Brian Ostroff, managing director of Windermere Capital, recently took some time to speak with Resource Investing News about the fundamentals driving phosphate market, and more specifically, Canada’s phosphate hopeful, Arianne Phosphate.
Brian Ostroff is a managing director at Windermere Capital, where he focuses on the junior and mid-tier mining sectors. He brings over 25 years of small-cap mining expertise to the table, having served at RBC Dominion Securities and as a managing partner at Goodrich Capital, an M&A advisory firm. Prior to joining Windermere Capital in 2009, Brian spent four years as an independent proprietary trader.
RIN: When it comes to fertilizers, it seems that phosphate is less talked about than potash. But that doesn’t mean that it is any less important. With that in mind, can you just give us a brief overview of the market?
BO: In my opinion that is correct. Phosphate along with potash and nitrogen are the three components of fertilizer and over the last few years it has been potash that has received most of the attention from the investment community. I’m not entirely sure why but it has led to a “chicken and egg” situation in the sense that there are also a lot more potential investments in the potash area. Have more companies in the space led to more analyst coverage (and thus investment demand) or, did the increasing interest in the potash space lead to more companies being created to look to exploit the opportunity?
The one important thing to realize is that all three components are in fact separate and they all have different supply/demand characteristics resulting in different timing, pricing and opportunities for the three components. I think investors are making a big mistake when they look at “fertilizer” investments, and not understanding the difference. A perfect example of this occurred this past July. A large Russian company (Uralkali) said that it was going to abandon a potash cartel that it was part of, opting to concentrate on volume of production rather than pricing. It would be similar to Saudi Arabia opting out of O.P.E.C. to go it alone. Investors correctly assumed that this should drive the price of potash down and they sold a lot of the potash producers down roughly 20% across the board that day. The problem is investors sold all fertilizer stocks down that day including the nitrogen and phosphate companies which didn’t make a whole lot of sense.
For some time now I have believed that the best opportunity for investors is in the phosphate space. You are right in saying that it has been the component most neglected and in fact, there are not a lot of potential investments in the space. Of course, as an investor, I love that. Great macro environment, few ways for investors to get involved equals higher prices for those companies that have an interesting asset. Also, the relative obscurity of phosphate may be starting to change in that I am starting to see more analyst coverage in the space and some investor demand. Further, a couple of weeks ago there was a very large transaction in the phosphate world with Mosaic buying the phosphate assets of CF Industries in a $1.4 billion deal. Events like that cause investors to start to look at an industry for opportunity.
RIN: What is going on in terms of supply and demand? What is the long term outlook on phosphate?
BO: Phosphate really is an interesting market. Phosphate is the one component of fertilizer that North America is not self-sufficient in. Actually, neither is South America, Western Europe and most of Asia. This deficit is almost entirely made up from production out of the Middle East and North Africa. In fact the biggest player in phosphate by far is Morocco. Did you know that Morocco is roughly four times bigger in phosphate than Saudi Arabia is in oil? For all those who think about “security of supply” when it comes to various commodities, you had better give some very serious thought to phosphate. Now I understand that geopolitically Morocco is a much better bet than a lot of other countries in the region but I think it might be a stretch to call it “secure.”
And things seem to be getting a little tense there. Some of Morocco’s phosphate comes from a region called Western Sahara. I think your readers that truly want to understand the dynamics of the phosphate market should Google “Morocco/Western Sahara” and try to understand what is going on there. The general gist: many in the international community do not acknowledge Morocco’s “ownership” of Western Sahara and the resentment towards the situation seems to be intensifying. The United Nations has appointed a special envoy to try and address the issue particularly between Morocco and Algeria which seems to be leading the charge towards an independent Western Sahara. The situation there has become so heated that Morocco has recently recalled their envoy to Algeria and there are those in the United States Congress that want to look into the matter. Some investors are also talking with their wallets as pension funds from both Norway and Sweden have divested their holdings in Potash Corp. because Potash Corp. receives some of their phosphate from the Bou Craa mine in Western Sahara. Other players on the export supply side of the equation are countries such as Tunisia, Egypt, Syria, Jordan, Israel and Russia. That should make your readers sleep well tonight.
So that is the supply side of the equation. On the demand side of the equation I have already talked about the regions of the world that are in deficit but I would like to take that one step further. Fertilizer is one of those industries where all the players like to be as integrated as possible. They like to own their own phosphate rock deposits, ship it to their own phosphoric acid facilities, mix it with their own sulfuric acid to create their own phosphoric acid and finally mix it with their own ammonia (Nitrogen) to produce their own finished product; MAP and/or DAP. This is so ingrained into the industry that roughly 85% of the phosphate rock production is owned by integrated producers. The risk is that other 15%. Those who need it are reliant on those who have it; not the most comfortable situation especially when you think about, as I have mentioned, those who have it. So, here in North America, Potash Corp., Mosaic, Agrium as well as some other small players require phosphate rock. So do the Indians (India is the largest importer of phosphate), several Russian companies as well as many other smaller diversified players. Further, even some players that have sufficient rock today will not have adequate supply in the years to come. For example, Israel Chemical will be out of rock supply in about nine years and Mosaic is heavily reliant on a favorable permitting process in Florida in order to make up for its needs a few years out; no new environmental permits equals very big problems and, Mosaic is no stranger to environmental issues in Florida.
The last thing I will touch on briefly is that not all phosphate is the same. You see, in the case of gold or silver or many other minerals that you mine it doesn’t matter if you mine it from Canada, Argentina or Russia, it is all the same and you get the same price for it. This is not the case for phosphate. Once the phosphate rock is mined, it gets concentrated and the level you can concentrate it to (roughly 27%-40%) is wholly dependent on the nature of the deposit and all of these deposits have other elements in them. For example, about 90% of the world’s phosphate comes from sedimentary deposits. These deposits typically have decent in situ grades but there are limits as to the level of concentrate you can produce. You can, for example, start with 24% in the ground but you might only end up with a 31% concentrate. The other problem is what those other trace elements are. In sedimentary deposits you will often find uranium, thorium, cadmium, mercury and other real “nastys” that are definitely an environmental concern and possibly a food safety concern but, since this is 90% of the world phosphate production, there is not much we can do about it. Ten percent of the world production of phosphate rock does however come from igneous deposits. These deposits typically have a much lower in situ grade (roughly 4%-14%) but due to their geological make up can be concentrated up to a much higher level (35%-40%) and do not usually have a lot of the other deleterious elements. So, when buyers buy phosphate rock, they pay based on how much phosphate is in the concentrate. If Morocco sells a 30% concentrate, a producer of a 39% concentrate (several Russian companies that have igneous deposits) would naturally receive a 30% premium to Morocco since they have 30% more phosphate in the concentrate. Further, there is an additional premium to be paid because of the “clean” nature of the concentrate.
Given all the dynamics mentioned, I am a big believer in the future of phosphate rock and as a Fund, we have several investments in the space. I mentioned that unlike potash, there are not that many viable investments in the phosphate space especially once you layer on geopolitics. Most available rock comes from MENA (Middle East North Africa) and there are some projects developing in Africa. For our Funds, this is basically a no go. Our phosphate investments are in exploration or development stories in areas we think secure. Currently our largest investment is in Arianne Phosphate.
BO: As mentioned, Arianne is currently our largest investment so I obviously agree with the statement. First of all it is the right resource. Arianne has been gifted with an igneous deposit. These deposits are very rare and found in the Kola Peninsula in Russia, a couple in Brazil, South Africa and Canada. In the case of Arianne, they are able to produce a 39% phosphate concentrate which sells at a very premium price. Currently, a Russian Company called PhosAgro produces a 39% concentrate as well and it sells for roughly a $100/ton premium over benchmark Moroccan concentrate. Of interest, PhosAgro has said that within the next few years, their growing requirement for all of their own rock will mean that they will no longer sell to the outside market making Arianne’s rock even more precious. Also, consistent with other igneous deposits, Arianne’s concentrate has almost no deleterious elements such as Uranium, Cadmium, etc. The worldwide demand for this “clean” rock is growing at twice the rate of that for traditional phosphate rock but quite honestly, the only thing limiting the demand for the clean rock is the supply. If there were more available, there would be a market for it. Arianne has it, and it will sell for premium prices.
As for the right location, it’s perfect. North America runs a deficit of roughly 5 million tons of rock a year. This deficit recently increased by 1 million tons because Agrium, a very large integrated fertilizer company, just closed one of their mines in Ontario, Canada due to depletion. Agrium now has to rely on Morocco for over 40% of its rock requirements. Mosaic, Potash Corp., and others all need rock and have to import it from outside North America. So here is this deposit in Quebec that makes a very pure concentrate, it has a very large resource, close to infrastructure including a deep sea port right in the heart of where there is a shortage. It is also in a good jurisdiction when it comes to permitting, social acceptance, familiarity with mining and sourcing of investment.
RIN: Arianne just released its bankable feasibility study for the Lac a Paul project, right off the bat, what should investors take away from the numbers?
BO: A lot of people throw around the word “world class” but this asset is just that: world class. They have 750 million tons of high quality rock situated in two deposits making it the single largest phosphate development asset in the world. The metallurgy confirms their ability to produce a 39% concentrate. They will produce 3 million tons a year. They are able to transport it to a deep sea port and ship it anywhere in the world 365 days a year. They can do this for under $94/ton cost and then sell it for a projected $213/ton. They have a long life of mine and the potential to grow that looks, dare I say, obvious. Arianne has a $1.9 Billion dollar NPV and a fully diluted market cap of $140 million.
RIN: In 2012 when Arianne released its prefeasibility study it took into account both the Lac a Paul zone and the Manouane zones. However, for the BFS, the company only looked at Lac a Paul and came back with a $1.9 billion NPV, as opposed to the initial $1 billion NPV with both zones. How significant is this development?
BO: I think it is very significant. First, to your point, in the prefeasibility study, Arianne had a 17 year life of mine from two deposits; Lac a Paul and Manouane. Arianne set about doing some additional drilling and was able to greatly expand its Lac a Paul deposit to the point that now Lac a Paul alone can provide close to 26 years of life. They still have another 8 years in Manouane that is not part of the Bankable feasibility study or that $1.9B NPV. The significance is that for those who are looking for an answer to dependency on international providers of phosphate rock, you can find an alternative for a very long time right here.
RIN: What potential for expansion does the project have?
BO: It looks pretty large. Lac a Paul is still open laterally and at depth. Aside from Manouane, that also may have expansion potential, there are several other areas that have potential. There is the Nicole zone that sits in between Lac a Paul and Manouane and this may (I stress ‘may’) be an extension of Lac a Paul and all part of one continuous zone. Arianne has said that they will do some additional drilling and is hoping to have 50+ years of mine life.
RIN: In the case of Arianne, I see the BFS is calling for a CapEx of $1.2 billion, any thoughts on that?
BO: Yes, many. Obviously that is not a trivial number but I think taken in context it is a very manageable number. First of all, as I think they have shown, it is a world class asset that will be around for a very long time. For all the reasons I have sited, phosphate is an important resource and we don’t have many other prospects to insure that we will have it. This is not like gold or copper where there are a dozen billion dollar plus projects looking to be built to add to the hundreds of mines that already exist. There are no other projects of this type anywhere and, if you need phosphate, you need this asset to be built. Another thing to keep in context is this is a project that will do roughly $650 million a year (every year for who knows how long) and make over $300 million a year in gross profit. For all those who say it’s too expensive, let me ask you this: If the project had a capex of $120 million and would provide $65 million/year in revenue with a gross profit of $30 million a year, wouldn’t you think those economics were very attractive? You would be surprised at how many people don’t realize that the $1.9B NPV is a number that includes the payback of your $1.2B capex; you are getting a net present value of $1.9B after you have paid your costs. You would also be surprised at how many people don’t realize that the roughly 21% IRR is unlevered; it assumes that all $1.2B will be raised as equity, no debt. This is obviously not the case so imagine what the IRR looks like if you get 70% of that $1.2B in debt. Lastly, as big as that $1.2B capex sounds, it is small change for either the companies that understand the need to own the asset outright or, the companies that will want to secure some of the off-take.
RIN: As part of the $1.2B of CapEx, Arianne has set aside $232.2 million dollars for their transportation system. What are the company’s transportation plans?
BO: That is very true. In the prefeasibility study, only minimal thought was given to how you were going to move this stuff from the mine to your potential customers. As most will tell you, when it comes to bulk commodities like iron ore, coal or phosphate, logistics make the difference between success and failure. With this in mind, Arianne set out to have a rock solid (pardon the pun) plan to transport the concentrate. They will truck the concentrate on an already existing oversized road capable of handling 165 ton loads, which it currently handles for the timber industry. This is not a public road and there is little, if any, non-commercial traffic. It will be trucked down to silos on the north shore of the Saguenay River. From there, the concentrate can be loaded on to very large ships able to transport 365 days a year. One of the big changes from the prefeasibility is that everything will occur on the north shore, saving the company the time and expense of having to cross the river.
RIN: Arianne has an all-in shipment cost of $93.70 per tonne. How significant is this in comparison with other phosphate companies?
BO: Ninety-four dollars a ton, all in cash cost on a ship ready to set sail is extraordinary. Remember, this is a 39% concentrate and therefore this ship leaving port is carrying 30% more rock than most other ships. It sure beats $140/ton for a 30% rock coming from halfway around the world from a place where one day geopolitical events may not even allow a ship to leave port.
RIN: So, when it comes to courting the major players in the fertilizer space, is there a greater interest in lower operating costs or lower capital costs?
BO: Definitely the operating costs are of more interest/importance. The thing about CapEx is you only spend it once. Remember, in the prefeasibility report, there was an assumed $800 million CapEx for 17 years of life with a questionable logistics plan. The bankable has a $1.2 billion CapEx but that is for 26 years plus, an additional 8 years for Manouane as well as any other resources they may find. The $1.2B is amortized over a lot longer period and gets you a very competitive cost on the ship. You know, the first day the mine starts to operate the CapEx is spent and gone. What does matter is the OpEx because you will live with that every day for the entire life of mine. As I said, at $94/ton on the ship, Arianne is in a very enviable position.
RIN: What are your expectations for Arianne in the future?
BO: Well the company will be filing their full BFS within the next couple of weeks. From where I sit, it will then be “game on.” I think there are many reasons to view Arianne as a takeover target. The security of supply issue is enormous. If something goes wrong, not only will the price of phosphate rock go through the roof but you might not be able to source it at any cost which means all these not-so-integrated fertilizer companies might not have enough end product to sell. Beyond the security of supply issue, there is also a very real economic benefit to someone who needs the rock. By relying on a third party supplier of phosphate rock, your costs are probably $100/ton more than if you own Arianne. At 3 million tons a year, a company is forgoing $300M in margin. These companies (Agrium, Mosaic, Potash Corp, etc.) trade at roughly 7 times earnings meaning they are leaving $2.1 billion dollars in market cap on the table. If I am the management of a company that needs rock, I really need to give Arianne some serious consideration.
RIN: What if a buyer does not emerge?
BO: That is a very fair question, common sense does not always prevail. I know the management of Arianne can’t sit around all day waiting for the phone to ring so they are moving the project forward. I think the economics of this project are compelling even as a standalone. With a projected $300 million a year in EBITDA, you are looking at a Company that should be worth over $2-3 billion a few years out assuming phosphate prices haven’t gone up, considerably more if they have gone up. The project is in mining friendly Quebec where there is money available to the mining industry. There are willing off-takers that are prepared to pay money upfront. I think this project can be built simply on its own merit and may ultimately be worth more to shareholders.
RIN: Any last thoughts?
BO: Well many say that I am biased because of the size of our position. That may well be true but our position wouldn’t be as large as it is if we didn’t fully believe in the macro of phosphate rock in general and the characteristics of this project in specific.
It’s interesting. Arianne’s stock is one of very few to have gone up over the last few years after announcing their BFS and so investors assume I should be content. The reality is, two weeks ago our funds owned a really cheap stock that was trading at 10% of its NPV ($100M market cap; $1B NPV). Today our funds own a stock that is trading at 7% of its NPV ($140M market cap; $1.9B NPV); it’s hard to be content.
I know in this day and age investors have A.D.D. and very few, if any, believe in investing with a longer term horizon. I guess I just don’t understand what investors don’t see. You have a world class asset in a great jurisdiction. It is a commodity that the world needs and where there are serious threats to the supply of it. They will produce a premium product. It trades at a ridiculous valuation; you can own a $1.9 billion asset for $140 million dollars. As an investor, isn’t that what you are looking for? You check with your investment advisor, you consider yourself lucky to have found it, you buy it (probably a lot of it if it fits with your risk tolerance), you forget about it and one day you wake up and it has either been acquired or it is producing oodles of cash. One way or another, you have made a very good return on your investment.
RIN: That’s a good point. Well thank you, Brian for sharing your insight with us.
BO: Thank you.
Securities Disclosure: Brian Ostroff and family members own shares of Arianne Phosphate. The Windermere Capital, and its affiliates, own shares of Arianne Phosphate through its two funds and manager.
Editorial Disclosure: Arianne Phosphate is a client of the Investing News Network. This interview was conducted as part of Arianne’s advertising campaign.