I last looked at Trilogy Metals Inc. (NYSE:TMQ) shortly after its joint venture agreement with South32 Limited (OTCPK:SOUHY). The company was doing a roadshow right before the COVID pandemic and I was still managing external money, so I got an invite to attend.
My overall impression at the time was that the Ambler Mining District (“AMD”) is a top-tier resource endowment with multiple interesting targets/projects, with the most advanced being TMQ’s Arctic Project. However, any region that has to deal with indigenous communities and environmental concerns will struggle to advance in the current ‘ESG’ focused environment. Time has proven me correct as Trilogy’s Arctic project is essentially unchanged since I last looked at it. The road to connect AMD to existing infrastructure is still unpermitted and unbuilt.
However, with valuations back to 2017 levels, I believe Trilogy is an attractive ‘real option’ for investors who are bullish on copper prices and patient. Once the road permitting issues are resolved, Trilogy’s valuation should re-rate higher. I rate TMQ’s shares a speculative buy.
Trilogy Metals Inc. is an exploration and development stage Canadian mining company currently advancing its mineral properties in Alaska, USA. The company’s flagship project is the Arctic Project (50% owned through JV), located in the Ambler Mining District in northern Alaska.
Arctic is a feasibility-stage polymetallic project that will primarily produce copper and zinc with C$1.5 billion in pre-tax NPV and 25.8% IRR, according to a recent feasibility study released on February 14, 2023. The Ambler Mining District also includes the Bornite project, an advanced copper project with significant cobalt mineralization (Figure 1).
Arctic Is A World Class Project…
There is no doubt that the Arctic Project is a world-class mining project with 46.7 million tonnes of probable reserves grading 3.7% Cu Eq. (“copper equivalent”) (Figure 2).
In a world of declining ore grades with the average copper ore grades of ~0.9% for existing mines, the Arctic’s high grade reserves definitely stands out (Figure 3).
According to RBC Capital Markets, Trilogy’s Arctic project has one of the best combinations of size, profitability, and returns out of all the major undeveloped mining projects tracked by the bank (Figure 4).
From Trilogy’s February 2023 feasibility report, Arctic is envisioned as a 10,000 tonne-per-day (“tpy”) open pit mine producing 149 million lbs of copper, 173 million lbs of zinc, 26 million lbs of lead, 32.5k oz of gold, and 2.8 million oz of silver per annum (Figure 5).
Based on base case metal price assumptions of $3.65 / lb Cu and $1.15 / lb Zn, the Arctic project is projected to generate over $400 million in peak-year pre-tax cash flows (Figure 6).
At spot metal prices, the project’s NPV value increases even further to over C$2.1 billion pre-tax or $1.6 billion post-tax.
…With Tier 1 Backers…
Not only does Trilogy have a tier 1 project, it also has an impressive roster of shareholders and partners in developing the Arctic project. Trilogy’s shares are largely institutionally held with insiders and large, deep-pocketed investors owning approximately 55% of the company (Figure 7).
Furthermore, Trilogy owns the Ambler Mining District projects through a joint venture with South32, one of the largest diversified mining companies in the world with a $21 billion market cap (Figure 8).
Given the Arctic project’s robust economics and deep-pocketed investors, financing the project’s estimated $1.2 billion initial capital cost should not be a major issue.
…But Mineral Production Is Still Years Away
Unfortunately, the main impediment to the Arctic project is its remoteness. The project site is in the remote Alaskan north and currently does not have any major road access (Figure 9).
In order to advance the project, a 211 mile road (“Ambler Access Road) will need to be constructed to connect the project site with existing infrastructure. However, this proposed road has been in permitting purgatory since 2017 (Figure 10). In fact, when I last looked at the company just before the COVID-pandemic, the company was marketing the expected receipt of the final Environmental Impact Statement (“EIS”) on the road, and expected construction to begin shortly (Figure 10).
Although the United States Bureau of Land Management (“BLM”) granted permits authorizing the road in the summer of 2020, a coalition of national and Alaskan environmental groups and indigenous tribes filed lawsuits against the road permit, arguing that due process was not carried out. Ever since, Trilogy’s Arctic project has been mired in lawsuits and regulatory delays.
Currently, Trilogy expects the BLM to publish a draft supplemental environmental impact statement (“SEIS”) during the current calendar quarter with a public comment period upon publication. After that, the BLM anticipates publishing a final SEIS along with final pre-decision consultation with Alaska Native Tribes and Corporations, and issuing a Record of Decision in Q4/2023.
The Case For Copper
As the world transitions away from fossil fuels, there is an increasing demand for copper and other base metals. According to the Visual Capitalist, an electric vehicle can require up to 10 times more copper than a conventional vehicle (Figure 11).
That is why most analysts believe there will be a structural supply shortfall of copper on the order of millions of tons per annum in the coming decades (Figure 12).
Trilogy As A Call Option
Eventually, a valuable project like Arctic should be built if copper prices are high enough and metal shortages are severe enough that governments will brush aside environmental concerns. However, since production may be years or even decades away, one way to think about Trilogy’s stock price is as a call option on copper prices.
For example, a 20% increase in commodity prices can increase the Arctic project’s pre-tax NPV by 71% (Figure 13).
Given the supply/demand picture from Figure 12, it is reasonable to expect copper prices will continue to go higher in the coming years as the copper market falls into supply deficit. Therefore, Trilogy’s NPV ‘value’ may go higher even if it makes no advancements on the Arctic project itself.
Stock Price Cheaper Than In 2019
Currently, Trilogy has a C$124 million market cap for 50% of the Arctic project, with a C$1.1 billion NPV, or 0.23x P/NAV based on the feasibility of commodity prices. Using February 14, 2023 spot pricing (from Figure 3 above), Arctic’s NPV is C$1.6 billion so Trilogy is trading at 0.16x P/NAV. This NAV excludes the Bornite project and other projects and mine life expansions that could potentially add value over time.
In fact, if we plot Trilogy’s market cap and compare it to the price of copper, Trilogy’s market cap is back to 2017 levels when copper prices were sub-$3 and the Arctic project was much less advanced (Figure 14).
Another interesting reference point is that in December 2019, when Trilogy initially announced the JV agreement with South32, copper prices were also sub-$3, but Trilogy had a C$400 million market cap then. According to the company’s 2018 Pre-feasibility study (the “PFS” was the latest project valuation report prior to the JV agreement and can be downloaded from sedar.com), the Arctic project had a C$1.4 billion NPV using a $3.00 Cu assumption. Trilogy’s 50% share was worth C$700 million or a P/NAV of 0.57x. Therefore, Trilogy is currently trading at less than half the valuation of December 2019, with spot copper prices 30% higher!
Takeout Is Logical Conclusion
While Trilogy’s valuation is plumbing multi-year depths, consolidation is heating up in the metals space, with Glencore (OTCPK:GLCNF) making a run at Teck Resources (TECK), Hudbay Minerals (HBM) acquiring Copper Mountain (OTCPK:CPPMF) and Lundin Mining (LUN:CA) buying the Caserones copper mine in Chile.
I believe the logical conclusion to the Trilogy saga is an eventual sale of the company to South32, which already owns a 11% stake in Trilogy.
Risks To Trilogy
The biggest risk to Trilogy continues to be permitting delays. Even with fantastic economics, if the project cannot be built, then value cannot be realized. Fortunately, Trilogy does have the backing of major indigenous groups in the region, so permitting should only be a matter of time (Figure 15).
Another risk to Trilogy is if metal prices were to suffer declines as the global economy falls into recession. Lower metal prices could negatively impact Trilogy’s NPV, and thus stock price.
In summary, I believe Trilogy is an interesting ‘real option’ on the price of copper. Trilogy owns 50% of an economically robust copper mining project in Alaska that should eventually get permitted and built. It is currently trading at 0.23x P/NAV, which appears low given the attractive economics of the project. I believe long-term investors will be richly rewarded over time as the Arctic project is further advanced.
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