DISCOVERY METALS -  24th May 2010   PROJECT CAPACITY UPGRADED TO 3MPTA LEADS VALUATION HIGHER Discovery Metals Plc Activities - Copper exploration and development in mine in Botswana    Price @ close 21st May               41.75p Target Price                                  79p Index                                            AIM Sector                                          Basic Resources Ticker                                           DME.LN Shares in issue                            271m Market cap                                   £113m Net cash (March 2010)                A$34m Next event                                   Project Update Fairfax act as Nomad & Broker   Yes  Discovery Metals has significantly upgraded its plans for the development of the Boseto Project in Botswana from a 2mtpa to 3mtpa ore mined operation, following findings from the BFS work and the substantially larger resource base that can clearly support the enlarged plan. As a consequence we are raising our valuation from 61p to 79p  

YEAR END JUNE

2009A
2010E
2011E
2012E
2013E

Copper Price
c/lb
233
300
300
300
250

Copper Produced
kt
0.00
0.00
0.00
14.63
36.96

Silver Production
000'z oz
0
0
0
396
795

Revenue
A$m
0.55
4.07
4.96
117.85
250.05

EBITDA
A$m
-4.91
-2.70
-1.70
59.18
137.75

Pre Tax Profit
A$m
-4.44
-3.93
-16.65
39.09
120.75

Post Tax Profit
A$m
-4.44
-3.93
-16.65
39.09
120.75

EPS
(Ac)
-2.26
-1.10
-4.66
-10.76
33.25

PER (x)
(x)
0.00
0.00
0.00
6.83
2.21

Free Cash
A$m
-14.03
-17.15
-141.92
-6.68
124.04

Source: Fairfax & Discovery Metals   Expansion: An update on the BFS work has led to management's decision to expand the mine from 2mtpa to 3mtpa ore mined and processed.  This follows on from the additional defined open cut resources at Plutus and Petra (now extending over a 25km strike from around 11km).  Current resources sit at 102.8mt at 1.4% Cu and 17.3g/t Ag, measured, indicated and inferred, with 22.5mt in measured and indicated. The enlarged plan takes long term expected production from around 25ktpa of copper in concentrate to around 37ktpa.

The incremental cost to take the operation from 2mtpa to 3mtpa could be as little as US$15m as per a quote from selected EPC (Engineering, Procurement and Construction) contractor Sedgman Ltd.  The appointment of a firm for the EPC contract marks a significant milestone in the development of the Boseto.  The contract is subject to internal and external approvals and will cover: concentrator facilities, water, air, site infrastructure including a number of essential buildings, electrical power (reticulation and control rooms) and internal plant site roads.

Underground Potential: Management is investigating the underground potential of Boseto that could lead to further incremental production growth with a definitive feasibility now underway for completion by the end of June next year which could lead to incremental production growth at Boseto by early 2014. Timings:  The decision to develop an expanded operation has led to 6 weeks of delay to previous timings. The final BFS results are expected to be published in July, and will focus solely on the open pit aspect of Boseto's development.  Production to start late 2011 is maintained with first concentrate to be delivered that year and full production in 2012.

Financing:  Discovery is in a strong financial position with cash of A$34m at the end of March, with a further A$6m to come from options due to expire this month.  Cash reserves are soon to start being spent on long lead items.  The company will be looking for a significant debt component in the financing previously indicated at around 60%.  Total capex is currently expected to be in the region of US$165m (previous US$150m forecast plus US$15m for expansion).  We have conservatively assumed that total capex is in the region of US$176.5m.  This would leave US$70.6m in equity, which when factoring cash reserves and retaining A$10m to cover other costs leaves it with around US$40m to be raised in new equity later this year.

Valuation:  We value Discovery Metals at 79p/share based off an NPV using a 10% discount rate (around US$390m) on the free cashflows derived from Boseto.  We have used copper prices starting at 300c/lb next year falling to 220c/lb by 2014.  Our modeled production profile starts in 2011 ramping up towards 37ktpa copper in concentrate by 2013/14 (see previous graph) at cash costs starting at around 134c/lb falling to 103c/lb by 2014 for a capex of US$176.5m.  We have used a 15 year mine life all open pit.  We have factored in a ramp up period of around 2.5 years which sees copper recovery rates start at 70% and reach 83% as there is a possibility that stabilising the plant may take a little time due to the mixture of oxide and sulphide ore.  The majority or ore will be sulphide but there is some oxidation closer to surface.

Our valuation factors in an equity raise of US$40m at 63Ac (38p) or 10% below current price.  We have also included US$20m for exploration potential and A$10m of cash, as the remaining cash that will be held at year end (June) will be included as part of the financing of the project.  We are using US$/GBP exchange rate of 1.5 and A$/US$ exchange rate of 0.9 this year (affects equity raise) and A$0.85/US$ long term as company reports in A$.

Conclusion: There remains considerable upside potential from our valuation through: stronger copper prices, a higher share price when an equity financing takes place which will reduce dilution, underground developments, and the development of other projects within the company's extensive exploration tenements (see below).  Discovery's current resource sits on around 5% of the possible 1,300km strike extent within its tenements and work is underway to test this further that could lead to one or more new operations that could lead to Discovery Metals becoming a mid tier producer.

The company is one of the few developing copper stories available for investors to participate in at the junior/mid cap end of the market.  Being in Botswana the political risk is particularly low which should be very attractive.  The company will not be subject to the proposed Henry windfall tax in Australia.  The long term fundamentals for the copper market are also strong which we feel will enhance value for shareholders and consequently view the company as an exciting opportunity for investors.

Source: Interactive Brokers