“Worst Pricing Mismatch I’ve Ever Seen” (Nick Hodge)

Another look at Hodge's recurring Graphite teaser pick that he says is still "the one to buy."

By Travis Johnson, Stock Gumshoe, July 25, 2012

Nick Hodge has been teasing a favorite graphite stock since late last year, and he’s lately been pushing it hard again, saying that this particular mine is now the source of the “worst pricing mismatch” he’s ever seen.

Which gets the blood boiling at least a little bit, right? After all, what is the point of investing in individual stocks if you’re not looking for “pricing mismatches” — the stocks that are trading for less than they’re really worth? So let’s see if we can check and make sure he’s still teasing the same pick, and you can see if you think it sounds like the kind of investment you’re interested in.

Here’s the new chatter about this stock from his latest email:

“Whenever the price of a commodity rises as dramatically as it did with graphite, inevitably companies try to find more graphite to mine.

“Makes sense, right? If the price is flying, why not mine it and sell it?

“Well that’s exactly what happened.

“Before graphite prices took off, there were only a couple graphite companies outside of China. Now there are 36.

“But the one to buy is still the one I went to visit late last year, when this bull was just getting started.

“And that’s what I want to tell you about today….

“this graphite company is simply restarting a mine that was already in production. Mining stopped there decades ago because graphite prices were in the toilet.

“The mine it owns has already been thoroughly tested. And it’s closer to new graphite production than any other company outside of China…

“The conservative estimate is that this company has at least 470,000 metric tons of high-quality graphite.

“So to put a total value on the mine, we have to multiply that by the current price of $2,600 per tonne.

“Right now, if graphite prices remain unchanged, this company is sitting on AT LEAST $1.22 billion. And it could be much more than that if the price of graphite rises, as expected….

“this company’s entire market cap is only $46.9 million.”

He basically draws a picture that’s similar to what we saw from the rare earth stocks a few years ago — when the “story” of the rare earths shortage and Chinese hegemony reached the front pages, and every company that could claim they had a potential rare earth exploration project was able to raise millions of dollars and send its share price flying, even if there was never any hope that they’d actually mine anything within five or ten years. You’ve probably noticed that even the “real” rare earths companies that helped to spark that mania — stocks like Molycorp (MCP), Avalon Rare Metals (AVL) and Lynas (LYSCF) that in some cases even have real production and revenuem — have collapsed in the years since, and are still, well, trying to develop extremely complex projects.

He says there are now graphite companies popping up all over the place to meet rising demand and increasing investor interest, but that it will, similar to the rare earths, be the few actual advanced projects that are worth your attention … and, of course, that the best one is the one he teased and recommended a bit over six months ago (yes, we covered it back then, too, but it seemed time to catch up). Hopefully the survivors of the expected graphite “bubble” will be stronger than the rare earths survivors, but I suppose time will tell.

So what is the stock he’s picking?

Well, yes, it’s the same one we already covered — here’s the intro in case you forgot about it in the interim:

“This Makes Everything Obsolete

“50,000x thinner than a human hair…
“230x more powerful than silicon…
“200x stronger than steel…

“New ‘miracle material’ promises breakthroughs
“in everything from batteries and medical science…
“to oil exploration and defense systems…

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“Here’s your chance to be first in line for 300% gains.”

If you don’t remember our last piece about this one, we mentioned it a few times in passing in March when the ad was running hot and heavy and then covered it more fully in April. The stock teased is Northern Graphite (NGC in Canada, NGPHF on the pink sheets)– and while it’s pretty disingenuous to tease a graphite miner by using the promise of graphene, high quality graphite has apparently been in quite a bull market over the last five years or so.

What do I mean about the graphene/graphite disjoint? Well, graphene is the “miracle” nanomaterial that led to a Nobel Prize just a few years ago, it is shocking in its strength, flexibility, conductivity, and clearly a hugely promising material. A year or so ago Byron King was touting a different graphite mine and in so doing called graphene the “new silicon,” which is a popular notion. And it might even end up being true, it’s certainly cool science.

But the graphite market isn’t really about graphene for the foreseeable future, it’s about steel and batteries — there’s more graphite in a lithium battery than there is lithium, and graphite is a key component for steelmaking. At some point in the future graphene may be a big enough business that the highest quality graphite will go into graphene, and it’s possible the volume demand will be enormous enough for that to drive graphite prices, but for now graphene is a hugely expensive nanomaterial whose cost comes from processing the material into a one-atom-thick sheet, not from the raw material which is priced, like iron ore, by the ton. Making graphene out of large flake graphite, which is what Northern Graphite is hoping to mine, is probably better … but creating it artificially, at least at this point, wouldn’t drive a dramatically different price for the end product. Researchers are making graphene in lots of different ways now — large flake graphite is basically just giant stacks of sheets of graphene, but that doesn’t necessarily mean it’s going to be easiest or most efficient to mass-produce graphene out of even high-quality flake graphite, I have no idea. You can read up on it here in the Wikipedia entry for graphene, it’s fascinating stuff.

Graphite, though, is something else — it’s sometimes referred to as the “highest grade of coal,” though it’s not really a flammable fuel, and the well-known uses have historically been in steelmaking (it’s used to add carbon), lubrication, and pencil leads, most of which can be done with either synthetic graphite or with the mined stuff, particularly the inexpensive mined graphite (there are several different grades of graphite, with large flake graphite like much of the projected output of Northern Graphite’s mine being the “fanciest” … again, here’s a wikipedia entry for Graphite if you want more basic detail).

So no, don’t buy a graphite mine because graphene is going to become the next super material. But should you buy it because graphite prices are going up? Well, that’s what Hodge thinks and apparently what Northern Graphite thinks too — in the note on graphite pricing at the Northern Graphite website this is how they put it:

“Price appreciation is largely a function of the commodity super cycle and the industrialization of emerging economies as new, high growth applications such as Li ion batteries have not yet had a substantial impact on demand and consumption”

So even the explorer itself is not pushing the lithium ion battery story … let alone the next iteration, the “graphene” story, they’re still saying that the spike in graphite prices is from the “commodity supercycle” … which really means, given the source of most graphite demand, that higher prices for graphite have been forced by demand from steelmakers.

But the anticipated spike in graphite prices that is leading to the development and re-development of graphite resources around the world is largely about energy storage, which includes vanadium batteries and various fuel cell technologies that use graphte, but most of the projected near-term demand would come specifically from lithium ion batteries and their use in electric cars. There’s quite a bit more on this in the investor presentation updated this month by Northern Graphite. Lithium ion batteries demand further processing of the graphite, into spherical graphite for the anodes, and Northern Graphite is also studying ways to produce that refined and concentrated product (which gets a premium price, they say $6,000-8,000/ton).

Northern Graphite’s proposed mine, Bissett Creek in Ontario, is in a good location — close to infrastructure, and in a mining-friendly country — and it has been pretty well studied, with feasibility studies done 15 years ago or so before the Chinese crushed the market with their low prices. It’s not necessarily going to be a cheap mine, though — they believe that the vast majority of their graphite will get premium pricing as “large flake” graphite, in the neighborhood of $2,000/ton these days (though pricing has apparently come down a bit over the last six months), and they’re projecting their cash costs to be around $850/ton. If you look at the spike in graphite prices from 2008-2011, you can see why Bissett Creek wasn’t developed — if prices fall back to where they were in 2008, this mine wouldn’t make any money by their calculations.

They are fairly close to possible production, though, so this isn’t a company that’s just defining a resource, they are actively trying to build a mine. They just released a bankable feasibility study about two weeks ago, which caused the shares to lose about 30% of their value in a matter of a day or two — largely, I guess, because the internal rate of return and the net present value calculations. The low-end pricing for graphite that they use as an example gives them an after-tax net present value for the mine of only $46 million, which is below the company’s current market cap of about $56 million — higher graphite prices give them a much higher present value, of course, up to a net present value after tax of $125 million if graphite prices are $2,800/ton. They expect premium pricing for their relatively high-grade products.

It’s probably worth your time to read through the feasibility study details if you’re interested in the stock — the company will need to raise money soon to start construction if they’re going to get the mine built and operational within the next 18 months as they’re hoping, and according to the study they’re going to need almost $100 million to build the mine. If they do get permitting and approvals to start construction this quarter, as they project in their presentation, that probably means they’d have to do some combination of pre-sales to a customer, additional stock sales, or other outside partnerships for financing the project, they currently have only about $10 million or so in cash.

Graphite certainly has a chance to be the “flavor of the month” for a while among commodities, which can easily cause pricing for these junior miners and explorers to explode, as we saw when Northern Graphite’s stock was driven over $3 by the attentions of Nick Hodge and others back in March before it fell back down to about a buck, but I think it’s really important to underscore that this is an industrial commodity, and while production has been low in the West because of low prices, it’s not necessarily all that rare. If steelmaking falls, or if lithium ion batteries do not enter a supercycle from booming electric car production, then my very preliminary understanding fo the economics of this commodity is that there aren’t a lot of other large end markets for high quality graphite that could be expected to keep pricing elevated. That’s not to say it can’t work, of course, but it seems to me that unless you see the steel market returning to glory (overcapacity of steel production is a huge problem right now, particularly in China) a lot of the argument for real performance from Northern Graphite or any of the other potential emerging producers has to be based on high demand for heavy lithium ion batteries, which pretty much means lots of electric cars.

I love the idea of graphene, but it won’t drive graphite mining profits anytime soon. And I love the idea of electric cars, but it strikes me that we’re in a bit of a holding pattern about just how quickly they will catch on and ramp up production. So I can see the potential for increased graphite demand, but it’s hard for me to count on the high end pricing of Northern Graphite’s feasibility study … and the fact that their low end for pricing puts the net present value for the project lower than the market cap of the company itself gives me great pause, and a fair amount of confidence that somewhere along the line — perhaps soon, if they choose to do equity financing that dilutes current shareholders — the share price could easily be substantially lower even if the mine plan for starting commercial production by the end of 2013 remains essentially intact.

Now, that’s probably a skeptic’s take — and I should let you know that I completely missed out on the rare earths mania, too, because it was really hard to justify the economics of any of those projects, even the ones that weren’t just fertile ideas in the heads of optimistic copywriters. So I can’t tell you where the price of graphite will go, or whether Northern Graphite or their two most-teased competitors will do well over the next year or so. The other two that you’ll probably often see teased are Flinders Resources (FDR in Canada, FLNXF on the pink sheets), which is trying to restart a mine in Sweden, and Focus Graphite (FMS in Canada, FCSMF on the pinks, used to be called Focus Metals before graphite became a hot investor term), with more of a technology/processing focus attached to their smaller resource deposit in Quebec. All three are down substantially (40-70%) from the “graphite peak” in March and April, and all are tiny with market caps between $25-60 million so they can easily see their share prices doubled or halved on a bit of good or bad news that drives investor attention. All three say that they can be in production within two years but none has yet started mine construction — Flinders probably has the easiest path in terms of financing, since they say they have enough cash to restart their mine in Sweden, thanks largely to the fact that there are stockpiles of ore and a processing plant already on site from when that mine (Kringel) closed down a decade ago due to low prices, but it’s a pretty fine distinction for three companies that are working with pretty similar timelines.

If you want to review the investor presentations from these companies, which do give some good detail about expected pricing, mine life, and timelines, Northern Graphite’s is here, Flinders is here, and Focus Graphite is here. These are small resource companies and they know that they have to market their story and explain their market to investors, so they update these presentations pretty regularly.

And if you’d like to share your opinion on graphite stocks, well, I’d love to hear it — just shout it out with a comment below.



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July 25, 2012 5:49 pm

If it is linked to steel production I don’t think I’d be getting to excited. Look at BHP and RIO not exactly setting the world on fire with expectations. Looks like near term no one is expecting a return any time soon to high steel consumption.
Hope I’m wrong.

July 25, 2012 7:02 pm

Really useful analysis, Travis. Thank you. I wonder if the recent abundance of natural gas may have delayed the growth in electric car sales. It may be easier and more immediately beneficial to convert internal combustion engines from diesel/gasoline to cleaner burning and cheaper LNG than to produce an effective long-distance electric car. When one charges a battery-powered vehicle from a grid, one is now effectively “filling the tank” with some mix of coal (the worst possible choice in terms of climate change) and natural gas (a much better environmental choice but admittedly still a hydrocarbon). For the short term, why not rely more on the latter directly? Given the ultimate source of the energy used in electric cars, is better or worse to rip up tons of earth to get the pounds of materials needed to make battery-powered vehicles?

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July 25, 2012 8:49 pm

I own three graphite stocks enzr,fcsmf,ngphf, it may take one or two years to realy start to take off but I am expecting some good multiples

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