Inco may write down Voisey’s: Research Capital

In a report titled Inco: High-Quality Assets in a Leading Company, analysts Barry Allan and Oscar Cabrera of Toronto-based brokerage house Research Capital put forward figures that suggest the nickel major’s Voisey’s Bay project in Labrador will eventually require a hefty writedown in carrying value.

To lay the groundwork, the authors first trace the financial history of the project.

In June 1995, Inco bought an initial 25% stake in the subsidiary of Diamondfields Resources that owned a 100% interest in the Voisey’s Bay project and other claims in Labrador. Then, in late 1996, after fighting off rival Falconbridge in a bidding war (the battle is well documented in Jacquie McNish’s The Big Score), Inco acquired the remaining 75% of Voisey’s Bay in return for a combination of cash, common shares, series E preferred shares and newly printed “class VBN” shares (Inco bought back the VBN shares in early 2001).

The total consideration offered for the 75% stake was US$3.1 billion, placing the total value of the project at US$4.1 billion.

The project has also been subject to a 3% net smelter return royalty under an original option agreement with claim-holders.

An extensive exploration campaign carried out by Inco in the late 1990s proved up reserves of 31 million tonnes grading 2.88% nickel, 1.69% copper and 0.15% cobalt. There are no significant gold or platinum group metal credits.

The massive sulphides at Voisey’s Bay were found to be contained in three deposits: the Ovoid, which is amenable to open-pit mining, and the Eastern Deeps and Western Extension, both of which will have to exploited at a later date using underground methods.

In its last significant discussions with the provincial government in mid-1998, the company outlined a 6,000-tonne-per-day mine-mill project at Voisey’s Bay that would cost US$500 million. The plan also considered expenditures for a US$125-million hydrometallurgical plant, underground development and exploration, for a total pricetag of US$690 million.

The proposed mine would produce about 117 million lbs. nickel, 68 million lbs. copper and 5.4 million lbs. cobalt per year, at an estimated total production cost of US$80 per tonne, net of byproduct credits, so that the total operating cost would be US$1.06 per lb. of nickel.

As is widely known, the provincial government turned down the plan, and discussions were suspended (they have resumed at only low levels since then). The impasse has also resulted in a cooling of parallel talks with native groups regarding employment and other issues.

Taking into account the exploration and development campaigns of the late 1990s, Inco now carries the Voisey’s Bay project on its balance sheet to the tune of US$5.6 billion, as of the second quarter of 2001.

However, Research Capital calculates that, at a discount rate of 10% and a long-term nickel price of US$3 per lb, Voisey’s Bay has a net present value of only US$598.8 million.

The analysts further calculate that the project’s cumulative net cash flow, after capital and taxes, is only US$2.5 billion, meaning that the book value of the project is overstated by approximately US$3.1 billion, or US$17.19 per common share (C$27.09).

“We anticipate that once Inco reaches an agreement to develop Voisey’s Bay and completes a definitive feasibility study, the book value of the project on the balance sheet may be reduced,” write Allan and Cabrera. “We further believe the market is already discounting this writedown.”

Farther along in the report, the authors state their belief that Voisey’s Bay is robust enough to support a senior project facility equal to 60% of the net capital cost of development, net of any special government initiatives.

With respect to Inco’s developing its more-advanced Goro project in New Caledonia and Voisey’s Bay simultaneously, the authors state that “development of both projects at the same time would overextend Inco’s financial capacity, and additional financing in the order of US$200 million would likely be required . . . to fund a US$100-million direct-cash shortfall and maintain an acceptable cash balance.”

They add, however, that “if nickel prices rise steadily through 2003 and reach a spot price of US$4 per lb. in the first quarter of 2004, Inco could develop both projects and would not need any alternative source of financing outside of bank debt.”

The authors say that at a nickel price of US$4 per lb., Inco’s writedown on Voisey’s Bay would likely shrink to US$1.5 billion from US$3.1 billion.

Overall, Research Capital calculates Inco’s total operating value to be US$5.3 billion, broken down into: Canadian operations, at US$3 billion; PT Inco (59%) at US$867 million; the Goro project (70%, assuming a portion is sold) at US$779 million; Voisey’s Bay at US$599 million; and recycling and custom milling at US$50 million.

Inco’s total net value is calculated to be US$3.7 billion (US$20.35 or C$32.05 per share) after taking into account various factors, including: equity investments; exploration; research and development; environmental liability; unfunded retirement obligations, working capital; long-term debt and corporate overhead.

In their calculations, the analysts make the following price assumptions: nickel, US$3 per lb.; copper, 85 per lb.; cobalt, US$9 per lb.; gold, US$275 per oz.; and a Canadian dollar worth US63.

In 2000, Inco supplied 259,374 tonnes of nickel (roughly one quarter of the world’s total primary demand), ranking the company second after Russia’s Noril’sk Kombinat among global nickel producers.

Noting that Inco has “tremendous leverage of underlying value to higher nickel prices,” Allan and Cabrera estimate that the fundamental underlying value of Inco ranges from a low of C$19.85 per share at a spot nickel price of US$2.50 per lb. to C$60.21 at US$4 per lb.

The authors also believe that if Inco’s share price does not fully reflect the value of its underlying assets, particularly as it begins to develop Goro and Voisey’s Bay, the company will become increasingly more attractive as a takeover candidate by one of the global mining giants.

At the time Allan and Cabrera wrote their report, in early January, Inco shares were trading at $27.38, and Research Capital put a “buy” recommendation on the stock with a price target of $38.

The authors comment that “at a commodity price of US$4 per lb. nickel, the underlying value and share price of Inco should approach C$50 per share, which we think is a real probability by late 2003. If economic growth takes hold in earnest before 2004, the shortage of nickel may be acute.”

Allan and Cabrera’s Inco report, along with their other mining reports, are available online at: www.researchcapital.com. The same web site feature Research Capital’s Metals Research Today, a daily compendium of metal prices plus the stock prices of the most-watched mining companies.

Research Capital and Thomson Kernaghan recently announced their intention to merge, a move that will produce one of Canada’s largest independent brokerage houses.