Tim Treadgold: Mount Gibson as a born-again iron-plated cash box?

Officially, Mount Gibson Iron is a reborn iron ore miner enjoying a second life at just the right time.

Unofficially, it’s a cash box amassing a war chest for its next deal, which is why what you see today might be quite different tomorrow.

Whether the future will be as exciting and profitable as the past is why the stock needs to be seen almost as a new float, albeit one sitting on a $400 million cash pile and with a lot more coming to pay for a transaction, or two.

Before getting to Mount Gibson’s future, it’s worth looking at the how the company got to the point of having so much cash on hand and why the cash pile is growing rapidly.

Koolan Island, off WA’s Kimberley coast, is both the company’s plum asset and the reason why it will undergo a significant change over the next few years for the simple reason that the iron ore on the island has been depleted to the point where the end of mining is clearly in sight.

But before mining ends Mount Gibson will be raking in the cash thanks to the island mine yielding the highest-grade iron ore in Australia, and the price of that ore is significantly higher than that received by any rivals.

Whereas BHP and Rio Tinto are probably receiving a generous $US117 a tonne for their ore which averages 62% iron (and Fortescue Metals is probably receiving $US98/t for its lower grade material), Mount Gibson will be getting around US$140/t, which at the latest exchange rate of US69 cents equates to $A200/t – perhaps an all-time record high.

Followers of the Australian iron ore mining business will be familiar with the story of Koolan Island, developed by BHP in the 1950s, closed, eventually acquired by Mount Gibson, re-opened, and closed again in 2014 when a sea-wall holding back the Indian Ocean collapsed, flooding the main pit which is below sea level.

For Mount Gibson, which was also operating a smaller iron ore mine on the WA mainland, the flood might have been the end of its Koolan Island business, except for two well-structured insurance policies – one which covered the sea wall and another for loss of business in the case of a catastrophe.

Insurance payments, plus ongoing cash from the Iron Hill mine inland from Geraldton, kept Mount Gibson in a strong financial position as it set about reconstructing the sea wall and re-starting the Koolan Island mine, which has a residual reserve of 21 million tonnes of ore grading a best-in-class 65.5% iron.

Shipments from the born-again Koolan Island started two months ago with the aim being to ship 2.1 million tonnes in the first 12 months, rising progressively to more than 5m/t in year four and five, before finishing in year six – a short life and modest tonnes compared with the big mines in the Pilbara.

But – and this is the key to Mount Gibson – Koolan Island iron ore has always attracted a premium price and costs are kept low by the fact that the mine is located close to the ship loader, minimising haulage expense.

And right now, with Brazilian output reduced, Rio Tinto cutting Pilbara exports and Chinese demand the strongest in years, the price of iron ore has rocketed up – and while the jury is out on when normality will return (as it always does) the price could remain elevated for some time.

An example of the cash-generating potential of Koolan Island (and the cash-box nature of Mount Gibson as it harvests earnings in preparation for the next deal) could be found in one of the few investment bank research reports into the stock, from Macquarie Bank.

Last week, Macquarie retained a buy rating on Mount Gibson tipping a price rise from 97c to $1.10, a target reached within day. But also in that analysis was a table which showed how much higher the stock could go under certain iron ore price scenarios with the spot (short-term) price at the time of $US110/t pointing to a theoretical Mount Gibson share price of around $1.85.

No-one ever believes that spot-market prices stay for long, but since that report the iron ore price has risen to $US117/t, which presumably means Mount Gibson could have a theoretical share price of $1.90 to perhaps as high as $2.

That sort of optimistic assessment is not a valid basis for sensible investing. A more appropriate way of looking at the stock is that cash horde of $400 million which equates to a cash backing per Mount Gibson share of around 35c, with the rest made up of Koolan Island earnings and remnant cash flow from the final months of the mainland projects which are shipping out low grade ore to help pay for site rehabilitation.

Over the next 12 months, if the 62% iron ore price stays around $110/t, the island mine could generate free cash flow approaching $US70/t because it’s cash break even on the 62% iron ore price is $US40/t – and it’s producing 65.5% ore which will attract a handsome price premium.

That means the target 2.9m/t in year one of the re-start could generate more than $200 million in cash and with annual production targets rising to as high as 7.4m/t in year four of a five-year campaign it’s easy to see Mount Gibson amassing a cash pile of more than $1 billion, and perhaps double that.

Fascinating as the history of Mount Gibson and Koolan Island is, it is not a stock for cautious investors because the mine has a finite life.

But, for speculators interested in a mining company getting set for its next deal, it is stock with a proven track record of mine operations and a fistful of dollars to do something interesting.