Siddharth Rajeev, B.Tech, MBA, CFA Analyst Michelle Wu, B.A.Sc (Mineral Engineering) Research Associate-Mining Investment Analysis for Intelligent Investors March 14, 2011 Yellowhead Mining Inc. (TSX-V: YMI) - Positive PEA Results; Announces $20 million Bought Deal Financing Sector/Industry: Junior Exploration/Mining www.yellowheadmining.com Market Data (as of March 14, 2011) Current Price C$1.45 Fair Value C$3.00 Rating* BUY Risk* 5 (Highly Spec) 52 Week Range N/A Shares O/S 35.15 mm Market Cap C$50.96 mm Current Yield N/A P/E (forward) N/A P/B 2.13 YoY Return N/A YoY TSXV 39.8% *see back of report for rating and risk definitions 1,600,000 1,400,000 1,200,000 1,000,000 800,000 600,000 400,000 200,000 - $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 17-Nov-10 23-Dec-10 28-Jan-11 5-Mar-11 Investment Highlight Key Financial Data (FYE - October 31) (C $) 2010 Cash 4,734,825 Working Capital 4,925,431 Mineral Assets 10,905,163 Total Assets 16,394,531 Net Income (1,549,566) EPS (0.06) On March 8, 2011, YMI announced positive results from the Preliminary Economic Assessment (PEA) conducted by Wardrop on the Harper Creek project. The PEA gave a base-case pre-tax NPV (8%) of US$598 million based on a copper price of US$2.66/lb, gold price of US$1,058/oz and silver price of US$16.57/oz. The PEA estimates the breakeven copper price (including initial and sustaining capital) is US$1.94/lb, US$1,058/oz for gold and US$16.57/oz for silver. YMI intends to commence a feasibility study next month. The drill program at Harper Creek is ongoing. The company currently has about $4.5 million in cash. YMI's capital budget for the next 12 months is $25 million, which includes $12.5 million for the feasibility study and $12.5 million for exploration. On March 14, 2011, YMI announced a $20 million bought deal financing comprised of 13.80 million units at a unit price of $1.45. The underwriters also have an over-allotment option to purchase up to an additional 2.07 million units at $1.45 per unit. YMI expects the financing to be completed before April 5, 2011. Yellowhead Mining Inc. is a Canadian company engaged principally in the acquisition, exploration and development of mineral resource properties. The company s principal asset is its wholly owned Harper Creek mineral property north east of Kamloops, BC. The Harper Creek mineral property is a volcanogenic sulfide deposit with copper, gold and silver. The most recent PEA stated a measured, indicated and inferred resource of 649 million tonnes at 0.31% copper, 0.03 gpt gold and 1.12 gpt silver. Note: An FRC analyst has visited YMI s property in the past 12 months; see the back of this report for additional disclosures
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 2 Positive PEA Results On March 8, 2011, the company announced the results of the PEA conducted by Wardrop (a Tetra Tech Company) on the Harper Creek project. The PEA was based on a large-scale open pit mining and milling operation at Harper Creek. The following table shows the primary inputs and assumptions used in the study. Inputs Annual Production Mine Life Recoverable Cu Au Ag Average LOM Annual Production Cu Au Ag 70,000 tpd 22 years 2.857 bn lbs 0.265 mm oz 4.87 mm oz 0.13 bn lbs 12,000 oz 225,000 oz Capital Cost (incl. contingency) Site Operating Cost (incl. precious metal credits) $759 million $1.40 per lb Based on the above inputs, the PEA gave a base-case pre-tax NPV (8%) of US$598 million based on a copper price of US$2.66/lb, gold price of US$1,058/oz and silver price of US$16.57/oz. The following table shows a scenario analysis. Source: Company The optimistic scenario (which used US$3.01/lb Cu, US$1,221/oz Au and US$19.73/oz Ag) gave a pre-tax NPV (8%) of US$1.05 billion, while the pessimistic scenario (which used US$2.25/lb Cu, US$980/oz Au and US$15.50/oz Ag) gave a pre-tax NPV (8%) of US$87 million. The significant difference between the NPV estimates in the optimistic and the pessimistic scenarios indicates the project's high sensitivity to commodity prices - which is typical for large tonnage deposits. The PEA estimates the breakeven copper price (including initial and sustaining capital) is US$1.94/lb, US$1,058/oz for gold and US$16.57/oz for silver.
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 3 The PEA also updated the measured, indicated plus inferred resource to 649 mm tonnes at 0.31% Cu, 0.03 gpt Au and 1.12 gpt Ag. This is encouraging as the previous estimates (in August 2010), shown below, neither had gold/silver resource nor resources in the measured category. Resource Estimate (cut-off - 0.2% Cu) Aug-10 Tonnage Grade Contained M etal (mm tonnes) Cu (% ) Au (gpt) Ag (gpt) Cu (mm lbs) Au (mm oz) Ag (mm oz) Indicated 569.00 0.32% 4,010 Inferred 62.70 0.33% 456 Total 631.70 0.32% 4,466 M ar-11 M easured 89.99 0.30% 0.033 1.18 595 0.095 3.40 Indicated 442.07 0.31% 0.032 1.06 3,021 0.453 15.00 Inferred 117.24 0.29% 0.032 1.32 750 0.120 4.95 Total 649.3 0.31% 0.03 1.12 4,366 0.668 23.35 Power is expected to be supplied by an upgraded BC Hydro transmission line approximately 8km north of the plant. Concentrates are expected to be transported on B-Trains to a rail loadout facility in Vavenby, located 25 km away. The concentrates will then be loaded onto railcars and shipped to the Port of Vancouver. From the Port of Vancouver, the concentrates will be loaded on ships and transported to smelters/refineries in the Pacific Rim. The following image shows the excellent infrastructure associated with the project. Source: Company
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 4 We estimate the PEA used a final recovery of 86% for copper. A comprehensive metallurgical testwork program is expected to be completed in the feasibility study, which is expected to commence next month. Plans for 2011 and Development Timeline In February 2011, the company submitted its draft Application Information Requirements (dair) to the BC Environmental Assessment Office (BCEAO) for review by both provincial and federal regulators. The company's plans for 2011 are shown below: Complete a Feasibility Study, scheduled to commence mid-april Drilling to support the Feasibility Study including geotechnical, hydrological, foundation testing, metallurgical and condemnation. Continue with the Environmental Impact Study with concurrent permitting Step out drilling to the east and north to increase the resource Investigate and implement opportunities for improvement in project economics. Source: Company The following table shows the proposed development timeline for the Harper Creek project. The feasibility study is expected to be completed in Q1-2012. If everything goes according to plan, the project should be in production by Q2-2014. Source: Company Drilling Program The drill program at the Harper Creek project is currently ongoing. To date, results from 7 holes were released. Highlights of the drill intersections are listed in Table 1 and the collar locations of these drill holes are mapped in Figure 1. Table 1 Highlights from the Winter Drill Program (Source: Company) In te rv a l (m ) R e s u lts H o le F ro m T o L e n g th C u % A g p p m A u p p b H C 1 0-7 6 1 3.0 4 0.2 2 7.2 0.4 9 1.4 3 8 4 9.9 8 3.0 3 3.1 0.3 5 1.1 6 1 2 1 2.5 2 3 6.6 2 4.1 0.4 4 3.6 6 5 2 8 2.0 2 9 9.2 1 7.2 0.7 7 4.7 6 1 H C 1 0-7 7 8 0.5 1 5 0.4 6 9.9 0.4 5 1.6 7 0 3 9 8.0 4 1 0.6 1 2.6 0.4 4 2.5 3 2 H C 1 0-7 8 2 0 2.4 2 6 3.5 6 1.1 0.3 6 0.7 3 9 H C 1 0-7 9 1 3 8.1 2 3 6.2 9 8.1 0.3 1 1.3 1 8 2 4 9.3 3 1 5.0 6 5.7 0.3 5 1.3 2 9 H C 1 0-8 0 2 2 7.9 3 0 6.0 7 8.1 0.2 5 0.7 3 6 H C 1 0-8 2 2 5 3.4 2 7 9.3 2 5.9 0.2 5 0.7 1 2 3 1 9.3 3 7 2.5 5 3.2 0.3 7 1.2 6 1
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 5 Figure 1 Updated Drill Plan Map (Source: Company)
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 6 Figure 2 Cross Section A-A (305420E) as Labeled in Figure 1 (Source: Company) From the drill plan map, we can see that drill hole HC10-76, HC10-77, HC10-78 are located on the western portion of the designed pit along with many historic drill holes. The intercepts of these 3 drill holes confirmed historic drilling results and identified mineralization below the current pit limit at depth. Holes HC10-79 and HC10-80 were drilled on the eastern limit and HC10-82 is near the northern limit of the proposed pit, which demonstrated potential for resource expansion along strike to the east and down-dip to the north. Current drilling (HC-83 to HC-85 as shown in Figure 1) is targeted at the northern limit of the proposed pit to test the down-dip extension of the deposit. Future drilling is planned to further examine the mineral potential up-dip to the south and at eastern extension. Financials At the end of FY2010 (ended October 2010), the company had $4.73 million in cash. Working capital was $4.93 million. In FY2010, the company reported a net loss of $1.55 million (EPS: -$0.06). We estimate the company had a burn rate (cash spent on operating and investing activities) of $0.10 million per month in FY2010 - note that this estimate also accounts for the exploration tax credits received by the company. The following table shows the company s cash and liquidity position at the end of FY2010.
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 7 Liquidity Analysis (C$) 2010 Cash 4,734,825 Working Capital 4,925,431 Current Ratio 12.75 LT Debts/ Assets - Burn Rate/Month (incl exploration costs and tax credits) ($100,032) Cash from financing activities 5,854,951 Subsequently, in November 2010, the company raised $2.63 million by issuing 2.44 million units. Each unit consists of one common share and one half of a warrant (exercise price - $1.40 per share; maturity period - 24 months). Proceeds of $0.48 million were received prior to the end of FY2010. The company currently has about $4.5 million in cash. YMI's capital budget for the next 12 months is $25 million, which includes $12.5 million for the feasibility study and $12.5 million for exploration. The following proposed financing, if completed, should cover the company's expenses for the next 12 months. Announces $20 million bought deal financing - On March 14, 2011, YMI announced a $20 million bought deal financing comprised of 13.80 million units at a unit price of $1.45. Each unit will consist of one common share and one half common share purchase warrant (exercise price - $2.00; maturity - 24 months). In addition, the underwriters have an over-allotment option to purchase up to an additional 2.07 million units at $1.45 per unit YMI expects the financing to be completed before April 5, 2011. Stock Options and Warrants: The company currently has 2.99 million stock options outstanding (exercise prices ranging from $0.40 to $1.08) and 3.87 million warrants (exercise prices ranging from $0.50 to $1.40) outstanding. Valuation & Rating At the time of our initiating report on YMI in January 2011, our Discounted Cash Flow (DCF) model had indicated a negative NPV on the Harper Creek project. We had used an operating cost of $1.20/lb (PEA estimate - $1.40/lb), capital cost of $755 million (PEA estimate - $759 million) and a final copper recovery of 88% (we estimate the PEA used a recovery of 86%). We have revised these estimates to make them inline with the PEA estimates. Since our initiating report, we have raised our long-term (2014+) copper price forecast from US$2.03 to US$2.25 per lb. We also used the updated resource estimate in our revised valuation models which includes gold/silver resources in addition to copper. Note that our previous model, which was based on the August 2010 resource estimate, did not account for gold/silver resources. Our revised DCF valuation on YMI is $1.63 per share. We used 100% of measured and
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 8 indicated, and 50% of the updated inferred resources. DCF Summary Resource (tonnes) 590,680,000 Average Copper Grade (%) 0.31% Average Gold Grade (gpt) 0.03 Average Silver Grade (gpt) 1.10 Recovered Copper (bn lbs) 3.43 Recovered Gold (oz) 313,939 Recovered Silver (oz) 5,762,626 M ine Life (years) 25 LT Copper Price (US$ per lb) $2.25 LT Gold Price (US$ per oz) $1,000 LT Silver Price (US$ per oz) $18.35 Capital Cost ($) $759,000,000 Avg Operating Cost ($/lb) $1.40 Discount rate 11.6% LT C$/US$ 1.10 Net Present Value (C$) $58,061,283 W orking Capital (incl. the proposed PP) $23,509,400 Fair Value $81,570,683 No. of Shares (dil) 50,145,108 Fair Value per Share $1.63 The sensitivity of our DCF valuation to changes in long-term copper prices is shown below: LT Copper Price (US$/lb) FV ($/share) $1.63 $1.25 -$9.37 $1.75 -$3.87 $2.25 $1.63 $2.75 $7.12 $3.25 $12.62 Our real options valuation, which we have introduced in this report, is $2.50 per share. Real Options Valuation Inputs relating to the underlying asset Estd.Value of Minerals if extracted today ($) $546,846,517 Annualized Standard Deviation of Mineral prices 28% Capital Investment ($) $759,000,000 Time to Maturity 5 Risk-free Rate 3.20% Output Stock Price $546,846,517 T.Bond rate 3.20% Strike Price $759,000,000 Variance 0.08 Expiration (in years) 5.0 Annualized div yield 0% d1 = 0.045 Value of Option ($) $101,760,058 N(d1) = 0.518 Working Capital (incl. the proposed PP) $23,509,400 d2 = -0.581 No of shares (Dil.) 50,145,108 N(d2) = 0.281 Value per share $2.50
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 9 Both our DCF and real options valuation models were based on the assumption that the proposed $20 million financing will be completed. Although we have continued to use a peer average EV/copper equivalent resource of $0.05 per lb, our comparables valuation on YMI dropped from $5.84 to $4.80 per share as a result of the expected share dilution from the recently proposed $20 million private placement. Therefore, based on our three valuation models, we reiterate our BUY rating and maintain our fair value estimate at $3.00 per share. Valuation Summary DCF $1.63 Real Options $2.50 Comparables $4.80 Average $2.98 Risks The following risks, though not exhaustive, may cause our estimates to differ from actual results: The value of the company is dependent on commodity prices. The company does not currently have any operating mines. Access to capital and share dilution.
Yellowhead Mining Inc. (TSXV: YMI) - Update Page 10 Fundamental Research Corp. Equity Rating Scale: Buy Annual expected rate of return exceeds 12% or the expected return is commensurate with risk Hold Annual expected rate of return is between 5% and 12% Sell Annual expected rate of return is below 5% or the expected return is not commensurate with risk Suspended or Rating N/A Coverage and ratings suspended until more information can be obtained from the company regarding recent events. Fundamental Research Corp. Risk Rating Scale: 1 (Low Risk) - The company operates in an industry where it has a strong position (for example a monopoly, high market share etc.) or operates in a regulated industry. The future outlook is stable or positive for the industry. The company generates positive free cash flow and has a history of profitability. The capital structure is conservative with little or no debt. 2 (Below Average Risk) - The company operates in an industry where the fundamentals and outlook are positive. The industry and company are relatively less sensitive to systematic risk than companies with a Risk Rating of 3. The company has a history of profitability and has demonstrated its ability to generate positive free cash flows (though current free cash flow may be negative due to capital investment). The company s capital structure is conservative with little to modest use of debt. 3 (Average Risk) - The company operates in an industry that has average sensitivity to systematic risk. The industry may be cyclical. Profits and cash flow are sensitive to economic factors although the company has demonstrated its ability to generate positive earnings and cash flow. Debt use is in line with industry averages, and coverage ratios are sufficient. 4 (Speculative) - The company has little or no history of generating earnings or cash flow. Debt use is higher. These companies may be in start-up mode or in a turnaround situation. These companies should be considered speculative. 5 (Highly Speculative) - The company has no history of generating earnings or cash flow. They may operate in a new industry with new, and unproven products. Products may be at the development stage, testing, or seeking regulatory approval. These companies may run into liquidity issues, and may rely on external funding. These stocks are considered highly speculative. Disclaimers and Disclosure The opinions expressed in this report are the true opinions of the analyst about this company and industry. Any forward looking statements are our best estimates and opinions based upon information that is publicly available and that we believe to be correct, but we have not independently verified with respect to truth or correctness. There is no guarantee that our forecasts will materialize. Actual results will likely vary. The analyst and Fundamental Research Corp. FRC does not own any shares of the subject company, does not make a market or offer shares for sale of the subject company, and does not have any investment banking business with the subject company. Fees were paid by YMI to FRC. The purpose of the fee is to subsidize the high costs of research and monitoring. FRC takes steps to ensure independence including setting fees in advance and utilizing analysts who must abide by CFA Institute Code of Ethics and Standards of Professional Conduct. Additionally, analysts may not trade in any security under coverage. 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