Formation Metals: Time for reflection

Note: Please observe that you are reading a June 2011 article, which does not reflect the present situation any longer.
Formation Metals quotes on TSX (Symbol FCO - FMETF on AMEX pink sheets -  FCO.TO on Yahoo)
Long time shareholders have had the hard time the company has. After the permitting process took over five years, the Canadian mining company needed looking for cash under more difficult circumstances. About 14 years after the first drillings on the RAM deposit in Idaho, there is finally an outlook for actual production. Mine construction is ongoing but output is not expected within another year. Retrofitting the hydro-metallurgy site near Kellogg has started to enable the cobalt production facility, which will be delivering cobalt with the highest purity.

The metal

Cobalt is what Formation Metals is mining for in Idaho. It is the rarer of the chemically related triad elements Iron, Cobalt, Nickle. Cobalt is used for strengthening iron alloys for high duty applications such as in jet engines. The fastest growth is however in rechargeable batteries for handheld electronic devices as well as their upsized counterparts for hybrid or electric vehicles. Moreover both cadmium-free nickle metal hydride batteries as their lightweight lithium ion counterparts use cobalt.

Cobalt most often is a byproduct of copper mining and as such its output is determined by the production volume of copper mines and their cobalt grade. Therefore the cobalt production level is little price sensitive: copper mines need adapting output to copper demand and price. It are the few swing producers as Formation Metals that can make the difference to increase supply when the cobalt price soares.

Expected output

Proven reserves enable a yearly cobalt production of 3.3 million pounds for 10 years, a comparable quantity of copper and traces of gold (4000 oz). Mine life can be prolonged as measured or indicated resources are converted to exploitable reserves. Production costs  expected are $10.3 per pound of cobalt. Taking credit of the value of the copper byproduct, net costs of $7.7/lb are expected. The current cobalt price of $18/lb is down over 50% from its early 2008 peak of $50/lb. Using these data, a cash flow estimate of $33 M can be made. This is 36.7% of the current market capitalisation and over 40% of the long term debt. The expected cash flow per share is $0.365. No revenues for the gold (4000 oz per annum) were accounted for, but on the other hand the metal extraction yield for Co and Cu was considered 100%. The target output of Formation metals would add (only) 3.3% to the global Cobalt production (45,500 tons in 2010). Moreover, global demand is rising yearly by twice that percentage. 

Financing

Formation metals has raised $80 million (CAD) in a public offereing issuing new shares at $1.50, with a warrant (to sweeten the deal) for every second share, allowing the purchase of one FCO share at $2.00 for 36 months. A recovery zone facility loan attributed late last year opened a credit line for another $77 million (USD). The Idaho Cobalt Project is fully financed. FCO even paid back most of an earlier convertible debenture concluded under less favourable terms.

Share price

After reaching $2.75 late 2010, the share price nosedived in anticipation of raising new capital. New shares issued at $1.50 in March more than doubled the number of outstanding shares. Existing shareholders were disappointed and many sold during or after the capital raise. As Formation Metals is now down to penny stock level (quoted C$0.99 at close on Friday June 24), its market cap is about C$90 million, very much the same it was when Formation peaked last December. In spite of raising C$80 M, the market cap has not increased. Did the C$80 M go down the drain, or is this a strong indication of mispricing ?

Put differently, subtracting the C$80 M risen from the current market cap, the Formation Metals tangible assets and mineral reserves are now valued by the market at C$10 M.

Outlook

Formation Metals has been in a downtrend for half a year and there is little indication that this will reverse suddenly. Yet, contrarians that get on board now, are doing a far better deal than those investors that participated at the capital raise: with Formation at penny stock level, there is no equilibrium price for their warrant incentive to be advantageous. 

When the trend reverses, likely resistance levels are $1.40-$1.50 (where we were when capital was raised) and $2 (which is the strike price for the lump part of the warrants outstanding). Peter Grandich has a target of $2.60 on Formation Metals. He also put forward an expected cash flow per share of $0.47.