An undervalued small cap copper play with the second largest resource on the ASX

UBS said the price of copper could have its own ‘lithium moment’ as the market is getting closer and closer towards a “fundamental inflection point.”

“We now forecast only a modest surplus in 2023, moving to a growing deficit from 2025. In our opinion, this increases the risk of material price upside of the next 2-3 years,” the analysts said in a note last week.

There’s a major gap in the ASX-listed copper space after BHP’s (ASX: BHP) acquisition of Oz Minerals earlier this year.

Sandfire Resources (ASX: SFR) is now the largest ASX-listed pure play, followed by the troubled 29Metals (ASX: 29M) and emerging Aeris Resources (ASX: AIS).

But when it comes to copper in the ground, there’s one emerging player that's making a statement over all the household names. And it’s only got a market cap of $80 million.

Meet Xanadu Mines (ASX: XAM).

A copper giant in the making

Xanadu operates the Kharmagtai Project (via a 50:50 Khuiten JV with Zijin) in Mongolia – It has a Mineral Resource of 1.15 billion tonnes, comprising 3.0 million tonnes of contained copper plus a gold by-product of 8.0 million ounces.

To put that into perspective, its resource on a Contained Copper basis is second to only Sandfire Resources on the ASX (data based on latest Mineral Resource announcements).

Xanadu's Contained Copper vs. larger cap peers

As at 3 May, Xanadu was trading at a discount of approximately 70% against its peers, based on the EV/Life of Mine (LOM) copper production metric.

Life of Mine Cu Production

UBS: “Getting closer to the buying level”

Copper prices are down around 3% year-to-date and unchanged in the past two years. Its price action has been a battle between the subdued macroeconomic environment and the energy transition – and macro is winning that tug-of-war, at least for now.

“Near term, prices could test theoretic cost support levels (~US$3.20/lb) if the already weak physical signals deteriorate further as supply lifts,” UBS warned.

At the same time, a lot of that’s already priced in as “speculative positioning has already shifted from net long to neutral/short,” the analysts said, adding that “we do not see a protracted period of oversupply driving prices into the cost curve for an extended period.”

While the global economy is set to slow in 2023, UBS expects increasing demand from solar/wind and robust auto demand to limit the drag from the economic cycle.

“In 2023, we forecast that energy transition demand will account for >100% of growth (i.e. offsetting contraction elsewhere) and >50% of demand growth in the medium term,” the analysts said.

“The window of opportunity for sufficient new projects being added to prevent a sharp slowdown in supply growth is rapidly closing,” said UBS.

“We believe the risk vs. reward for copper is improving and the medium-term outlook is constructive.”

De-risking a world-class copper project

A 2022 Scoping Study confirmed the potential of Kharmagtai as a globally significant project that’s well positioned to fill the looming copper supply gap. Some key highlights from the study include:

• Production: 200,000 tonnes of copper and 500,000 ounces of gold production over the first five years. Over its 30 year mine life, production will average 50,000 tonnes of copper and 110,000 ounces of gold per annum
• Costs: First quartile all-in sustaining costs of US$1.02/lb for the first five years
• NPV: Post-tax NPV of US$630 million at 8% discount rate and delivering payback over 4 years
• Capex: US$690 million

From here, Xanadu is progressing a funded 30,000 metre infill and expansion drilling program at Kharmagtai to support the delivery of its Pre-Feasibility Study and maiden Ore Reserve. The drilling targets areas of shallow open pit Resources, aiming to both upgrade the Resource classification and to extend strike length.

Furthermore, a high impact 24,000 metre discovery exploration drilling program is underway at Kharmagtai. This portion of the drilling is two-fold: targeting new discoveries of (1) high-grade, large-scale mineralisation at depth, similar to what transformed Rio Tinto's Oyu Tolgoi (which is approximately 100km away) to a Tier 1 asset and (2) shallow open pit Resource across 5 unexplored copper gold clusters.

The company is fully funded through to its Final Investment Decision. It expects to deliver a Mineral Resource upgrade in the December quarter of 2023 as well as a PFS and maiden Ore Reserve by the September quarter of 2024.

Xanadu shares are up 53% year-to-date to 4.6 cents, driven by catalysts including a landmark strategic partnership with China's Zijin Mining. Zijin is positioned as the world's 6th largest copper producer and aims to be ranked 3-5 for copper and gold by 2030.

Next door to the world's largest copper consumer

"Mongolia is the place to be for producing and exporting copper concentrate products; it’s on track to being as good as the Pilbara for iron ore. And without a doubt, Mongolia is significantly closer to key customers" said Xanadu Mines Executive Chairman and Managing Director, Colin Moorhead.

"Mongolian copper benefits from newly constructed rail infrastructure (plus water and power) in the South Gobi, enabling copper concentrates to be efficiently delivered across the border to smelters in neighbouring China."

In September 2022, Mongolia launched the 233 km cross border rail line between the Tavan Tolgoi coal field and Gashuun Sukhait on the Chinese border. The new rail line is expected to lower transport costs by 4-fold to US$8 a tonne relative to trucking, according to the railway authority.

As for offtake partners, a portion of the metallurgical testwork program (being completed during the PFS) will produce several concentrate samples destined to potential smelter offtake partners.

"With metallurgical testwork to date indicating low deleterious elements (i.e. low Arsenic, Fluorine and Bismuth), along with a strong gold by product, we’re expecting the Kharmagtai concentrate to be in high demand," said Moorhead.

What the experts think

MST Financial upgraded its valuation of the stock from 10 cents to 12 cents last month. Its key focus points include:

• Kharmagtai: The asset has a potential life-of-mine production of 1.5 million tonnes of copper and 3.3 million ounces of gold, with "abundant enhancement options and exploration opportunities."
• Zijin's the ideal partner: "As a major neighbouring player, Zijin’s financial and technical resources are welcomed, as well as its marketing capability (if required) and a logistical link to end markets."
• De-risked funding: Xanadu’s portion of the US$690 million construction capex earmarked to develop the Kharmagtai mine has the “potential of being fully funded all the way to commercial production, via a direct loan with Zijin at favourable terms”

MST has a valuation of 18 cents if Xanadu opts to opportunistically fund Kharmagtai through to commercial production (and avoid the uncertainty of equity and debt markets) as follows:

• Sell 25% Kharmagtai JV share to Zijin for US$25 million, and
• Retain remaining 25% share, with its share of project construction costs loan carried through direct loan with Zijin, currently priced at 9.65%

This wire was first published for Market Index on Wednesday, 7 June 2023.