrel mark despite demand from the world s biggest market, the USA, remaining flat. The key of course is growing demand from emerging Asian economies. Uranium is a commodity that has been quiet since its dramatic price surge that took it to a high above US$140/lb during 2007, when it accompanied crude oil s similarly dramatic rise. But the outlook for all forms of energy is favourable in a growing world hungry for energy, whether it s coal, uranium or oil. 1. Horizon Oil Buy around $0.295 Established oil producer with a key stake in the long-life Maari field offshore New Zealand. The company has an aggressive growth strategy, commercialising existing reserves in China and PNG. 2. Marenica Energy Buy around $0.089 Advanced uranium explorer with a substantial JORC-compliant resource in Namibia, West Africa. Scoping studies have suggested a profitable project, with development possible by Territory Resources Buy around $0.345 Established junior iron ore producer with a solid production base at its Frances Creek project in the Northern Territory is an important year, as it becomes debt-free and explores growth options. 1

2 Horizon Oil (HZN) 29.5c An established oil producer with a key stake in the long-life Maari field offshore New Zealand. The company has an aggressive but low-risk growth strategy, commercialising existing reserves in China and PNG. Corporate Details Status: Established Producer Size: Small Cap Commodity Exposure: Oil Share Price: 29.5c 12-month Range: 25.5c 39c Shares: 1,130.3b Options: 39m Top 20: 67% Net Cash: $5.7m Market Value: $333m Management Quality Financial Security Project Quality Exploration / Resource Potential Project Risk Rating ( out of 5) We ve spent a considerable amount of time poring over candidates to introduce into our portfolio in the oil space, but it s not an easy task. Unlike the hard rock (mining) sector, where there is some reasonable level of predictability surrounding a company s exploration, development and production activities, the soft rock (or petroleum) sector, is a completely different beast. Share price volatility is enormous and a petroleum stock s valuation can vary enormously (and quickly) on the back of perceived explorations successes and failures. Much more so than the hard rock sector. Accordingly, what we ve tried to do is take as much of the uncertainty, volatility and guesswork out of the equation with our oil sector recommendations. This means we are looking at value situations, ideally where there is existing or near-term production, which represent great buying opportunities irrespective of the results of upcoming drilling programs. We re not looking at one-hole wonders. This brings us to Horizon Oil, which is an established oil producer with loads of potential, but with longerterm value not properly reflected in its current share price. This is where the investment opportunity presents itself. The company possesses substantial and tangible growth prospects, irrespective of the outcomes of individual exploration wells in its current drilling program. 2

3 Horizon has a specific exploration and development focus on South East Asia, where there is strong and growing demand for oil and gas, a mature operating environment and limited competition from larger competitors. The company holds non-operated interests in the Maari oil development in New Zealand, as well as an interest in the Beibu Gulf oil development in China. Horizon also holds a significant footprint in offshore New Zealand and in the Western Provinces of PNG. Encouragingly, exploration drilling has already resulted in numerous discoveries, so the company s work program currently revolves around appraisal and development, rather than wildcat exploration. As a result, the company represents a much lower-risk oil play than many of its peers. Figure 1: Horizon's Project Locations Interestingly too, Horizon typically seeks to form joint ventures with partners who are sufficiently qualified to operate the projects, rather than operate themselves. This approach allows Horizon s management team to contribute its significant experience to these joint ventures, without being distracted by the details of managing the day-to-day operations. The company s most important development at present is Maari in New Zealand, operated by OMV (New Zealand) Ltd and located 80km offshore Taranaki at a depth of 102 metres. Horizon has a 10% stake in the field, which holds proven and probable reserves in excess of 50 million barrels of oil. Horizon acquired its 10% stake in January 2003 and participated in the drilling of the Maari-2 appraisal well that successfully appraised the central part of the field. 3

4 The Maari field was given the development go-ahead in November 2005, based on an unmanned wellhead platform housing the wellheads of five production and three injection wells, linked via subsea flowlines to the floating production, storage and offloading vessel ( FPSO ) Raroa, anchored 1.5km away. The joint venture has the right to conduct production operations for a period of 22 years, reflecting the predicted long life of the main zone at Maari, as well as from shallower and deeper zones that have not yet been fully appraised. On 1 July 2010 the New Zealand Crown Minerals Group approved the extension of the Maari PMP to incorporate the remaining area of PEP 38413, which contains Manaia field. The total area of the expanded petroleum mining permit is 80 sq km and includes various oil accumulations, including the successful MN1 well in the Manaia Mangahewa reservoir, from which the joint venture is now producing oil. Horizon also maintains a 30% stake in the nearby 2,595 sq km block, PEP 51313, after farming-in during late The block lies immediately adjacent and south of the Maari and Manaia permits. In terms of exploration activity, processing of seismic data accumulated during 2010 is underway, with the aim of fully evaluating three prospects, Pike, Paua and Matariki, for drilling during the 2011/2012 summer weather window. We understand that early processing results indicate that the new data is of good quality and is providing confirmation of the validity of the targeted prospects. Elsewhere, Horizon s major new project development thrust is in China, where the company has a major stake in offshore Block 22/12 in the Beibu Gulf. The Petroleum Contract for Block 22/12 was awarded to Horizon (then known as Bligh Oil and Minerals) during 2001, with Roc Oil farming into the Block and assuming operatorship during Block 22/12 is a 364 sq km permit located in 40 metres of water near several known oil fields, with the nearest productive field being Wei 12-1, located just 1.8km from the Block 22/12 boundary. Several discoveries have been made in the block; Wei and Wei by Total during the 1980 s, Wei and Wei by CNOOC during the 1990 s and Wei and Wei 6-12 South-1 in 2002 and 2006 respectively by the current joint venture. None of these fields have so far been developed, although the block now contains 58 mmbbls of oil in the Wei 6-12 and Wei 12-8 areas, with around 8 mmbbls in resources contingent on successful appraisal of the Wei 12-2 discovery. Following the discoveries at Wei 6-12 and more significantly, Wei 6-12 South in 2006, Horizon and its coventurers began formulating appropriate development concepts in consultation with the China National Offshore Oil Corporation (CNOOC). In terms of project planning, the joint venturers will adopt an integrated development concept that involves the connection of the Block 22/12 fields via an unmanned wellhead platform to a new-build auxiliary platform, which will in turn connect to existing CNOOC platforms and 16" pipeline to oil storage and shiploading facilities on nearby Weizhou Island. 4

5 Negotiations between the joint venture and CNOOC over the economics and commercial sections of the Overall Development Plan were concluded in June 2010, specifying terms, conditions and tariffs for the joint development of the WZ6-12 and WZ12-8W fields. As anticipated, CNOOC has elected to participate in the development and will back-in for its full 51% share of the project, with Horizon's stake reducing to 14.7%. Figure 2: Projected Production Profile A Supplemental Development Agreement (SDA) to formalise the agreed commercial terms is also currently being prepared by CNOOC. The SDA provides for further exploration and appraisal of the significant remaining exploration potential outside the current scope of the WZ6-12 and WZ12-8W developments. In addition, a feasibility study on development of the WZ12-8E field has been initiated. We anticipate first oil production from China during H Finally, Horizon s third area of petroleum development focus is in PNG, where the company has a 50% stake in PRL 4 Stanley and a 50% stake in PRL 5 Elevala/Ketu. During September 2009, Horizon completed a transaction with a subsidiary of Talisman Energy Inc. regarding its 100% stakes in PRLs 4 and 5. The net effect of the transaction, which included the transfer of a working interest and the shares in a wholly-owned subsidiary of Horizon Oil to Talisman, is that each holds a 50% stake in PRLs 4 and 5. 5

6 The sizeable sum of US$60 million payable to Horizon comprised: US$30 million cash that was received in September 2009; US$8 million to be drawn down at any time and applied to Horizon s share of capital expenditure on the licences; and US$22 million to be drawn down and applied to the Group's share of capital expenditure on the licences after PNG Government approval of the working interest transfers required by the transaction has been granted. PRL 4 is located in the forelands of the Western Province of PNG, lying in close proximity to the Fly River. Recoverable P50 resources are estimated at 261 bcf of gas and 8 mmboe of condensate. A successful work-over and production test of the Stanley-1 well was conducted in mid-2008, with the well flowing very successfully at rates of up to 30 million cubic feet of gas per day ( mmcfd ). Work on the initial stages required to bring Stanley field to development have begun. The proposed project entails the production of 140 million of cubic feet of gas per day from two wells, extraction of initially over 4,000 barrels of condensate per day and potentially 40 tonnes of LPG per day, with re-injection of the dry gas until a gas market develops. Detailed reservoir modelling supports the recovery of more than 8 million of barrels of condensate over a 10-year period. PRL 5 is also located in the forelands of the Western Province of PNG, lying in close proximity to the Fly River, approximately 65 km from PRL 4. Recoverable P50 resources are estimated at 480 bcf of gas and 25 mmboe of condensate. Unfortunately, the joint venture was recently advised in November 2010 by the PNG Minister of Petroleum and Energy of his refusal to approve a licence extension. Several options remain open to the joint venture to gain the requested PRL 5 extension, including taking action under the laws of Papua New Guinea and/or the Agreement between the Government of Australia and the Government of the Independent State of Papua New Guinea for the Promotion and Protection of Investments. The joint venture intends to meet shortly to determine the appropriate course of action. Horizon Oil and Talisman, as the continuing partners in PRL 4 and PRL 5, had already rescheduled the drilling program for Parker Rig 226 to account for uncertainty of the timing of renewal of PRL 5. Importantly, the drilling of the Stanley-2 well on PRL 4 (and any subsequent development of the field) will be unaffected by the delay in the renewal of PRL 5. The joint venture has been granted a one-year extension of PRL 4. Rig 226 has been assigned to other operators for the drilling of one or two wells after Stanley-2 is completed and before moving to Elevala-2 and Ketu-2 in PRL 5. Despite this setback, we believe Horizon offers investors exposure to a large undeveloped reserve base without having to rely on high-risk exploration success. We anticipate the company will commit to a number of development projects in China and PNG over the next six months, which should see a quadrupling in developed reserves and a huge boost to production from current levels of 1,800bopd to over 10,000bopd in 6

7 2013. We envisage that Horizon will have no difficulty in raising the $150m in funding necessary to cover its share of project development costs in China and PNG. Ultimately this should see Sales Revenue growing from $48.0 million in 2010 to $150 million by 2013, whilst Earnings Per Share (EPS) should grow from 1.7c in 2010 to 5.0c by This puts the company on a P/E multiple of less than six times 2013 forecast earnings, which in our view is particularly cheap. And this surge in revenue and earnings will provide the company with the means to fund new development opportunities. And unlike other stocks in the sector, which have greater exposure to exploration, Horizon presents a much lower-risk opportunity. The chart below shows that Horizon sits right in the middle of its oil sector peers and represents what we consider to be the best possible outcome for oil sector investors. Figure 3: Ranking Compared to Oil Sector Peers Ultimately, the company has cleverly positioned itself to take advantage of the emerging interest in PNG gas resources. The proximity to key growth markets in Asia has seen increasing interest in these assets by the oil industry heavyweights. And over the longer-term, Horizon is looking to participate in Talisman s broader gas aggregation strategy across PNG s Western Forelands, which could make it an attractive target to all petroleum heavyweights committed to LNG export out of PNG. We recommend Horizon Oil as a Buy around $

8 Marenica Energy (MEY) 8.9c An advanced uranium explorer with a substantial JORC-compliant resource located in Namibia, West Africa. Scoping studies have suggested a profitable project, with development possible by Corporate Details Status: Emerging Producer Size: Small Cap Commodity Exposure: Uranium Share Price: 8.9c 52-week Range: 6c 21c Shares: 498.6m, Options: 73m Top 20: 65% Net Cash: $3.5m Market Value: $44m Management Quality Financial Security Project Quality Exploration / Resource Potential Project Risk Rating ( out of 5) The key to uranium investment is to start with a uranium-friendly location, which has a history of welcoming and encouraging uranium development. Otherwise, as an investor you can be taking some pretty big risks. Unfortunately Australia has an unpredictable track record in terms of its uranium policy track record. The Three Mines Policy means that for many years there was little incentive to explore for new deposits, as new project development was ruled out by the Federal Labor Government. Over recent years however, things have begun to change slowly. New uranium developments have kicked off in South Australia, whilst the Northern Territory seemingly remains welcoming of new uranium developments. A change of State government in Western Australia a few years ago from Labor to Liberal meant that the long-standing ban on uranium mining in that state was overturned, allowing companies to apply for development of their projects. And a few projects are on the drawing board for development over the next five years, including BHP s Yeelirrie project. The problem though is that uranium remains such a hot political issue in Australia, particularly as the Greens seem to be wielding more political clout at a federal level. The future of Australia s uranium industry 8

9 is therefore clouded as a result, and even Western Australia s fledgling industry could be stopped in its tracks with a change of government in that state. Accordingly, from a uranium investment perspective we ve historically looked offshore for more secure investment regimes. One of the best in our view is Namibia in West Africa, which is host to Rio s mammoth Rossing operation, which has operated continuously since 1976 and is the world s largest open-pit uranium operation. We ve visited Namibia on a number of occasions and we are impressed by the country s support for its mining industry and the relative certainty that uranium companies enjoy operating there. This brings us to Marenica Energy, an emerging uranium company that we ve followed for several years now. The company has been involved in uranium exploration and evaluation in Namibia since The company s 80%-owned Marenica project covers 527 sq km and lies within the same uranium province as the Rossing and Langer Heinrich uranium mines and immediately north of the large Trekkopje mine, currently being developed by French energy group Areva. Figure 1: Marenica Project Overview In terms of infrastructure that could service a potential mining development, the region boasts good tarred and unsealed roads and an accessible power grid, but the main issue for Namibia, which is basically a desert terrain, is a good reliable supply of fresh water. Areva have constructed a large desalination plant on the coast as part of the infrastructure required for their development, which may also be able to supply 9

10 other operations with fresh water in the future. Their initial start-up is something like 25 million cubic metres of water a year. Before we examine the company s production plans, let s take a look at the project s exploration history. Previous exploration, notably by the Goldfields Group of South Africa, over the northeast portion of the EPL outlined several uranium-mineralised areas. More than 32,000 metres of drilling was conducted in the course of delineating secondary uranium deposits that are associated with palaeo-drainage channels and weathered bedrock. So far, Marenica has completed more than 37,000 metres of RC drilling and over 1,000 metres of diamond drilling within the project area. And importantly in late 2010, Marenica announced significant new zones of uranium mineralisation within the Southern Palaeochannel System, located 7km southeast of the main deposit at Marenica. The results were generated from a program of wide spaced, reconnaissance Reverse Circulation (RC) drilling (comprising 67 holes for 1,980 metres) at the MA7 Target. 29 of these holes returned anomalous uranium results of greater than 50ppm eu3o8, outlining two separate mineralised trends, each over 2,000 metres long and up to 400m wide. Some of the best intercepts included ppm eu3o8 from metres depth, ppm eu3o8 from metres and ppm eu3o8 from 2.75 metres depth. The initial discovery results from the Southern Palaeochannel are pleasing, with the initial broad spaced drilling demonstrating significant continuity of the mineralised system. This mineralization has the potential add significantly to the current resource base at Marenica and as a result the company is planning to conduct in fill resource definition drilling over the MA7 Target area during the first half of Table 1: Current Marenica Resource Base The current Measured, Indicated and Inferred Resource for the Marenica Project comprises 648 million tonnes at a grade of 97ppm, for 138M lbs of contained U3O8 (see Table 1 above). 10

11 Based on this resource figure, the company commissioned SRK Consulting to undertake a comprehensive Scoping Study on its Marenica Project. The results of the study were released in late 2010, showing that a US$260 million heap leach operation could deliver 3.5 million pounds of uranium annually at a highly competitive operating cost of US$38 a pound. The Scoping Study found the Marenica Project could produce a total of 45 million pounds of uranium over a 13 year life based on the existing defined Indicated and Inferred Mineral Resource. This is a significant increase on the company s earlier expectations as a result of the decision to develop a bulk open-pit and heap leach operation with a lower cut off grade (COG) of 50ppm, rather than as a continuous agitated leach circuit fed by higher grade ore. The mining optimisation study defines a potentially minable 270M tonnes of low grade oxide ore, to be processed as run-of-mine heap leach material. Table 2: Scoping Study - Key Operating & Financial Parameters The mineralisation will be upgraded through a combination of screening and scrubbing, with approximately 50% of the run-of-mine ore to be discarded as waste prior to processing. Importantly, this upgrade process reduces the ore to be processed over the life of mine to 135M tonnes, and potentially increases process grades to 193ppm U3O8 using a conservative upgrade factor of 1.8 times. Previous metallurgical work by ANSTO has shown that ROM material can be upgraded by a factor of 2.5 to 3.5 times. The Study s mining cost estimates are based on an assumed US $1.00/t for palaeochannel material movement and US $1.30/t for basement material due to the expected requirement for shatter blasting. No incremental adjustments above and below the reference level have been applied as the pits are expected to be only 80 metres deep. 11

12 The mine optimisation is based on current indicated and inferred mineral resource and the proposed upgrade of these inferred resources by further drilling should improve resource confidence and further enhance the already attractive project economics. Operating and capital costs used to develop this scoping study were based on industry standard capital and operating cost data for similar sized processes. Using a long-term uranium price of US$65 a pound, the study indicates that the Marenica project can produce a positive NPV and IRR and pay back the initial project capital in 5 years. The results of the study have provided Marenica with the confidence to undertake additional drilling and metallurgical work in order to upgrade the inferred resource base, which should continue to enhance project economics. Preliminary work required for the Environmental and Social Impact Statement began during November The Scoping Study assumes receipt of all required permits to construct and operate the mine and plant within three years. Company management believes that construction and commissioning of the plant would take place during 2013 and 2014 respectively. A Definitive Feasibility Study relating to the Indicated Resources is expected to be completed by the end of Figure 2: World Nuclear Reactors From a corporate perspective there was good news during 2010, with French group Areva taking a 10.6% stake (now diluted to 9.5%) in Marenica by acquiring Polo Resources former shareholding. With Marenica situated just 30km from Areva s Trekkopje operation, there is certainly scope for the development of a lasting relationship with Areva. 12

13 Towards the end of 2010 the company secured $5 million worth of debt and equity funding from China's Hanlong Energy Limited, representing a 5.8% stake in the company. The company and Hanlong have entered into a Memorandum of Understanding encompassing longer-term feasibility and development funding, off-take arrangements and potential co-operation on future strategic acquisitions in the uranium sector. Hanlong is a subsidiary of the privately-owned China-based Sichuan Hanlong Group Co, Ltd, a large diversified group with a broad portfolio of investments in mining resource development, electricity production, infrastructure development and real estate, with annual revenues of more than US$2.5 billion. Figure 3: Uranium Supply-Demand Outlook In terms of in-ground uranium value, Marenica is heavily discounted because of its relatively low grade and largely Inferred Resource status (90% of the resource base lies within the lower-confidence Inferred category). Both issues can be addressed though, as ongoing drilling will enhance resource confidence by moving a larger chunk of mineralization into the Measured & Indicated categories. Meanwhile, ongoing ANSTO test-work can reinforce the company s plan to significantly upgrade the overall ore grade by discarding waste ore prior to processing. A rough rule of thumb with respect to uranium-related corporate deals over recent times suggests a conservative valuation of around US$5/lb of contained U3O8. Marenica Energy on a fully-diluted basis is valued at just $0.40/lb of contained U3O8. As a result, even taking into account the largely Inferred resource status and timeline of end-2012 until completion of a comprehensive feasibility study, we believe Marenica represents a good value, relatively low-risk uranium exposure. During the September 2010 quarter the company spent $0.642m on exploration and development, representing 57% of total expenditure for the period. We recommend Marenica Energy as a Buy around $

14 Territory Resources (TTY) 34.5c An established junior iron ore producer with a solid production base from its Frances Creek project in the Northern Territory will be an important year, as it becomes debt-free and explores growth options. Corporate Details Status: Established Producer Size: Small Cap Commodity Exposure: Iron Ore Share Price: 34.5c 52-week Range: 13c 43.5c Shares: 265.1m, Options: 4.5m Top 20: 57% Net Cash: $2m Market Value: $91m Management Quality Financial Security Project Quality Exploration / Resource Potential Project Risk Rating ( out of 5) Iron ore is an intriguing commodity that has shaken off its rather staid and dirty image in the minds of investors and taken on an almost-gold like luster over the past decade. This has truly been an amazing transformation for a commodity that has traditionally been a low-margin business dominated by the industry heavyweights like Rio, BHP and Vale, which account for around 70% of production. All of a sudden, junior companies want a piece of the action and many of these juniors have hefty market valuations. The reason of course for the dramatic increase in the level of interest in iron ore (and the subsequent surge in iron ore prices) is the seemingly insatiable demand for the key steel-making ingredient from China. Quite simply, even the iron ore heavyweights failed to appreciate the emerging Chinese juggernaut, meaning their operations were caught napping. Quite simply, China wanted more iron ore than BHP and Rio could actually produce each year from their Pilbara operations. Only now are the mine and infrastructure enhancements being implemented to allow iron ore supply to catch up to escalating demand. But the key point is that iron ore will always tend to be a relatively lowmargin business. The high-price environment of the past decade, which has seen junior companies seek their fortune in the sector, is not the norm. Price levels will eventually recede as supply catches up with 14

15 demand. Yes, demand will remain strong, but the three industry heavyweights, Rio, BHP and Vale, will in our view maintain their relative positions of strength in the industry. The iron ore majors are used to low-price environments, where commitments to new projects costing in the hundreds of millions of dollars are made with a view to recovering their capital outlay over a period of a decade or more. Iron ore is an industry where there is not a shortage of product. Rather, infrastructure impediments at a time of surging demand has led to record prices. This brings us to Territory Resources, which is a solid, modestly-valued junior iron ore producer with a lowcost existing operation. The company has missed out on the hype that has surrounded a lot of its iron ore sector peers, which we believe is a good thing. The company has a sound growth plan in place that will see it steadily grow its operations and also with the leverage to expand through acquisition. Figure 1: Frances Creek Project Location Northern Territory iron ore miner, Territory Resources, has been on our radar screen for some time now. Nevertheless, despite an enviable track record of robust operational performance, the company has suffered over recent years from a series of unfortunate market setbacks, essentially unrelated to its operational performance. So it s nice for us to now to take a look at the company, with its various corporate distractions now seemingly well and truly behind it. The Frances Creek project had a successful history of iron ore production and export until 1974, when a combination of lower iron ore prices, and damage from Cyclone Tracy, led to the mine s closure. A number 15

16 of major changes over the past 30 years made the revival of Frances Creek possible, most of them related to infrastructure enhancements. Territory s 100%-owned Frances Creek hematite iron ore mine is located 200km south of Darwin near the township of Pine Creek and just 15km from the Adelaide-Darwin rail line. Territory recommissioned the Frances Creek iron ore operation in 2007 on a relative shoe-string budget by comparison with most of its sector peers, with the key being the project s close proximity to existing transport infrastructure, most significantly the Alice Springs-Darwin railway line. This has enabled Territory to avoid many of the pitfalls that are impacting some of its peers, which are developing relatively isolated deposits at high cost. Frances Creek made its first shipment of iron ore to China in September 2007 the first iron ore shipment from the Port of Darwin in more than 30 years. Ore is mined from a series of open pits using conventional drill, blast, hydraulic excavator and truck methods and then crushed into a lump or fines product specification, transported to a rail siding and then loaded onto trains for transportation to the company s stockyard at Darwin Port. Figure 2: Quarterly Iron Ore Production Profile As we know, iron ore has historically been a relatively low-margin business, although the changing market dynamics of the past decade, directly related to China s emergence on the world economic stage, have seen a surge in iron ore pricing. Nevertheless, the key to longer-term survival and profitability is the capacity for iron ore producers companies to minimize costs. 16

17 Territory recognized this early on and successfully implemented a major initiative to enhance efficiency at Frances Creek, with the company s target being to export at an annualised rate of 2.2 million tonnes of high-grade lump and fines product at a cost of US$55 per tonne, with a long-term operating cost target of US$50 per tonne. Territory is in a unique position amongst Australia s iron ore juniors, with marketing agreements in place with the company s cornerstone shareholder, Hong Kong based-noble Group Limited. Noble plays a key role as intermediary in the supply chain of iron ore into China, currently trading about 20 million tonnes annually into that market. Territory has entered into a life-of-mine supply agreement with Noble. Territory is in the box seat to maximize returns, as all of its ore is situated within 190km of the port of Darwin and within close proximity of rail, road and port facilities. And the company s financial performance is now doing justice to its operational capabilities. For the 30 June 2010 financial year, iron ore shipments rose strongly by 29.8% to 2,027,385 tonnes, compared with shipments of 1,562,517 tonnes during This underpinned a major turnaround in the company s financial fortunes, with Territory achieving a net profit after tax for the FY 30 June 2010 of $41.3 million. Table 1: Quarterly Iron Ore Production During the September 2010 quarter, sales receipts were strong at $54.1m, with a positive net operating cash flow of $12.0m. This allowed repayment of $12.8m worth of debt during the quarter, reducing the core debt to Noble Group to $21.8m as at 30 September Territory retains an $8.5m stake in recently-listed Blackwood Corp and is also owed $13.6m from Monarch Gold, with negotiations ongoing for the debt to be fully repaid. 17

18 Overall shipments were below expectations at 463,510 tonnes of high-grade lump and fines ore for the September quarter. Shipping and ore production were below forecast as a result of reduced crushing performance due to the late arrival of additional dump trucks, the early arrival of wet conditions and several plant failures. Importantly though, the appointment of experienced contracting group, Barminco, as the crushing contractor should provide Territory with more than enough crushing capacity to meet existing and future production needs. From an iron ore pricing perspective the outlook is sound, with sales prices forecast to be between US$110 and US$125 per tonne. The negative impact of strong A$ is being offset somewhat by the strong US$ price. For the FY 30 June 2011, we anticipate overall shipments of around 2 million tonnes, which is around 10% below the company s production stated production target. Nevertheless, this should be a solid result. Figure 3: Current Resources/Reserves Location From a growth perspective, construction of the beneficiation plant was completed on schedule during December The beneficiation plant is important as it will enable the company to process its scalps and low grade ore stockpiles and upgrade them to saleable grade specifications. Territory will also conduct tests to determine if the beneficiation process can upgrade lower-grade deposits in the northern regions to extend the mine life of Frances Creek. 18

19 And just recently Territory announced that a re-optimisation of the project s deposits had extended the mine life at Frances Creek, with a 50% increase in Ore Reserves to 5.69 million tonnes grading 57.8% Fe, 0.10% P, 8.8% SiO 2 and 3.5% Al 2 O 3. This will underpin continued iron ore production at the operation until at least Meanwhile, Total Indicated and Inferred Mineral Resources have increased to 9.56 million tonnes grading 58.0% Fe and 0.11% P. The company also hopes to further extend mine life through a three-pronged program, with approval for a $4.67 million exploration budget for the 2011 financial year to aggressively explore for and develop iron ore resources both in the near-mine environment and within a 30-35km radius of the Frances Creek operation. From a regional perspective, Territory during late 2010 was able to secure the right to explore for and develop iron ore resources on a prospective and strategically located tenement, McCarthy Hill, 25km southeast of Frances Creek. The exploration tenement contains similar rock sequences to those at Frances Creek, including significant indications of high-grade hematite based on recent rock chip sampling. Territory released the results of an initial program of Reverse Circulation (RC) drilling at the McCarthy Hill prospect in late December 2010, with hematite-rich iron mineralisation intersected over 500 metres of strike. The program of 31 drill holes for 2610 metres intersected some very encouraging intercepts, including % Fe, % Fe & % Fe. Significantly, the RC drilling program tested only a limited strike extent due to Aboriginal heritage restrictions. While the company has worked closely with the Traditional Owners to allow access to the region, the first pass program was restricted to a small area of the extensive tenement. Given these constraints, the initial results are encouraging, particularly as there is an additional 10km strike length of prospective horizon within the tenement. Territory s longer-term growth strategy is to embark on an acquisition program backed by Noble Group aimed at securing a new pipeline of exploration and development assets for carbon steel-related raw materials particularly iron ore, manganese and chromite. Leveraging from the Company s mining and development experience at Frances Creek and its reputation as a reliable, high quality iron ore exporter, this acquisition program is designed to position Territory as a major supplier of raw materials to the rapidlyexpanding Asian steel industry over the next decade. Territory Resources has never been better placed, with solid production combining with a steadily growing reserve base. For FY 30 June 2011 we anticipate EPS of around 13c, which puts the company on an extremely modest P/E multiple of less than 3x. With debt rapidly declining and likely to be repaid within the current financial year, the company is now also much better placed to look at growth opportunities in iron ore and the carbon steel business generally. We recommend Territory Resources as a Buy around $

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